Reckless Credit, Retail Investors and Systemic Risk: Microfinance Meets Bubble Regulation
For several years, microfinance, particularly in developing nations, has been believed to be a
powerful force in alleviating poverty among “the poorest of the poor.”1 Correcting a market failure that
results in the very poor not having access to credit, microfinance promises to “disrupt” the status quo and
transform on a global scale.2 Supporters as diverse as Bono and the Bill and Melinda Gates Foundation
have testified as to the potential of microfinance to assist borrowers in becoming self-sustaining
entrepreneurs. Major nonprofit microfinance institutions (MFIs) such as Grameen Bank, Opportunity
International and FINCA have grown steadily to provide credit services to millions of borrowers. In
addition, many microfinance institutions have begun as for-profit institutions or converted to for-profit
institutions. Some of these institutions have even attracted outside capital in the form of syndicated loans,
debt securities offerings and private equity investments. A smaller number have even held initial public
offerings, such as SKS Finance (India) and Banco Compartamos (Mexico).3 Furthermore, some
institutions have experimented with securitizing microloans. Because of the increased profitability of
such MFIs and the relatively high interest rates they charge their customers, the public has recently begun
to scrutinize the activities of MFIs in developing countries and to question the benefits of microfinance.4
In addition, as the microfinance industry matures, commentators have begun to critique decades-old
claims that increasing access to credit among the poor would make a significant impact not only in the
lives of individuals, but also on whole communities.
The increased attention to the inner workings of microfinance has led to various governmental
responses, such as increased regulation, legal investigations, and even government-supported borrower
defaults.5 In the United States, journalists and scholars have begun to criticize MFIs, analogizing
microfinance to domestic subprime mortgage borrowing and warning of a microfinance “bubble.” The
Business participants in emerging markets use various terms to describe the poor. “Bottom of the Pyramid,” or
BOP, is used to describe the four billion people on the earth that survive on $3000 or less a year. See ELISABETH
RHYNE, MICROFINANCE FOR BANKERS AND INVESTORS: UNDERSTANDING THE OPPORTUNITIES AND CHALLENGES OF
THE MARKET AT THE BOTTOM OF THE PYRAMID (2009). The “poorest of the poor” is often used to describe the one
billion people who exist on no more than $1 a day. An additional billion people exist on more than $1 a day, but
less than $2.
See BEATRIZ ARMENDARIZ & JONATHAN MORDUCH, THE ECONOMICS OF MICROFINANCE (2d ed. 2010 (“For many
observers, microfinance is nothing short of a revolution or a paradigm shift.”).
Robert Cull, Asli Demirguc-Kunt & Jonathan Morduch, Microfinance Meets the Market, 23 J. ECON. PERSP. 167
See Neil MacFarquhar, Banks Making Big Profits From Tiny Loans, N.Y. TIMES, April 13, 2010, at __. (“Drawn
by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now
dominate the field, with some charging interest rates of 100 percent or more.”).
In February 2010, President Daniel Noriega of Nicaragua announced a moratorium on repayments of microfinance
debt, after encouraging a populist campaign of “movimiento no pago” in 2008 after many agricultural borrowers
defaulted on their loans. President Noriega is critical of the MFIs in Nicaragua and the high interest rates that are
charged by them. The moratorium frustrated MFIs seeking to enforce loan agreements and resulted in decreased
microfinance lending in that country. See Nicaragua Microfinance: Micro-Credit Moratorium Threatens
Multilateral Support, EIU VIEWSWIRE, Mar. 26, 2010 at 3, available at 2010 WLNR 6429948.
parallels are fairly clear. In the U.S., government agencies extolled the virtues of homeownership,
emphasizing the many long-term benefits to building wealth through owning a home. To ensure greater
access to this avenue of success, lenders were encouraged to be creative in lending to broader swaths of
the population and quasi-government agencies stood ready to guarantee some home loans and purchase
others, ensuring that lenders had ready access to capital for further home lending. Over time, mortgage
lending was serving customers that had previously been underserved: minority groups, women
borrowers, the self-employed and the cash poor. Large down payments and strict lending criteria were no
longer obstacles to borrowing.
Likewise, microfinance institutions articulated their mission as increasing access to credit to the
very poor in particular developing countries. Governments and global aid agencies embraced
microfinance as a cure for poverty. Reluctant philanthropists rallied to microfinance, which seemed to
embrace both a charitable mission but also capitalist values of self-reliance, hard work and ingenuity.
Self-employed borrowers with no collateral would not be locked out of the world economy merely
because of capital constraints. In addition, in India and South Africa, microfinance was seen as a tool to
empower would-be borrowers historically discriminated against by race or caste. Overcoming obstacles
of scale and geography, MFIs have loaned billions of dollars to millions of borrowers over the past two
decades who were previously untouched by the banking sector. Microfinance products have expanded
from small loans to savings accounts to insurance to cell phones.
However, both widespread mortgage lending and microfinance lending seem to risk similar
negative results. Both subprime mortgage lending and microfinance lending involve comparatively high
interest rates. Expanding borrowing opportunities to the poor may necessarily mean lending to
individuals who are less financially literate and less able to understand the implications of borrowing.
Increasing the leverage of poorer borrowers increases the likelihood of financial catastrophe should any
external shock occur. Furthermore, the increased availability of loans for income-producing investments
(home improvements and small business) may encourage using loans for consumption, which does not
produce a return available to repay the loan. Finally, easy access to credit may lead to overborrowing and
an inability to repay, even without an external shock. Many domestic concerns of predatory lending,
transparency and disclosure are echoed by microfinance critics.
In addition, institutional comparisons may be made between subprime mortgage lending and
microfinance lending. In both cases, regulated and unregulated firms compete against each other for
borrowers. In the case of microfinance, a wide array of firms, from government-owned to nonprofit to
for-profit, compete against each other even though each firm has differing cost structures and social goals.
In both industries, host governments play an important role that may be exacerbate certain risks or create
new political ones. Also, the existence of secondary markets for loans and equity investors may push for
increased profits at the expense of sound lending practices. Finally, though participants may articulate
social goals and emphasize the “double bottom line,” the ability to serve both social and business goals
may create tension.
Finally, both types of borrowing may have an impact on the systemic risk inherent in a particular
economy. The subprime mortgage market became so large, with so many investors taking the same sorts
of investment risks, that when housing prices plummeted, so did the market and large parts of the U.S.
economy. Some commentators have argued that a microfinance disaster may have the same sorts of
ripple effects in an economy, particularly when many borrowers in the same geographical region depend
on microfinance borrowing. Microfinance institutions may be lightly or heavily regulated, resulting in
great variance in prudential soundness. In addition, others have claimed that microfinance institutions
may not be “too big to fail,” but rather too politically important to fail.6
Microfinance, though heavily chronicled in the finance and business literature, has been virtually
ignored in legal scholarship. This vacuum is puzzling given the amount of regulatory activity, albeit
foreign regulatory activity, in this area and the parallels that can be drawn to renewed U.S. regulatory
activity in the related area of consumer finance. This Article will compare the inherent risks in subprime
mortgage lending to microfinance lending and analyze new and proposed regulation in various countries
aimed at curbing microfinance abuses. Furthermore, this article will take up the much-debated question
of whether nonprofit MFIs are better suited than for-profit MFIs to balancing the risks in expanding credit
to low-income populations.
A. Mechanics of Microfinance
The topic of microfinance is now so prevalent in public discourse that a description may not be
necessary. However, the term “microfinance” is generally used to describe the process of offering small
loans, usually less than a few hundred U.S. dollars, to impoverished segments of the population that
would otherwise not have access to credit. Historically, microloans were offered to entrepreneurs
engaging in small businesses in informal economies, primarily in developing countries. In addition, MFIs
focused on offering loans to women, both single women who were heads of household and second
earners. The stereotypical borrower was a woman who used her borrowed capital to purchase a goat,
inventory to be resold, seeds and other inputs to grow vegetables for sale, or equipment and materials
such as a sewing machine or bamboo to produce goods for sale.
For a typical commercial lender, the risks inherent in loaning funds are credit risk and inflation
risk. Lenders generally guard against credit risk by lending to qualified borrowers with steady income
and good credit histories. In addition, lenders will secure riskier loans by requiring collateral.
Microfinance borrowers generally have none of these things, and the regions in which they live do not
have a robust infrastructure of credit bureaus or other databases to be able to quickly ascertain a
borrower’s financial profile. Few microborrowers have collateral, and the existing laws for perfecting
security interests and foreclosing on collateral may be insufficient. However, microlenders have
capitalized on social ties and local customs to create a system that cheaply qualifies and monitors
borrowers. In traditional microfinance, a group lending model, sometimes called the Grameen model,
requires borrowers to form their own lending groups. Each borrower will receive a loan, but each
member of the group will guarantee the loan. Therefore, on repayment dates, the group will be required
to pay a certain amount to the lender, and the entire group will be in default if the payment is short. This
arrangement builds on pre-existing local savings groups and incentivizes the group members to screen
participants and monitor them. Probably because of this model, repayment rates by groups in
Savita Shankar & Mukul G. Asher, Regulating Microfinance: A Suggested Framework, ECONOMIC & POLITICAL
WEEKLY, Vol. 45, No. 1 (2010) (“[i]n a democratic country, politically MFIs may be ‘too sensitive to fail’” because
great numbers of low-income borrowers will be affected).
microfinance are very high.7 In addition, microloans may have very short terms, from one month to one
or two years. This model eliminates inflation risk, but most importantly reduces credit risk by requiring
borrowers to repay small loans in order to ensure future monthly or yearly microloans. Finally, small
repayment amounts are viewed as easier to make than larger, lump payments for cash-poor borrowers.
As will be discussed later, interest rates in microfinance are comparatively high for short-term
loans, and at first glance may shock the casual observer. Stated rates below 30% annualized are
considered low, whereas higher rates may exceed 100%. To a U.S. borrower, these rates seem at worst
usurious or worthy of a loan shark and at best, akin to rates charged by payday lenders or the worst credit
card issuers. Furthermore, if credit risk has been reduced to a negligible amount, then such a high rate
seems unwarranted. However, MFIs explain that the transaction costs of a single microfinance loan are
incredibly high per dollar loaned. Traditional banks achieve economies of scale by loaning large amounts
to single borrowers at the same per-loan cost as other loans, but earning a higher amount in interest and
fees per loan. MFIs do not have this luxury. Furthermore, MFIs must travel to their borrowers in remote
areas, require weekly or monthly repayments that cost more man hours and travel time, and may not be
able to rely on sophisticated technology or information systems in the field to achieve added efficiencies.
Therefore, MFIs must pass these costs on to the borrower. However, exactly what portion of these
interest rates constitute operating costs, capital costs, loss reserves and profit is a subject for further
inquiry. As will be discussed later, the high interest rates charged open the MFIs make microfinance
vulnerable to criticism and regulation.
B. The Goals of Microfinance
Microfinance began as a philanthropic tool operated by nonprofit organizations, most private
nongovernmental organizations (NGOs) and some state-owned financial institutions. The oldest and most
famous NGO is Grameen Bank, which was founded in 1976 by Muhammad Yunus.8 Yunus, a native of
Bangladesh, is an economist who was educated in the United States and worked there during the 1971
revolution that would create the independent state of Bangladesh from what was known as West Pakistan.
Returning to his homeland, Yunus had strong patriotic feelings for the newly formed state and its people.
Teaching rural economics at Chittagong University in an impoverished area, he was drawn to try to use
his training to assist villagers by using microloans. After the founding and flourishing of Grameen Bank,
Yunus supported MFIs in Bangladesh and other countries, sharing knowledge and expertise to help grow
the industry of philanthropic microfinance. In the 1990s, however, some NGOs transformed into for-
profit MFIs,9 and some MFIs were conceived of as for-profit from the beginning.10
Yunus has been very vocal in his contempt for MFIs that earn profits in excess of a “reasonable
return” and therefore reverse the goals of microfinance. In Yunus’ view, MFIs exist to help the poor earn
An interesting area for further research is how common individual default is within groups and what are the
informal penalties that groups exact from defaulting members. Some critics argue that the group lending model
masks true default rates. However, as the credit risk for the MFI is based on the group repayment rate, this criticism
may be weak.
See MUHAMMAD YUNUS, BANKER TO THE POOR (1999).
BancoSol was founded in 1992 as the first for-profit bank focused solely on microfinance, but it was founded by a
microfinance NGO, Prodem.
See VIKRAM AKULA, A FISTFUL OF RICE (2011) (describing how Akula set out to form an experimental, for-profit
MFI in India, though it required initial grant funding).
a return, not to earn a return from the poor. The fact that some nonprofit MFIs have transitioned to for-
profit status with return-seeking investors is evidence that these institutions have abandoned the social
goals of microfinance. Though others believe that microfinance can benefit both clients and investors,
Yunus presents a public face for the theory that microfinance is a philanthropic, not commercial concern.
The mission of philanthropic microfinance has therefore been to improve the lives of borrowers,
perhaps in a way that straight aid cannot. Microfinance pioneers sought to break the culture of
dependency by enabling the poor to invest in themselves and become self-sufficient. Microfinance
attracted donors because of the combination of social goals and recognition of Western values of
capitalism, work ethic and entrepreneurship. Microloans were not handouts, nor were they “free.”
Borrowers paid interest, which encouraged borrowers to self-select and use the capital for return-
generating activities. Though rates were relatively high, many investments open to the poor generated
high, fairly immediate returns: turning bamboo into baskets, purchasing breeding livestock, planting
vegetables, purchasing inventory for a kiosk.
Microfinance was also seen as a way to democratize credit. For example, in India, certain
“scheduled castes” had historically been excluded from certain parts of the economy, and government
actors saw microfinance as a way to further goals of inclusion and opportunity. Similarly, in post-
apartheid South Africa, microfinance was also seen as a way to provide access to capital to a historically
Some MFIs do more than make microloans. The Grameen Bank, for example, generates a feeling
of community by treating each borrower as a “member” and asking members to honor sixteen rules,
which apply to many aspects of personal life. Other MFIs, such as Equity Bank, offer other social
services at no cost or little cost. Some FMIs also provide business training and require attendance at
periodic meetings about various aspects of business and borrowing. Philanthropic microfinance focuses
not just on providing access to credit, but on improving the lives of borrowers through microcredit and
C. The Explosion of Microfinance
From its humble beginnings, microfinance now boasts over 2,420 institutions in 116 countries.11
The United Nations declared 2005 the Year of Microcredit. Prior to the economic crisis of 2008, MFIs
were adding borrowers at a median annual growth rate of 23 percent a year. Not only do MFIs loan
billions of dollars to millions of customers, philanthropic donors and return investors loan money to MFIs
and purchase equity in them. A new type of investment fund, the microfinance investment fund has been
created, and microfinance institutions may constitute a new asset class.
Most interestingly, and most challenging, these thousands of MFIs come in all forms and sizes.
Some are government-owned, while others are private entities. Some are regulated banks, which take
deposits and have reserve requirements, but most are nonbank financial institutions that may encounter
little or no regulation, depending on the jurisdiction. Some are variations, such as credit unions or
cooperatives. And most importantly, some are nonprofit entities and a growing number are for-profit
Microfinance Information Exchange, How Many Borrowers and Microfinance Institutions Exist?, (Dec. 2008)
entities. Finally, of those for-profit entities, a handful are publicly-held corporations focusing solely on
III. The Economics of Microfinance
A. Microfinance Pricing
To most traditional borrowers, the interest rates charged by MFIs seem extremely high. The
Grameen model charges 20% a year, and these rates are seen as the lowest in the industry. These rates are
often compared to the rates charged by Banco Compartamos, which can top 100% after the value-added
tax is added in Mexico. Most other MFI rates are in between these two, and are estimated by CGAP as
having a median of 28%. However, comparing MFI rates to rates charged by commercial banks to
lenders with credit histories and credit scores is not simple.
1. Interest Rates: High Costs or High Profits?
Traditionally, the interest rate charged a borrower should reflect the creditworthiness of the
borrower. The riskier the credit, the higher the interest rate should be. However, MFIs have very little
information about microborrowers, who have no pay stubs, no tax returns, no income statements or bank
accounts. Market theory would suggest that these borrowers would be able to borrow from established
banks, but merely at a higher interest rate. However, market failure, either because no equilibrium is
reached or because of interest rate caps or because of lack of access, occurs and leaves these borrowers
with no access to credit. MFIs step in, but must overcome the information asymmetry problem without
creating adverse selection problems or moral hazard. The group lending model overcomes many of these
problems, as does frequent, periodic repayments, training, meetings, and recurring small loans with short
However, these mechanisms are extremely costly. In addition, microfinance borrowers live in
rural areas, where loan officers must travel often to collect payments and have meetings. In many of
these areas, technological infrastructure is not available for recordkeeping, requiring expensive
documentation by hand. The cost of going “the last mile” is quite high, much higher than costs of
traditional banks with lobbies where borrowers come in to transact business. Finally, fixed costs per loan
are the same for small loans as for large loans, so MFIs that make small loans to thousands of borrowers
may have the same costs as a bank that makes large loans to thousands of borrowers, earning more
In addition, costs of capital may be high for for-profit MFIs. Traditional banks take deposits at
low savings rates, which enables them to lend fund at higher rates. MFIs may have to borrow funds to re-
lend, at higher rates than savings rates paid to depositors.
As the industry matures and MFIs face more and more competition, MFIs will be forced to
become more efficient, and interest rates should decline.12 As more and more infrastructure firms are
emerging that cater to the needs of MFIs, administrative costs should diminish.13
Between 1992 and 2006, Banco Sol’s market share in Mexican microfinance declined from 100% to 23.4%.
During this time, the average interest rates that it charged declined also from over 27% to 22%.
MIS problems in MFIs.
2. Transparency: Simplification or Obfuscation?
Even if a microfinance critic could get comfortable with the high flat interest rates charged by
MFIs, that same critic might be persuaded by those who argue that the rates are much higher than
claimed. First, the borrower is usually quoted a flat interest rate that is charged on the full amount of the
loan over the loan period, even though the loan is being repaid weekly, thus reducing the principal.14 The
interest rate is not calculated on the declining balance. MFIs respond that borrowers understand this
calculation and find it easier to conceptualize a $100 loan that costs $120 after twelve months, paid in
weekly installments, than a $100 loan that will bear interest at a stated amount, calculated on the
declining balance. In addition, many MFIs require borrowers to save part of the principal amount, or a
small amount each week, in a reserve account. If interest is calculated on a $100 loan, but $10 of it is put
into reserve, then the borrower is really only receiving $90 in funds, increasing the practical interest rate.
Critics charge that terms like these can create effective interest rates that are much higher than the stated
3. What is a Reasonable Return?
Microfinance as an industry seems to prompt unique questions regarding the rate of return that
MFIs generate. As the New York Times stated in April 2010, “the overriding question facing the
industry, analysts say, remains how much money investors should make from lending to poor people,
mostly women, often at interest rates that are hidden.” If applied to any other industry in which for-profit
entities participated, this question would seem odd. Regulators, at least in efficient markets, generally do
not look to see whether the amount of return is so much more than the cost to generate that return that we
should somehow regulate against that surplus. For example, in the U.S., regulators generally do not
worry about how much a Gap t-shirt is marked up over its production cost or even whether an acquiring
company is paying too much of a premium for a target corporation. Regulators tend to only get involved
if they believe that firms with monopoly power are extracting monopolistic rents in the form of too-high
prices. In the U.S., regulators tend to look at this ex-ante, as firms are consolidating through mergers and
acquisitions in order to prevent firms from achieving such monopolistic power. Otherwise, regulators
trust that the market will create an equilibrium price over the long term that will generate enough of a
return on investment for firms to remain in the industry at a level that ensures consumer demand.
Therefore, one legitimate reason to ask whether microfinance rates are producing too much profit for
MFIs is to ascertain whether MFIs are indeed extracting monopolistic rents from their borrowing
Grameen’s Yunus has argued that microcredit rates should be between 10 and 15% over the cost
of funds paid by the MFI.16 This interest rate premium, in Yunus’ view, would cover operating costs with
some small margin for profit.17 Under this framework, seventy-five percent of MFIs worldwide are
Aneel Karnani, Microfinance Needs Regulation, STANFORD SOCIAL INNOVATION REVIEW (Winter 2011).
See id. (arguing that a typical Indian MFI loan would have a stated annual interest rate of 17.5% but an effect rate
See MUHAMMAD YUNUS , CREATING A WORLD WITHOUT POVERTY (2008).
As discussed elsewhere in the Article, loan loss reserves are fairly nominal as default rates on microcredit is very
gouging borrowers.18 However, in those MFIs, the additional interest rate is used to cover operating
expenses, not to increase the profit margin. In fact, a greater percentage of nonprofit MFIs fail Yunus’
criteria than for-profit MFIs.19
Microfinance pricing is the Achilles’ heel of microfinance, particularly because the default rate of
microcredit is so law. A U.S. borrower may be able to understand why a subprime mortgage interest rate
would need to be high or a payday loan, given the higher default rates. However, explaining quickly and
succinctly to the public that microfinance rates are high because of higher operating costs is not as
intuitive or simple.
IV. The Microfinance Backlash
Though microfinance was the darling of the development world in the 2000s, the 2010s have
been quite critical of MFIs and their practices. MFIs have not provided a united front to these criticisms.
Perhaps because the industry comprises MFIs that are large, small, nonprofit, for-profit, privately held
and publicly held, MFIs feel free to level their own critiques at each other.20 Grameen’s Yunus, for
example, has been quite public in his criticisms of both Banco Compartamos and SKS Microfinance for
issuing equity shares to the public.21 Supporters of philanthropic microfinance accuse commercial MFIs
of “mission drift,” which causes them to pursue profits at the expense of borrowers. However, this
strategy of framing the true villains of microfinance as commercial MFIs has not insulated Yunus or
Grameen from scrutiny. The government of Bangladesh, which owns ten percent (10%) of Grameen
Bank,22 has began an investigation into Grameen’s practices in January 2011 and fired Yunus as
Managing Director of the bank in March 2011.
A. Microfinance as Predatory Lending
The subprime mortgage crisis in the U.S. renewed an academic and regulatory interest in
preventing predatory lending, the practice of employing aggressive sales tactics to sell loan products to
consumers who may not understand the true costs of those loan products. A typical example would be
that of a mortgage broker convincing a potential borrower either to borrow more than the borrower can
prudently afford; to borrow at an overall cost that is unaffordable for the borrower or higher than market
rates; or both. In the U.S., predatory lending accusations have been leveled at subprime mortgage lending
and at other types of “fringe banking”23 primarily used by the poor: payday lending,24 title lending,25 rent-
See Adrian Gonzalez, Analyzing Microcredit Interest Rates: A Review of the Methodology Proposed by
Mohammad Yunus, MIX DATA BRIEF No. 4 (Feb. 2010).
See id. (noting that the MFIs with the highest interest rate premium had low average loan sizes and very large
See Connie Bruck, Millions for Millions, NEW YORKER, Oct. 30, 2006, at __ (describing the rift between “the
Yunus faction” and commercial lenders and noting “[h]yperbole distorts the debate on both sides”).
See Muhammad Yunus, Sacrificing Microcredit for Megaprofits, N.Y. TIMES, Jan. 14, 2011, at A23 (arguing that
microcredit has “give[n] rise to its own breed of loan sharks”).
Grameen’s website states on one page that the government owns ten percent and the members (almost all
borrowers) own 90%. On a different page, the government is said to own five percent and the members 95%.
Regardless, the government seems to be the largest shareholder. See www.grameen-info.com.
See Jim Hawkins, Regulating on the Fringe: Reexamining the Link Between Fringe Banking and Financial
Distress, IND. L.J. (forthcoming 2011).
Natalie Martin, 1,000% Interest – Good While Supplies Last, 52 ARIZ. L. REV. 563 (2010).
to-own products,26 and even credit cards.27 These types of products generally have higher interest rates
and fees compared to traditional loan products offered by commercial banks to less risky borrowers. In
addition, these products may have more opaque terms so that consumers are less able to understand the
total cost of credit to them.28 Perhaps because consumers overestimate their ability to repay, consumers
may have to borrow again to repay existing loans and find themselves in a state of overindebtedness.
Critics of predatory lending in the U.S. point to abuses that exist even in the presence of existing
federal and state laws regarding Truth-in-Lending, usury, fraud and debt collection. Nevertheless,
consumer borrowers often exhibit irrational behavior that leads to negative individual consequences and
external consequences. Because of a widespread concern that consumers might not understand the
dangers of riskier forms of consumer debt, Section X of the Dodd-Frank Wall Street Reform and
Consumer Protection Act29 creates the Bureau of Consumer Financial Protection. This Bureau is an
executive agency charged with regulating the offering and provision of consumer financial products and
services. In addition to collecting information, collecting complaints and conducting research, the Bureau
will also promulgate rules interpreting the various existing federal consumer financial laws.
Given recent attention to concerns that some segment of the U.S. population may be at a
disadvantage in accessing consumer credit because of lack of financial literacy, transparency and
regulation of sharp lending practices, the extension of these concerns to global microfinance seems clear.
Though access to credit may be of great benefit to all, the extension of credit at high interest rates to
populations with very little or no education and a low literacy rate necessarily raises concerns. As long as
microfinance loans were being repaid, concerns about pricing and transparency were muted. However,
following economic downturns, when borrowers had more difficulty repaying, accusations of predatory
lending have surfaced, forcing MFIs to defend their pricing models.
B. Poverty Alleviation Skepticism
Measuring either the individual-level or community-level effects of microfinance is difficult and
so far no clear picture on long-term effects of microfinance has emerged.30 At first blush, one would
think that comparing microfinance borrowers to nonborrowers in the community would yield a difference.
However, microfinance borrowers are to some extent self-selected, leading to sample bias.31 And,
because MFIs choose some villages over others in which to start a branch, comparing communities with
See Todd Zywicki, Consumer Use & Government Regulation of Title Pledge Lending, 22 LOY. CONSUMER L.
REV. 425 (2010).
See Jim Hawkins, Renting the Good Life, 49 WM. & MARY L. REV. 2041 (2008).
See Angela Littwin, Testing the Substitution Hypothesis: Would Credit Card Regulations Force Low-Income
Borrowers into Less Desirable Lending Alternatives?, 2009 U. ILL. L. REV. 403 (2009).
See Oren Bar-Gill & Elizabeth Warren, Making Credit Safer, 157 U. PA. L. REV. 1 (2008) (describing various
mistaken assumptions that consumer borrowers make when applying for and using various types of credit).
Dodd-Frank Wall Street Reform And Consumer Protection Act, Pub. L. No. 111- 203, 124 Stat. 1376 (2010).
Abhijit Banerjee, et al., The Miracle of Microfinance? Evidence From a Randomized Evaluation, (“Thus, there is
so far no consensus among academics on the impact of microcredit.”).
This problem is similar to the problem in comparing the effect of charter schools or private schools with selective
admissions over other similarly-situated schools. Applicants necessarily place a greater value on education than
nonapplicants and have incentives to work hard in school. Successful applicants may necessarily have a greater
chance at school success than unsuccessful applicants. Studies comparing successful applicants to unsuccessful
applicants in schools with admissions lotteries have found little long-term effects from school admission, further
confirming the theory of selection bias in comparing outcomes.
microfinance branches to those without is also problematic. Second, any measured effects will be
ambiguous as to whether they reflect increased welfare. For example, increased consumer spending could
be “good” because microborrowers have generated increased income through investment in businesses or
could be “bad” because microborrowers are using microloans for consumption. Likewise decreased
consumer spending could be “good” because microlending has given the female head of the household
more power, resulting in more “patient” discretionary spending or “bad” because overborrowing has
caused more cash to be used toward debt service. Unfortunately, there is no measure of optimal
discretionary spending for all households. And, although microfinance may spur the creation of new
businesses, there is also no measure of the optimal measure of new businesses or a way to distinguish
between the creation of businesses with good potential and those without. Therefore, the question of how
and what to measure is also complicated by the inability to interpret what is being measured.
So far, regardless of how impacts are measured and what impacts are measured, any empirical
evidence that microfinance has alleviated poverty or increased the standard of living on a community
level is slight at best.32 Even individual-level evidence of welfare improvement is small.33 Given the
large saturation of microfinance in some areas, these results are surprising.34 Most of the pro-
microfinance stories are simply narratives, anecdotes from successful microborrowers. These stories are
inspiring accounts of the benefits of microcredit in the individual lives of microentrepreneurs. However,
these anecdotes are now being juxtaposed against narratives of overindebted microborrowers, including
those who commit suicide. Given that microborrowers number in the millions, neither set of anecdotes
provide much evidence of either the positive or negative side of microborrowing. However, the negative
anecdotes seem to be more prevalent recently.
C. Political Forces
The anti-microfinance soundbite of 2011 came from the Prime Minister of Bangladesh, Sheikh
Hasina Wazed, who at the end of 2010 announced that microfinance was “sucking blood from the poor in
the name of poverty alleviation.”35 However, many believe that the Prime Minister’s criticism, and
actions against Muhammad Yunus, are politically motivated.36 If the attacks on Yunus are politically
motivated, this would not be the first time that politicians have stirred public ire against MFIs for political
advantage. In March 2006, the chief minister of the state of Andhra Pradesh, India, shut down sixty MFI
See Steve Beck & Tim Ogden, Beware of Bad Microcredit, HARV. BUS. REV., Sept. 2007, at __ (noting that in
Bangladesh, 25% of households received microcredit, yet Bangladesh as a country had not increased its overall
See id. (“[l]ittle evidence exists that microcredit borrowers, on average, commonly, directly, and quickly escape
poverty, as many assume.”).
By comparison, loans guaranteed by the Small Business Administration in the U.S. may be considered one variety
of microfinance loans. Studies have shown that SBA loans have a very small impact on communities. See Ben R.
Craig, William E. Jackson III and James B. Thomson, SBA-Loan Guarantees and Local Economic Growth, Federal
Reserve Bank of Cleveland Working Paper No. 05-03 (YEAR). However, these loans are very uncommon,
representing approximately one percent (1%) of small business loans made each year. See Veronique de Rugy, the
SBA’s Justification IOU: Does Small Business Need Government Loan Guarantees?, REGULATION, Spring 2007, at
26 (noting that “[t]he SBA’s 7(a) loan guarantees serve only a tiny fraction of the nation’s small businesses”).
See Vikas Bajaj, Microlenders, Honored with Nobel, Are Struggling, N.Y. TIMES, Jan. 5, 2011, at B3
Yunus and the Prime Minister do not have cordial relations, stemming from Yunus’ 2007 attempt to form an
opposing political party.
branches and told borrowers not to repay loans received from MFIs.37 Following news reports, now
questioned for their accuracy,38 that a leading MFI had harassed a borrower’s grown children, causing
them to commit suicide, Chief Minister Yeduguri Sanderiti Rajasekhara Reddy39 formed a working group
that declared private MFIs to be unethical predatory lenders and prescribed a 13% interest rate cap.
However, the roots of the controversy may have been that the MFIs were competing against government
banks lending to self-help groups (SHGs). Eventually, the Reserve Bank of India lifted the restrictions
and ordered borrowers to commence payments.
Elsewhere, in Latin America, leaders have also been known to seek populist support by criticizing
MFIs. In Nicaragua, “Movimiento No Pago” is a movement begun by high-profile debtors to protest
against the MFIs, a movement that may be supported by President Daniel Ortega. This movement
encourages borrowers not to repay and asks the government to declare a moratorium on MFI repayments.
This movement is ongoing and possibly nurtured by President Ortega’s anti-capitalist stance. Even in
Bolivia, the “crown jewel” of microfinance in South America, an explosion of MFIs and undisciplined
lending in the early 2000s was met with governmental encouragement of default.40 In countries with a
culture of loan forgiveness, MFIs may experience a change in popularity during tough economic times.
D. Existing Regulation of Microfinance
One of the ways that a microfinance backlash may be felt is in changes to regulation of
microfinance. When microfinance is welcomed by a government, or seen as an important part of
development, then MFIs may benefit from either no regulation or exemptions from regulation. However,
following a crisis or a perceived crisis, critics may call for regulation. The most popular forms of
proposed regulation are restrictions on interest rates.
V. Financing Microfinance
Knowing how each type of MFI is financed gives insight into how MFIs might operate and
whether MFIs will effectively be able to monitor the “double bottom line.” To survive, an MFI must at
the very least be sustainable in a sense that its operating costs and loan loss reserves are covered by
revenues.41 To be operationally self-sufficient, an MFIs revenues must also cover the financial expense,
or cost of raising capital.42 For nonprofit MFIs, capital costs of philanthropic donations and government
grants may be zero. The MFI does not pay back these infusions with or without a return. In addition,
nonprofit MFIs may have access to very low-rate loans from government-owned financial institutions or
other entities. For-profit MFIs, however, will have substantially higher capital costs, which will require
See V. Kasturi Rangan & Katharine Lee, Who Killed Bhavani Manjula? – A Story of Microfinance in Andhra
Pradesh, HBS CASE STUDY 9-508-021 (July 13, 2010) (probing one anecdotal example of Indian microfinance
suicide in Andhra Pradesh, the “mecca of microfinance”).
See id. (reporting that the borrower’s family had been harassed by a private moneylender and had borrowed and
repaid much smaller loan amounts from the MFI).
Minister Reddy was elected in 2004, following the pro-business Chief Minister Nara Chandrababu Naidu, who
had embraced microfinance during his 1995-2004 term.
Irina Aliaga & Paul Mosley, Microfinance Under Crisis Conditions: The Case of Bolivia, in WHAT’S WRONG
WITH MICROFINANCE? 120, 134 (Thomas Dichter & Malcolm Harper, eds. 2007).
This measure is the “operational self-sufficiency ratio.” See Armendariz & Morduch, supra note __, at 243.
See id. at 244.
them to either reduce operating expenses or increase revenues in order to be as financially self-sufficient
as a nonprofit MFI.43
In the microfinance industry, the terms “nonprofit” and “for-profit” are not precisely apt. The
activities of each type of MFI are similar, if not sometimes indistinguishable. Both types of entities make
generally the same kinds of microloans to the same kinds of borrowers with the same kinds of terms:
unsecured loans with small principal amounts at comparatively high rates of interest to underserved poor
populations. Each kind of MFI claims to run “at a profit,” implying that they generate loan revenue that
exceeds the total cost of each loan. In the U.S., we identify and distinguish these types by investigating
how each entity was organized under state law and whether the entity made a particular type of tax-
exempt election under federal law. Globally, however, these entities are more varied and may transform
from one category to the other. Furthermore, they compete in the same markets.
What distinguishes the nonprofit MFI (NPMFI) and the for-profit MFI (FPMFI) are their sources
of capital. Nonprofit MFIs receive funds to use in its lending activities from non-return investors: public
or private investors making philanthropic (often tax-deductible) donations and governmental entities.
For-profit MFIs, however, must attract capital from traditional return investors who receive either debt
securities or equity securities. This difference in finance structures may lead to operational advantages or
A. Philanthropic Microfinance
Because of the traditional goals of microfinance, poverty alleviation and increasing individual
welfare, early MFIs were generally nonprofit. NPMFIs remain the most numerous type of MFI. To
ensure that funds are available for lending, NPMFIs are dependent on public and private donors for
capital. However, the nature of this funding means that the NPMFI has low capital costs, either in the
form of zero-cost charitable donations of low-cost below-market funding from private or governmental
organizations. However, because of banking regulations, most philanthropic MFIs may not be able to
accept deposits, which is one significant way to fund lending activities at low cost.
The biggest advantage of nonreturn or low-return capital is that it is cheap. However,
philanthropic funding may not always be easy to find for an MFI that relies on this kind of capital.44 As
philanthropic trends change, or as the economy ebbs and flows, donor funds may fluctuate.
B. Commercial Microfinance
Commercial MFIs must get their capital from debt, equity or deposits. In addition, MFIs that
have transformed from NPMFIs may have retained donor capital. The majority of funding comes from
debt. Much of this is commercial borrowing from banks, and some of these loans are guaranteed by
microfinance networks such as ACCION International and some philanthropic institutions. The potential
The OSS ratio can be amended to take into account the “market” rate of capital for a nonprofit. See id. at 244
(“FSS takes into account additional adjustments to operating revenues and expenses that model how well the
microfinance institution could cover its costs of its operations were unsubsidized and if it were funding its expansion
with liabilities at “market” prices.”). However, many researchers assume market rates that may be lower than would
Grameen Bank reports that it has not required donor funds, or accepted donor funds, since 1998. One goal of a
philanthropic MFI would be to gain operational self-sufficiency where all loan revenues cover costs.
for large, syndicated loans is beginning to be realized.45 In addition, a growing amount is from the private
debt markets. Large MFIs have been issuing bonds since 2002, which more recent issues being for longer
terms at lower rates.
In the U.S., many blame the 2008 housing crisis, and resulting economic crisis, on the
securitization of residential mortgages, particularly subprime mortgages, and exotic investment vehicles
such as collateralized debt obligations (CDOs). Some MFIs have experimented with securitizing
microloans, which would give MFIs more access to capital. Investors interested in microfinance have
also had opportunities to purchase CDOs that pool loans from a number of MFIs in various countries,
arranged by household names such as Morgan Stanley and Merrill Lynch. These investment products
hold the promise of creating investment opportunities that are less risky than investing in just one MFI in
one country. However, both of these types of structured finance have been very limited and have only
been successful with governmental support, which allowed for high credit ratings.
The last frontier for the FPMFI may be the initial public offering,46 but many commercial MFIs
are benefitting from funding from private equity. Of course, these two trends grow in tandem as the
potential for an IPO attracts private equity.47 By 2007, the MIX listed 91 private Microfinance
Investment Vehicles (MIVs) with $5.4 billion in assets.48 Some of these are funds that accept multiple
investors,49 but others are arms of institutions and foundations.50 Of those, most were funds that solely
invested in debt securities, but some invested in equity. Rhyne reported in 2010 that 25 equity MIVs
belonged to the Council of Microfinance Equity Funds and that some funds of funds specializing in MIVs
had emerged. Several large players in the investment industry have made commitments to microfinance.
TIAA-CREF invests in ProCredit Holding, the parent of several MFIs, and Sequoia Capital, working
through Sequoia Capital India, invested in SKS Microfinance.51
C. Hybrid Investors
Microfinance, even commercial microfinance, attracts “socially responsible investors,” both
individual investors, socially responsible investment funds, and nonprofit foundations, in addition to
traditional return investors. Because of this interesting intersection of demand, interesting and creative
ways to fund microfinance have emerged, including crowdsourcing. Kiva is one such website whereby
nonreturn investors can “invest” in microborrowers52 in very small increments, attracting the retail
philanthro-capitalist. Kiva investors expect to receive their principal back, with no return, but are
Mibanco, an MFI in Peru was able to successfully place a syndicated loan through Wachovia and the IFC in 2007.
To date, six MFIs have had public offerings: Capitec Bank (South Africa); Bank Rakyat Indonesia (Indonesia);
Equity Bank (Kenya); Banco Compartamos (Mexico); Financiera Independencia (Mexico); and SKS Microfinance
Prior to the public offerings of SKS Microfinance, Compartamos Banco and Equity Bank, most equity was pricing
at basically book value because of illiquidity. See Rhyne, supra note __, at 87.
Armendariz & Murdoch, supra note __, at 255-56.
BlueOrchard, Procredit Holding AG, Oikocredit
Grameen Fund, Omidyar-Tufts Fund
Upon the SKS Microfinance IPO, Sequoia’s investment realized a 13X return.
Kiva investors are actually providing capital for various local funds, which finance microloans to borrowers. See,
Christine Hurt, Is Kiva a Private Equity Fund, Conglomerate, available at
encouraged to reinvest. However, Kiva investors are not granted a tax deduction under U.S. law.53
Another model is the one pioneered by Acumen Fund, which makes debt and equity investments in
entrepreneurs in developing countries, but describes this as “patient capital,” more focused on the social
benefits of these investments.
VI. Avoiding a Microfinance Bubble
If this Article were a horror novel, then that novel would describe a development in microfinance
whereby FPMFI would increasingly go public, securitize microloans, outsource microloan origination and
receive governmental support to meet increasing benchmarks as to number of microborrowers.
Microborrowers would be encouraged to take out new microloans to repay existing microloans and to use
microloans for consumption. In addition, the investment industry would create CDOs and derivatives
based on microloan and CDO performance. Host governments would lightly regulate and take a hands-
off approach to consumer protection. In this model, the past predicts that FPMFIs would increasingly
make riskier and larger loans to consumers who would use the funds not for return-generating purposes
but for consumption. Armed with capital from securitizations, FPMFIs would continue to relax lending
standards to reach more and more borrowers, possibly raising interest rates in fairly obscure ways, with
mortgage originators earning commissions from each new borrower. At some point, liquidity would end,
either because of some external shock or investor taste, and overindebted borrowers would not be able to
refinance their debt. Investors, who may not have truly understood the risks of the microloans underlying
their securities would face loss of their investments should borrowers default. Faced with so many
defaulting microborrowers, governments would have to choose to either “bail out” the MFIs, who in
many cases are branches of foreign MFIs or part of global MFI networks, or the microborrowers, who
have no safety net. As we have seen already, some governments may side with populist sentiment over
1. Microfinance in Crisis: South Africa and Bolivia
Some countries have already experienced rapid growth in MFIs, followed by a perceived increase
in overindebtedness. In both Bolivia and South Africa, the number of MFIs grew rapidly. In Bolivia,
external shocks to the country’s economy in 1999 and 2000 threatened the perhaps bloated consumer
finance industry.54 In 1999, new regulations caused many MFIs to exit the industry there. In addition,
borrowers, particularly those in lending groups, defaulted.
South Africa has also already faced what was perceived as a crisis in microfinance. In response,
the National Credit Act of 2005 was enacted, which affected microfinance in two important ways. First,
the Act repealed the exemption from usury laws that microlenders had enjoyed since the 1990s. The Act
now prohibits “development credit” at an interest rate higher than that allowed by law, which fluctuates
with the South Africa Reserve Bank Repurchase Rate.55 In addition, the Act prohibits extending credit to
See Sarah Lawsky, Money for Nothing: Charitable Deductions for Microfinance Lenders, 61 SMU L. REV. 1525
See Robert E. Kennedy, Banco Solidario: The Business of Microfinance, HBS CASE STUDIES, 9-702-019 (Jan. 19,
As of March 24, 2011, the reserve rate was 5.5%, making the maximum interest rate allowed under a development
credit agreement 32.1%.
anyone who is “overindebted” or who would be overindebted after the extension of credit. The borrower
would then be able to rescind the agreement if the lender had extended “reckless credit.”
Neither of these crises seems to have destroyed the microfinance industry or otherwise
exacerbated widespread systemic risk in the financial industry. However, during these crises, widespread
equity participation in MFIs was nonexistent, and few of the characteristics of the housing bubble were
present aside from increased overindebtedness by consumers. What concerns scholars and regulators
about the U.S. financial crisis was the widespread participation in the subprime mortgage market, and to
date the microfinance industry has not seen widespread participation by financial institutions or private
2. Regulating Against a Bubble
Observers of the U.S. housing crisis might attempt to export regulatory solutions to the global
microfinance market in an attempt to prevent such a crisis. Some examples might be tighter consumer
finance regulations, such as Truth-in-Lending regulations or interest rate caps. Exemptions to regulations
for microcredit might be reformed to be dependent on microcredit for business purposes, not
consumption. However, the U.S. had these laws in place, so it may be that increased regulation of
borrowers, even in the form of protection, may not be helpful.
However, regulation of MFIs may be helpful. Normally, prudential regulation of financial
institutions seems more compelling if these institutions take deposits. However, soundness of lending
institutions, particularly MFIs may be just as compelling. Microfinance borrowers are much less likely to
default if they need to depend on future borrowing. If the soundness of an MFI is in question, the defaults
may rise. In addition, regulation of nonbank financial institutions may lead to more disclosure of
individual firms’ risk profiles. Regulations to ensure that microcredit is loaned to qualifying borrowers
may ensure against individual mortgage originators’ incentives to increase lending without worrying
about the soundness of these lending decisions.
Finally, investors may need additional protection to ensure sound decision-making at the end of
the chain that provides the capital. Private equity investors face a landscape of MFI investment
opportunities that are hard to compare due to little agreement on transparency and information disclosure.
As MFIs choose to become publicly-held, regulatory banks, these concerns may diminish. However, as
the Kiva revelations have shown, as retail investors enter the market, the need for more transparency in
the industry increases.
VII. Conclusion: Microfinance for the Future
Unlike many international banks, MFIs seem to have weathered the financial crisis and are ready
to continue the growth that has marked the past two decades. Many challenges and opportunities lay
ahead for an industry in which government-owned and private firms, some nonprofit and some for-profit,
compete against one another. While private investors may see a new asset class with great potential for
return, other social investors see opportunities to harness economic forces for social good. Against a
patchwork of existing regulation that has differing effects on the various MFIs, legal scholars may find a
fruitful field of inquiry in searching for how best law can help the microfinance industry grow while
protecting borrowers, industry participants, and both return investors and social investors.