developmental impact and coexistence of sustainable and charitable microfinance institutions:...

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Developmental Impact and Coexistence of Sustainableand Charitable Microfinance Institutions: AnalysingBancoSol and Grameen BankJESSICA SCHICKS aa Jessica Schicks, MPhil (Cantab.), Dipl. Oec., University of Witten/Herdecke, DinxperloerStr. 217, 46399, Bocholt, Germany E-mail:Published online: 06 Nov 2007.

To cite this article: JESSICA SCHICKS (2007): Developmental Impact and Coexistence of Sustainable and CharitableMicrofinance Institutions: Analysing BancoSol and Grameen Bank, The European Journal of Development Research, 19:4,551-568

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Developmental Impact and Coexistenceof Sustainable and Charitable Microfinance

Institutions: Analysing BancoSol andGrameen Bank

JESSICA SCHICKS

Based on the current discussion of the development of a commercial market

segment of Microfinance Institutions (MFIs), this paper evaluates the

developmental impact of charitable MFIs that rely on subsidies in

comparison with sustainable MFIs that operate independently from grant

funding. BancoSol from Bolivia serves as a case study of a sustainable

MFI. Grameen Bank from Bangladesh represents a charitable MFI. The

case studies confirm both the theoretical arguments for sustainable MFIs

promoted by the institutionist approach to microfinance and the arguments

for charitable MFIs advocated by the welfarist approach. The paper argues

that both kinds of MFIs are justified and should continue to coexist. The

second part of the paper suggests institutional solutions to facilitate the

coexistence of both types of MFIs.

Cet article repose sur le debat actuel portant sur le developpement d’un

segment de marche commercial des institutions de microfinances (IMF). Il

evalue les impacts respectifs sur le developpement des IMF qui dependent

de subventions et de celles qui en sont independantes. La Bancosol de

Bolivie represente un exemple d’IMF durable (sustainable MFI) et la

Grameen bank du Bangladesh un exemple d’IMF caritative (charitable

MFI). Les etudes de cas confirment a la fois les arguments theoriques, sur les

IMF durables appuyes par l’approche ‘institutionniste’ et les arguments sur

les IMF caritatives appuyes par l’approche en termes d’Etat providence.

L’article justifie les deux types d’IMF et la necessite de leur coexistence. La

seconde partie de l’article suggere des solutions institutionnelles destinees

a faciliter la coexistence de ces deux types d’IMF.

THE ‘SUSTAINABILITY DEBATE’ ABOUT MICROFINANCE INSTITUTIONS

A Microfinance Institution (MFI) is an organisation that provides small amounts of

credit and potentially other small-scale financial services to clients without access to

The European Journal of Development Research, Vol.19, No.4, December 2007, pp.551–568ISSN 0957-8811 print/ISSN 1743-9728 online

DOI: 10.1080/09578810701667573 q 2007 European Association of Development Research and Training Institutes

Jessica Schicks, MPhil (Cantab.), Dipl. Oec. University of Witten/Herdecke, Dinxperloer Str. 217, 46399Bocholt, Germany. Email: [email protected]

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the formal banking system. These customers are poor and cannot offer standard

collateral. Administrative costs are high in relation to the size of the transaction. In

reaching these underserved clients, MFIs help alleviate poverty,1 support investment

in business opportunities and contribute to the development of a country’s financial

system (Morduch, 2000).

The term ‘Microfinance Institutions’ includes a range of different organisations.

A crucial difference exists between MFIs that work primarily as charities, focused

on a developmental purpose and those that focus on recovering their costs.

Two Types of MFIs

When the concept of microfinance came to international attention, MFIs were

mainly non-governmental organisations (NGOs). Their primary sources of funding

were international donors, private benefactors and governments. They did not aim at

a monetary return but concentrated on creating social benefits. The well-known MFI

Grameen Bank of Bangladesh was founded on that basis and initially received

significant grant funding. Although it has since evolved, it serves as a case study in

the next section to illustrate the characteristics of charitable MFIs. Today, many

MFIs try to combine a social impact with financial goals, but a focus on

developmental effects normally implies continued reliance on donor funds. MFIs

that focus primarily on their social goals are henceforth called ‘charitable MFIs’.

Over time, the non-governmental MFIs found that poor clients hardly reduce

their demand when interest rates rise. Consequently, MFIs can generate more funds

for re-lending and cost-recovery than was previously considered possible. First,

MFIs found it possible to reach operational sustainability, the ability to cover

operational and administrative costs from revenues. Later, some even attained

financial sustainability, the ability to operate without donor funds and cover

commercial costs of capital. They recover their costs or even achieve a positive

return on investment. They receive their funds from private capital markets. They

might not be able to act socially where that reduces financial soundness, but they are

independent from donors.

As a result, many MFIs that were founded as charities but manage to become

independent from grants transform into licensed financial intermediaries or even

fully regulated banks.2 Since independence from subsidies raises the prospect for an

institution to sustain itself in the long run, this paper uses the terms ‘financial

sustainability’ or simply ‘sustainability’. Cost-recovering or profitable MFIs that

focus on financial performance more than on social impact are called ‘sustainable

MFIs’. BancoSol is an example of an MFI that managed to become self-sufficient.

Section 1 presents its case study, illustrating the characteristics of sustainable

microfinance institutions.

The tendency towards sustainable microfinance raises questions about the

sector’s aims and directions for future development. One controversy is whether

primarily socially-oriented charitable MFIs are needed or whether sustainable MFIs

can produce higher developmental benefits. Rhyne (1998) contends that a

combination of both profits and developmental impact is possible, while Paxton and

Fruman (1997) rather find a correlation between poverty outreach and subsidy

THE E URO PEA N J OU RNAL OF DEVELO PMEN T RESEARCH552

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dependence and emphasise that a variety of methodologies is needed for the

different market niches of microfinance. Depending on the underlying assumptions

about poor agents’ behaviour and their utility functions, nearly every strength or

weakness can be attributed to either charitable or sustainable MFIs. For example,

assuming a low sensitivity of credit demand to interest rates emphasises the

importance of subsidies to reach the poorest microfinance clients. In contrast, the

currently prevailing view that the credit demand of the poor is not price-sensitive

rather supports the view that sustainability is a reasonable aim for MFIs (Aghion and

Morduch, 2005). Despite discussion of the issue in almost every current

microfinance conference and its prominent role in the UN’s International Year of

Microcredit 2005, the sector remains divided between the proponents of charitable

and sustainable MFIs.

This paper looks at the case studies of BancoSol and Grameen Bank to argue that

sustainable MFIs as well as charitable MFIs both have developmental virtues that

justify their continuation. It suggests that institutional settings should be developed

that allow for a socially beneficial coexistence of both types of MFIs – an issue that

has so far been neglected in the microfinance literature. The first section analyses the

case studies to demonstrate the differences between sustainable and charitable MFIs.

The second section examines the coexistence of charitable MFIs with their

sustainable counterparts to propose institutions that enable their fruitful cooperation.

The final part summarises the paper’s conclusions and points out questions for

further research.

THE CASE STUDIES OF BANCOSOL AND GRAMEEN BANK

This section presents the case studies of BancoSol, one of the most successful

sustainable MFIs, and of Grameen Bank, the most popular charitable MFI. It focuses

on their financial situation and their outreach to the poor. It then analyses the

implication of the case studies for the sustainability debate. The case studies outline

how the commercial and the charitable approaches are both valuable models for

microfinance.

The Case Study of BancoSol: An Example of a Sustainable MFI

Bolivia’s Banco Solidario SA, also called BancoSol, is the first NGO that turned into

a deposit-taking bank (Mosley, 1996). This section describes its origins and

examines the size, sustainability and outreach to the poor it has achieved.

In 1986, the US-based NGO ACCION International, in cooperation with local

entrepreneurs, founded the Bolivian NGO Promocion y Desarollo de la Micro-

empresa (PRODEM). From the beginning, PRODEM focused on active micro

entrepreneurs as its main target group rather than the poorest. The main reason for its

foundation was to promote the expansion of the sector; hence its primary mission was

to achieve growth. However, it depended on donor funds and its outreach was limited

by its NGO status. Consequently, in January 1992 PRODEM transferred its staff and

its US$4.7 million loan portfolio to a newly founded private commercial bank for

microenterprises: Banco Solidario. While PRODEM received an 18 per cent share in

AN ALYSIN G BA NCOSOL A ND GRAMEEN BAN K 553

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the new bank’s equity, Bolivian institutions and private investors, Calmeadow

Foundation and ACCION International held the rest (Robinson, 2001). The purpose

of the transfer was to allow the bank to mobilise savings as a regulated institution and

to attract private investors by its profit orientation. The aims of working sustainably

and helping the poor were closely entwined. BancoSol pursues an ‘altruistic mission

through a profit-maximising strategy’ (Gonzalez-Vega et al. 1996: 4).3

Today, BancoSol has become a key force in the Bolivian banking system,

serving about 40 per cent of all borrowers (Morduch, 1999a). Over the years, it has

reached over one million microenterprises and disbursed more than US$1,000

million in loans. The current loan portfolio amounts to more than US$100 million

disbursed to about 74,000 clients. The MFI has a network of 37 branches and is

present in six Bolivian cities (BancoSol, 2005).

Despite its outstanding success, BancoSol is not privately profitable in the way of

providing a competitive return on investment (Schreiner, 2003). Still, it is one of the

few MFIs that attained first operational and then even financial sustainability. Its

operations are fully independent from subsidies. According to a study by the United

States Agency for International Development (USAID), BancoSol was already self-

sufficient in 1993, less than two years after its foundation (Christen et al., 1995). In

1995, BancoSol’s risk-weighted capital adequacy was 17 per cent, higher than the

requirement of the Basel Accord (Ledgerwood, 1998). In 1996, the bank received

funding from the private capital market by issuing a US$5 million bond (Aghion and

Morduch, 2005). In 1997, the Wall Street Journal (1997) reported that BancoSol paid

its first dividend (as cited in Schreiner, 1997: 24). In 1998, the bank attracted 74 per

cent of its funding from private capital markets (Robinson, 2001). For that year,

Morduch computes returns on equity of nearly 30 per cent (Morduch, 1999a).

According to Chu (1998), BancoSol was Bolivia’s most solvent bank and had the

highest-quality portfolio in Bolivia (cited in Robinson, 2001).

These estimates are based on reliable figures by MFI standards. BancoSol uses

conventional accounting standards. It is not exempt from paying taxes or fulfilling

legal reserve requirements (Schreiner, 1997). It never received grants to cover

operating expenses (Gonzalez-Vega et al., 1996). While some of BancoSol’s

activities are still kept in PRODEM and thus subsidised (Mosley, 1996), this is not

central to its operations.

Regarding its outreach to clients, BancoSol reaches many individuals, but not the

poorest, implying that its sustainability involves some trade-off with depth of

outreach. From its PRODEM origins on, reaching particularly poor clients

regardless of financial consequences was not the primary goal. Furthermore, since

the creation of BancoSol, the bank has operated in an increasingly competitive

environment and reacted by moving upmarket (Fernando, 2004). The average

income of a BancoSol borrower in 1992 was $360 (Hulme and Mosley, 1996).

Eighty per cent of these borrowers were only just above or below the poverty line, 15

per cent significantly above it, and only 5 per cent significantly below it. The share

of the poorest in BancoSol’s clientele is lower than their share of the Bolivian

population (Navajas et al., 2000). Morduch calls BancoSol’s borrowers ‘the richest

of the poor in Bolivia’ (1999a: 1576).


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The focus on the less poor is partly caused by BancoSol operating in urban

areas. Moreover, clients must have run their business for at least one year before

applying for a BancoSol loan (Gonzalez-Vega et al., 1996). Starting at US$100 and

averaging US$900, loans are bigger than for example at Grameen Bank. With 45–

48 per cent nominal interest (about 43 per cent in real terms) plus 2.5 per cent

commission upfront for loans in Bolivianos, or 24–30 per cent a year with 1 per

cent commission for loans in US dollars, BancoSol’s loans are expensive

(Morduch, 1999a). Initially, market-based interest rates were as high as 60 per cent

(Mosley, 1996).

BancoSol’s clients might not be the poorest but with an average loan size of

hardly more than half the Bolivian GDP per capita, depth of outreach is still better

than in many other MFIs. Most of the clientele of BancoSol would never have a

chance of access to finance via the traditional banking system. One-third of the

borrowers has undergone less than three years of education, many of them none at all

(Gonzalez-Vega et al., 1996). After all, a sustainable MFI with a small share of very

poor borrowers but a large total of clients might reach higher absolute numbers of

very poor borrowers than small charitable MFIs (Rosenberg, 1996).

BancoSol supplies funds to the poor and performs well. ‘BancoSol has matched

each discounted use of a public dollar for a year with more than two discounted

dollar-years of debt lent to the poor. This has increased with time’ (Schreiner,

2003: 12). As an answer to rising competition in the Bolivian market for

microfinance and a difficult macroeconomic situation,4 BancoSol has introduced

several new products. For example, it now offers individual loans (i.e. not group

loans), micro home loans, life insurance, debit cards and ATMs. It keeps operating

at the forefront of innovations.

The Case Study of Grameen Bank: An Example of a Charitable MFI

Grameen Bank, often simply called Grameen, is the world’s best known charitable

MFI. This section briefly describes its foundation and analyses its present size,

sustainability and outreach to the poor.

In 1974, the economics professor Muhammad Yunus initiated a field trip with his

students to a poor village in today’s Bangladesh.5 When Yunus realised to what

extent many poor people depended on the expensive credit of informal

moneylenders, he started lending small sums of his own money to the poor.

These microloans proved able to allow the poor to raise themselves out of poverty by

means of their own production. Against the objections of commercial banks and the

Bangladeshi government, Yunus continuously extended his project, calling it

‘Grameen’, which means ‘rural’ or ‘village’ in Bangla language. Over time he

gained the support of the Agricultural Bank and the Central Bank of Bangladesh.

In October 1983, the Grameen Project was transformed into a bank by act of

government legislation. Initially owned by the government, Grameen Bank is today

owned 90 per cent by the rural poor whom it serves (Grameen Bank, 2005). The

mission of the new bank was strongly development-oriented with a focus on the

poorest of the poor (Yunus and Jolis, 1998).6


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Over the years Grameen Bank has disbursed a total of more than US$5 billion.

Today it reaches 5.44 million borrowers. In November 2005 the disbursement for

that year was estimated at US$547 million. The MFI had 1,700 branches working

with 58,806 villages (Grameen Bank, 2005). Although BancoSol is already famous

for the breadth of its outreach, these figures show that Grameen Bank is significantly

larger than BancoSol.

In the beginning, Grameen did not think of financially sustainable operations.

The MFI was founded as a charity starting with Muhammad Yunus’ personal funds.

From its foundation, Grameen Bank was supported mainly by the Central Bank and

International Fund for Agricultural Development (IFAD). Over the years, donors

from industrial countries, the Ford Foundation and commercial banks have also

provided funds (Khandker et al., 1995: 89).

Regarding Grameen’s present sustainability, opinions are divided. Grameen

Bank itself claims to have reached sustainability. The decision to become free of

donor funds was made in 1995 when the last request for donor funds was issued.

Grameen felt it would be increasingly able to raise funds from the commercial

market and its own business. It wanted to improve its access to the capital market.

Additionally, it did not want to be dependent on the policy prescriptions of donors

(Yunus and Jolis, 1998). Grameen aims at funding its loans entirely from deposits

one day. According to the bank’s balance sheets, Grameen has run a profit in nearly

every year since its start of operations (Grameen Bank, 2005).

Independent research points out that Grameen’s self-assessment is too optimistic

(Hashemi and Schuler, 1997; Morduch, 1999a; 1999b; Schreiner, 2003). Grameen

might be reported profitable, and dependence on donor funds has definitely

decreased. Nevertheless, Grameen still receives considerable indirect support that is

used, for example, for head office activities like training, monitoring and evaluation.

The profit on the balance sheet is partly due to a lack of transparency. Grameen Bank

does not always follow conventional accounting standards. For example, it calculates

overdues using loans overdue for longer than a year and dividing by the current

portfolio. Normally, even one partial repayment overdue for a single day should be

counted as overdue. Also, it is not the current portfolio that should be used in the

calculation, but the smaller portfolio at the time the overdue loans were made. This

would significantly increase overdue rates. Grameen Bank’s profits are further

exaggerated by inadequate loan loss provisioning (Morduch, 1999a). Its high

repayment rates are only attained with a specific method of calculation that results in

better repayment rates when the amount of loans disbursed grows (Morduch, 1999b).

Recognising the bank’s subsidies is difficult because subsidies can appear on the

balance sheet in various forms. They can be equity grants such as public paid-in

capital. These increase the MFI’s worth. Other subsidies such as grants accounted

for as revenue, discounts on soft debt or costs absorbed by donors are profit grants.

They artificially inflate an MFI’s accounting profits (Schreiner, 2003). Most

subsidies for Grameen Bank come in the form of soft loans. The bank pays a

negative average real interest rate on its borrowed capital (Morduch, 1999a). Often

local banks buy Grameen’s bonds at favourable interest rates (Morduch, 1999b).

Additionally, Grameen Bank is exempt from income taxes and business profit tax.


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Estimates that take all subsidies and accounting methods into consideration

point out that Grameen Bank is not fully sustainable – let alone privately profitable

(Hashemi and Schuler, 1997; Schreiner, 2003). A calculation by Morduch with

the bank’s cost structure of 1999 shows that only with an interest rate of at least

32 per cent could Grameen have been sustainable (Morduch, 1999a). Although not

extremely high by MFI standards, this rate would risk weakening social impact

(Khandker, 1998).

The above findings might prove Grameen wrong in claiming financial

sustainability, but this is no problem for the MFI: even if it was never financially

self-sustainable it is a viable organisation. There is no reason to suppose that donor

funds will cease to flow for Grameen Bank. Should a withdrawal of donors ever

make it necessary, raising interest rates could allow for self-sustainability

(Schreiner, 1997). Furthermore, despite the current situation of unattained self-

sustainability, Grameen has access to the capital market. Issuing bonds to

Bangladeshi commercial banks, for example, raised US$160.75 million in 1994/95

(Yunus and Jolis, 1998). This proves that sustainability is not a necessary

requirement for raising private funds. It supports Morduch’s argument that a hard

budget constraint and a social orientation are sufficient to attract certain investors.

This charitable MFI’s long-term existence is secured, and Grameen has achieved

significant growth.

Grameen Bank is also successful in terms of developmental impact. As a

charitable MFI, it is primarily concerned about its benefits to the poor. It

measures its success in terms of improving the lives of its borrowers, not in terms

of repayment rates. It offers relatively low interest, usually around 20 per cent,

which is about 15–16 per cent in real terms (Morduch, 1999a). Without thinking

of its profits or creating returns, Grameen provides aid in humanitarian disasters

(Yunus and Jolis, 1998). Every year it provides scholarships to schoolchildren

(Grameen Bank, 2005). In 2003, the charitable MFI established a ‘Struggling

(Beggar) Members Programme’, allowing beggars access to insurance and

savings services and providing identity badges and guarantees for credit lines

with local shops. There are no fixed repayments, no collateral is needed and

necessities like mosquito nets are provided as interest free loans. At the end of

2007, about 97,000 participants had joined the Struggling Members Programme

(ibid.).

In 2002, under the name ‘Grameen II’, Grameen Bank improved flexibility of its

products to enhance its benefits for the poor. Prompted by a flood that made it

impossible for many Grameen borrowers to repay their loans within schedule,7

Grameen II represents a reform of the bank’s lending policies. It allows for more

flexible repayment schedules, a larger variety of loan sizes, extended saving

opportunities and the mobilisation of deposits from the public (Rutherford, 2005).

The introduction of Grameen II made borrowing even more attractive for many

clients, attracted new borrowers, and won old clients back (Hossain, 2005).

It augments Grameen Bank’s positive developmental impact even further.

Table 1 provides an overview of the main features of BancoSol and Grameen

Bank as revealed in the case studies.


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Analyses of the Case Studies in Light of the Sustainability Debate

This section briefly summarises the theoretical debate about sustainable and

charitable MFIs. It then evaluates the significance of the case studies for the

sustainability debate. In the microfinance literature, the main argument for

sustainability is that it allows for the attraction of private capital and broad outreach

to the poor (Rhyne, 1998). Figure 1 gives an estimate of the relation of private funds

and donor funds to the needs of potential microfinance clients: It is impossible to

reach all those in need of microfinance with the means that donors provide. With the

current extent of the microfinance sector, merely 18 per cent of the world’s poorest

living on less than one dollar a day are catered for (Meehan, 2005). Conversely, if

enough sustainable MFIs managed to mobilise private funds in capital markets, the

capital restraint of microfinance would vanish and all those in need and able to

benefit from microfinance could be served.

Additionally, sustainable MFIs do not inflict the cost of subsidisation on the

international community and are more reliable in the long term than those

dependent on donors. The influence of market forces on sustainable MFIs is

claimed to be conducive to innovation and cost reduction (Dunford, 2000). This

line of argumentation is called the institutionist approach or financial systems

approach to microfinance. It is primarily followed by leading organisations like

The World Bank, the Consultative Group to Assist the Poor (CGAP), and USAID

(Conning, 1999).

TABLE 1

A COMPARISON OF BANCOSOL AND GRAMEEN BANK

BancoSol Grameen Bank

Type of MFI Sustainable CharitableMain aims To use profitable high quality

financial services to improvethe future of Bolivians withlow income

To use financial services to promoteself-employment for the poor toraise themselves out of poverty

Foundation In 1986, NGO that aimed atcost-covering interest rates;institutionalisation as aprivate commercial bank in 1992

In 1974, small charitable project;institutionalisation as a bankin 1983

Donor funds Initial support by businesses aswell as charities, but never receiveddonor funds for operating expenses.Self-sufficient since 1993

Initially dependent on donor fund. Nonew funds requested since 1995 butcontinues to receive hidden subsidies(e.g. low cost capital)

Private funds Receives funds from private investorssince the mid 1990s

Receives funds from the capitalmarket since the mid 1990s

Breadth of outreach Accumulated total of over 1 millionmicroenterprises. Currently overUS$100 million outstandingwith 74,000 clients, 37 branches

Accumulated total of over 2 millionclients. In 2005 US$547 milliondisbursed to 5.44 million borrowers,1,700 branches

Depth of outreach The richest of the poor butstill in need of microfinance

The very poor

Area of operation Urban Bolivia Rural Bangladesh


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The main argument in favour of charitable MFIs is that they can reach less

profitable and therefore poorer clients (ibid.). They do not need to turn down

unprofitable customers. The extent to which sustainability and depth of outreach

exclude each other is subject to intense discussion. Paxton and Fruman (1997) find

a negative correlation, but no proof that a combination of sustainability with deep

outreach is impossible. Estimates indicate that charitable MFIs have a clientele

with an average income of 50 per cent of the poverty line. The clients served by

sustainable MFIs earn about 90 per cent of the poverty line (Morduch, 2000).

Furthermore, since charitable MFIs can focus on developmental impact without

facing trade-offs between financial and developmental aims, this can even make

them the more innovative institutions (Otero, 2005): free from market pressures,

they can take risks that are only worthwhile in terms developmental effect, not in

terms of money. If charitable MFIs beat the developmental impact of sustainable

institutions, their subsidies can be justified by the higher social benefit (Morduch,

2000). This view is called the poverty approach or welfarist approach to

microfinance (Conning, 1999).

The case study of BancoSol represents an MFI that always strived for

sustainability. Although not privately profitable, the bank can operate independently

of donors and get its funding on the capital market. In line with the literature

promoting sustainability, this has allowed for rapid expansion of the MFI in terms of

breadth of outreach. As a private bank, the MFI has reached a significant size.

However, as the welfarist approach predicts, BancoSol’s broad outreach has come at

some cost concerning the depth of outreach. The MFI only operates in urban areas

with rather well-off clients. A shift to poorer rural clients would probably not be

feasible without major institutional changes or a loss of sustainability. Nonetheless,

the clients of BancoSol are too poor to have access to the traditional banking system

and need microfinance. There is enough social orientation for BancoSol to have a

positive developmental impact. The case of BancoSol provides strong support for

FIGURE 1

THE RELATION OF PRIVATE FUNDS AND DONOR FUNDS TO THE NEEDS OF POTENTIAL

MICROFINANCE CLIENTS


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the institutionalist approach. It proves that sustainability is feasible for an MFI and

that it can be combined with large-scale developmental impact.

The case study of Grameen Bank represents an MFI that has always been run

under charitable goals. It only later adopted the additional goal of aiming at

sustainability, which remains subordinate to developmental impact. Due to this

focus on the poor, Grameen has not achieved full financial sustainability. However it

operates with tight budget constraints and is viably funded by donors as well as the

private capital market. Contrary to the reasoning of the institutionalist approach,

Grameen Bank’s charitable attitude has not prevented growth. It confirms the

welfarist approach, however, achieving a high level of outreach to the poorest. The

MFI mainly operates in rural Bangladesh and targets relatively poor clients with few

business opportunities. It even offers its services to beggars and finances charitable

activities that do not create financial returns. Also, in line with the arguments for

charitable MFIs, the bank’s new programmes and lending policy reforms show how

a charitable MFI can be innovative and provide tailored services for the poor. The

case of Grameen Bank offers strong support for the welfarist approach. It proves that

charitable MFIs can provide significant developmental benefits to the poorest of the

poor without being prevented from growing and raising funds from commercial

investors. It emphasises the social value of subsidies for charitable MFIs.

While the examples of BancoSol and Grameen Bank present very different types

of MFIs, they both represent extremely positive examples. BancoSol and Grameen

belong to the most successful MFIs in the world, both in terms of their financial

situation and their developmental impact. However, the case studies are not pure

examples of sustainable and charitable MFIs. BancoSol still receives indirect

subsidies through PRODEM, even if this is not crucial for its operations. Grameen

Bank calls sustainability its goal and even claims success on that matter, and

receives private funding from capital markets. It would best be described as a

‘viable’ MFI – one that is still slightly subsidised but can be confident of a

sustainable flow of funds and could even adjust its cost structure to reach financial

sustainability if necessary. Both case studies thus show that the separation into

charitable and sustainable MFIs is rather artificial, providing a useful tool for

research but representing an abstraction from a large continuum of institutional

types in reality. However, the case studies illustrate that both sustainable and

charitable MFIs have certain strengths to offer to the poor. If BancoSol manages to

operate sustainably, causes no costs to the international community and benefits the

poor, this merits support. Sustainability represents the only solution for building a

large scale microfinance industry and ultimately an inclusive financial sector that

serves clients from all levels of income. If Grameen relies on subsidies to some

extent but creates a correspondingly high developmental benefit for its particularly

poor clients, this merits continued provision of donor funds.

THE COEXISTENCE OF SUSTAINABLE MFIs AND CHARITABLE MFIs

The previous section showed that sustainable MFIs and charitable MFIs each offer

benefits the other cannot provide. As there is an argument for the existence of both


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profit-oriented and subsidised MFIs, it needs to be examined if there are problems

with them existing in parallel, and which institutional settings would be appropriate

for a favourable coexistence. This section first looks at the impact of subsidised

institutions on sustainable MFIs. It then analyses the influence of financially

sustainable MFIs on their grant-dependent counterparts with a stronger social focus.

Finally, the section examines mutual effects of both types on each other.

Effects of Charitable MFIs on Their Sustainable Counterparts: Problems

and Potential Remedies

Subsidies can enable charitable MFIs to offer better loan conditions with lower

interest rates. For those MFIs trying to operate in a cost-covering way, that makes it

difficult to attract clients in a competitive market. By taking away clients of

sustainable MFIs, microloans financed with development grants reduce the chances

for a sustainable microfinance business and the larger outreach it promises.

Competition with subsidised MFIs can force sustainable market participants to

lower their interest rates until their business is no longer viable, thus squeezing

profitable organisations out of the market (Aghion and Morduch, 2005).

Additionally, too much grant funding can even prevent a sustainable MFI sector

from even emerging in a local microfinance market. If the best clients are already

served by subsidised MFIs, there is little incentive for entrepreneurs to found non-

grant-dependent institutions (McIntosh and Wydick, 2005).

To minimise these negative impacts of subsidies, donors need to link future

funds for charitable MFIs to good performance, and to maintain hard budget

constraints (Aghion and Morduch, 2005). If subsidies are granted, they need to be

well-targeted: ‘Lenders with non-targeted subsidies can always drive any

unsubsidised competitor out of the market altogether, whereas targeted subsidies

can never eliminate a competitor from the market’ (McIntosh and Wydick, 2005:

285). Aghion and Morduch (2005) propose three concepts of ‘smart subsidies’:

1) Subsidies that only subsidise the institution, not the customer. They cover only

start-up costs or technical assistance for public goods like evaluation and data

collection. Similar to the infant industry argument, the subsidies need to be

withdrawn as soon as possible. 2) Short-term subsidies that only target the start-up

costs of the businesses of the very poorest clients. 3) Long-term subsidies of small

scale financial services so that they can be provided at the same cost as larger loans

or deposits but not cheaper.

The targeting of funds can also be improved by not broadly subsidising

charitable MFIs but rewarding success in areas that justify subsidies. The United

Nations Capital Development Fund proposes time-bound incentive-based contracts

for subsidies that channel MFI activities towards particularly beneficial operations,

(UNCDF, 2006)). Additionally, if charitable MFIs merit subsidies, for example for

being more innovative, targeted subsidies should not sponsor all charitable MFIs

alike. Instead they could create innovation awards and reward the winners with

‘subsidy prizes’. Charitable MFIs that are to be rewarded for reaching the poorest

clients, like Grameen Bank, can receive grants in accordance to the share of people


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from different levels of poverty in the clientele of an MFI. Or different amounts

would be attributed per client below certain levels of poverty.

Figure 2 illustrates how clients could be served by different institutions

according to their poverty levels and be subsidised correspondingly. P1 represents a

low level of poverty, just on the threshold of access to the commercial financial

system. Anybody in an equivalent or better financial position will be provided

financial services by standard commercial banks. Poorer people at poverty levels

between P1 and P2 lack the required collateral and sustainable income flows and are

rejected by the traditional commercial banking system. They need to be served by

MFIs specialised in poor clients and correspondingly small amounts of credit and

savings. However, they are able to cover the costs of their microcredit and do not

need to be subsidised. They can therefore be served by sustainable MFIs. Any person

poorer than P2 needs subsidisation. They can benefit from microfinance but are too

poor to cover the artificially high administrative costs. They will therefore need to be

served with subsidies from donors or with cross-subsidisation between richer and

poorer customers. Depending on the level of detail for the targeting of subsidies,

further poverty levels such as P3 and P4 can be distinguished within the customers of

charitable MFIs. For example, the poorer borrowers are, the higher could be the

share of the loan costs that is covered by small, medium or high subsidies. The

arrows in Figure 2 indicate improving circumstances of borrowers and savers who

can move up in the system.

In addition, donors need to ensure that no more subsidies are given than

necessary. The subsidies should only cover additional costs and not be an incentive

for sustainable MFIs to try to attract grants. Also, grant funding should be provided

for MFIs only where the demand for financial services cannot be covered by

sustainable MFIs. Donors should refrain from supporting charitable MFIs where

others can provide the same developmental gains. In a dynamic approach, donors

should also give sustainable MFIs the chance to enter a market or expand.

FIGURE 2

SERVING AND SUBSIDISING CLIENTS ACCORDING TO POVERTY LEVELS


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Committing to the withdrawal of subsidies should new unsubsidised institutions

want to enter can facilitate this; the charitable MFIs that get their funds withdrawn

could cooperate with or be overtaken by the new entrants. Continuity for their clients

should be ensured. Regular re-examinations should verify if justification for

subsidies still exists. Official guidelines and external monitoring could ensure that

development agencies cannot extend their involvement for longer than necessary.

Triodos Bank, one of the leading ethical banks in Europe, pursues a similar strategy.

It aims at being able to withdraw its funds as soon as possible and being replaced in

its investments by local commercial funding (van Golstein Brouwers, 2005).

Eventually, if subsidies are well-targeted and restricted to reasonable levels, the

existence of subsidised programmes should not be an incentive problem for

financially sustainable MFIs. After all, sustainability has other advantages for MFIs,

such as increased organisational freedom, access to private capital and enhanced job

security in the MFI because funding will not dry up. BancoSol, for example, would

not want to go back to subsidy dependence. Sustainable and charitable MFIs should

be complementary rather than competitive for either clients or subsidies.

Effects of Sustainable MFIs on their Charitable Counterparts: Problems

and Potential Remedies

Sustainable MFIs mainly work with those poor who are somewhat better off.

Charitable MFIs therefore complain that profit-oriented institutions take away their

best clients, leaving them with those who are poorest and most expensive to cater for

(The Economist, 2005). This reduces the ability of charitable MFIs to cross-

subsidise between accounts for stronger and weaker clients. The possibilities for

cross-subsidisation are also reduced by increasing competition in the microfinance

market, a profitable sector attracting increasing competition (Morduch, 1999b). As

there is no reason to protect inefficient projects just because of their social goal,

competition is generally desirable. However, by reducing the capacity of socially-

oriented MFIs to cross-subsidise between better off and poorer clients, competition

of MFIs can cause harm to the borrowers (McIntosh and Wydick, 2005).

Furthermore, the existence of sustainable MFIs exerts pressure on many charitable

MFIs. Many donors advocate sustainability as a goal for all MFIs and threaten those

that do not comply with a withdrawal of funds (ibid.).

Regarding measures against these problems, in fact, targeted subsidies according

to poverty levels as proposed above would render cross-subsidisation unnecessary.

It would give charitable MFIs the possibility to serve those too poor to pay all

administrative costs for their accounts and cover the MFIs’ costs of capital without

using those customers that are only slightly less poor to sponsor the poorer ones. As a

side benefit, this makes the cost of serving the poorest more clearly distinguishable

than under cross-subsidisation, so that better informed funding decisions can be made.

Regarding the pressure on charitable MFIs to become sustainable, donors should

evaluate objectively: when charitable MFIs deliver developmental impact that

justifies subsidies, there should be no requirement to become sustainable.8 However,

institutions whose clients are mature, need larger loans and deposit accounts and are


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able to pay higher interest rates can move up with the improving conditions of their

clients and grow out of subsidies.

Eventually, sustainable financial organisations should engage in microfinance,

accelerate its growth and enhance its impact. Nevertheless, this should not put

pressure on the missions of charitable MFIs (Meehan, 2005).

Mutual Effects between MFIs

The coexistence of sustainable and charitable MFIs will generally lead to a higher

number of organisations in the market. Profits attract more sustainable MFIs.

Subsidies allow for more MFIs to exist than would be profitable. In a nearly

saturated market, clients can misuse the higher number of competitors for double

borrowing. This weakens repayment rates (McIntosh et al., 2005). It creates

problems for both charitable and sustainable MFIs and can lead to a rise in

on-lending interest rates.

This problem should be met by an appropriate institutional design. The existence

of both sustainable and charitable MFIs should not lead to higher numbers of MFIs

competing for the same clients – subsidies should never allow the number of MFIs

to exceed market saturation. Strictly reserving subsidies for the lowest poverty

levels should preclude subsidised loans being given to clients that already receive

loans from sustainable MFIs.

Furthermore, there should be cooperation and information-sharing between all

MFIs operating in the same geographic market. Innovations for knowledge-sharing

about a client’s overall indebtedness are necessary. This could be provided by

problem-tailored IT systems and compatible client databases. Their common social

goals and the immediate financial gains from such a cooperation should motivate

MFIs to provide the necessary information. With these innovations in place,

competition is beneficial for borrowers because MFIs gain in repayments and can

lower interest rates (ibid.).

Overall, there is scope for fruitful cooperation between charitable and

sustainable MFIs. On the one hand, charitable MFIs often have in-depth knowledge

of local markets and the needs of the poor. If traditional banks want to move

downmarket, MFIs can support the downscaling process and create partnerships

with commercial banks to help them successfully manage the transition into the MFI

business. They can equally use their expertise to assist the foundation of new

sustainable MFIs. On the other hand, according to Morduch (2000), charitable MFIs

can benefit from cooperating with licensed banks to overcome the problem that in

most regulatory systems only commercial banks are allowed to hold savings. The

strategic partnership of CASHPOR, an MFI focusing on India’s rural poor, with

India’s largest private bank, ICICI Bank, represents an encouraging example of

cooperation between the different financial institutions. The MFI provides

specialised knowledge of the financial markets for the poor. The commercial bank

provides capital. This raises CASHPOR’s breadth of outreach and facilitates

conversion into a profit-making MFI while it enables ICICI Bank to develop the

rural segment of customers it previously lacked the infrastructure for (Meehan,

2005). ICICI Bank further explores partnerships with MFIs. It offers initial loans for


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MFIs to work as intermediaries between ICICI Bank and microfinance clients and

later incorporates them as viable units of the bank (UNCDF, 2006). While

cooperation has yet to spread throughout the microfinance sector, practitioners at the

Microfinance Conference 2005 in Germany have also recognised the importance of

partnerships between MFIs and mainstream banks (KfW Entwicklungsbank, 2005).

SUMMARY AND CONCLUSION

This paper has analysed the case studies of BancoSol, a sustainable MFI and

Grameen Bank, a charitable MFI. BancoSol exemplifies an MFI that achieved

financial sustainability soon after its foundation. It rapidly expanded its client base,

even if this meant focusing on less poor, urban clients. BancoSol illustrates that an

MFI can operate sustainably and have significant developmental impact. Grameen

Bank provides an example of a charitable MFI. Its operations are dominated by

social goals that financial sustainability remains subordinate to. It has not achieved

cost-covering operations but is able to attract private capital and reach larger

numbers of clients than many sustainable MFIs. Putting depth of outreach over

cost-recovery, Grameen serves the poorest rural clients and even beggars. Grameen

Bank demonstrates the potential social benefits of charitable MFIs that justify their

existence and subsidisation.

The case studies largely confirm the main arguments of both the institutionalist

and the welfarist approach to microfinance. Sustainable MFIs offer advantages in

being costless to the donor community, while expanding to reach large numbers of

those desperately in need of financial services. Sustainability is the only way to

‘transform microfinance from a successful, but small, cottage industry to a

powerhouse able to lift hundreds of millions of people out of poverty’ (Zingales,

2005). The main merits of charitable MFIs are their unconditional focus on

development and the depth of their outreach to the poorest of the poor. From a long-

term perspective, ideally, there should be no need for charity, the ultimate idea being

that everyone can be equally served by an inclusive financial sector which incor-

porates microfinance methodologies as a solution to the problem of serving the poor.

In the short term in contrast, as long as the market failure that microfinance addresses

still exists, charitable MFIs offer the only way to cater for those who are too poor to be

served by sustainable MFIs. They are needed in parallel to sustainable institutions.

Where sustainable and charitable MFIs coexist, they can harm each other,

hampering the achievement of developmental goals. Charitable MFIs can squeeze

out or deter sustainable institutions by lowering interest rates on their loans with

subsidies. Well-targeted subsidies and their restriction to the necessary level for

serving clients in different degrees of poverty counter these risks. Sustainable MFIs,

on the other hand, can hinder charitable institutions from cross-subsidising between

richer and poorer clients and push them towards grant independence. However,

targeted subsidies for charitable MFIs with clients too poor for sustainable

operations should provide the necessary support so that cross-subsidisation is not

necessary; and charitable MFIs should not be required to attain sustainability as long

as their developmental impact warrants subsidisation. When the coexistence of both


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types of MFIs risks increasing default rates and raising interest rates, the institutional

setting should reduce double borrowing. The controlled use of subsidisation and the

introduction of institutions for information sharing between MFIs can avoid

overindebtedness and oversubsidisation of clients. Well-designed institutional

settings can guarantee a favourable coexistence of different types of MFIs. Their

cooperation can even be mutually beneficial and enhance the overall developmental

impact of microfinance.

Much discussion is still needed on the sustainability debate. Further research is

required into the underlying assumptions of the institutionalist and the welfarist

approaches, examining inter alia the interest sensitivity of credit demand by the poor

and the social effects of high interest rates. Additionally, the spatial dimension of

microfinance demands investigation: The rural–urban divide has become apparent

from the two case studies, BancoSol focusing on urban and Grameen Bank on rural

areas. This dimension has not yet been sufficiently explored in microfinance theory.

So far, the institutional settings for favourable coexistence of different types of

MFIs have scarcely been examined at all. This might partly be the case because the

insight that both types should continue to coexist has to come first. Research should

develop appropriate institutional mechanisms and propose institutional structures

for comprehensive monitoring and evaluation in the microfinance sector. To divide

clients into groups for targeted subsidies, measurements of poverty levels and

possibilities of cost–benefit analyses for subsidies need to be further investigated.

Eventually, the divide between different types of MFIs should not be

overestimated. In reality a continuum of types of MFIs exists, where each institution

needs to choose its balance between commercial and charitable approaches. While

their focus on social or financial performance differs, all types of sustainable and

charitable MFIs share the common goal of serving the poor. This paper hopes to

inspire a constructive discussion of the value of subsidies and the development of

solutions that will ultimately benefit the poor clients of microfinance.

N O T E S

1. Some authors argue that microfinance is based on a neoliberal approach to poverty, interpreting it as amere lack of unfulfilled market potential. They claim that microfinance hardly addresses the realcauses of poverty, i.e. broader socio-economic issues such as the societal relations of power anddomination (see for example Milgram, 2006 and Weber, 2006).

2. While these are examples of upscaling, the existence of financially sustainable NGO MFIs has equallycreated a new interest of for-profit organisations in the microfinance business. In recent times,commercial banks like Citigroup have recognised the value of so-called ‘bottom of the pyramid’strategies. Besides improving their image with benevolence, they see serving the poor as aninvestment in access to new, ultimately lucrative markets (The Economist, 2005). Driven by similarmotives, local commercial banks sometimes enter the microfinance business if they lose theircorporate clients to bigger international banks. Both are examples of downscaling – banks goingdownmarket (Otero, 2005).

3. For information on BancoSol’s lending concept and details of its loans see Fitchett (1997) andMorduch (1999a).

4. For details of the crisis that competition with providers of consumer credit caused, leading to a loss ofclients and lower financial performance of BancoSol as well as overindebtedness of its clients, see forexample Aghion and Morduch (2005: 127).


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5. Details on Yunus and the foundation of Grameen Bank can be found in Yunus and Jolis (1998).6. Morduch (1999a) provides information on Grameen’s group loan concept and repayment schedules.7. Also see Aghion and Morduch (2005: 128) for Grameen’s repayment crisis in the 1990s due to

competition and ‘overlapping’ of clients.8. Morduch (1999a) and Aghion and Morduch (2005) analyse the need, procedure and incentive

problems of cost–benefit analyses for grant funding in microfinance. The Yaron Subsidy DependenceIndex helps estimate how much higher an MFI’s interest rates would need to be without subsidies(Yaron, 1992) and estimate the consequences for developmental impact.

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developmental impact and coexistence of sustainable and charitable microfinance institutions:...

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