michael chu fsf2011
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School Copyright President & Fellows of Harvard College.
Michael ChuHarvard Business School
MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESSFinancieros sin Fronteras IE Business School, 22 February 2011
Microfinance: Today and Tomorrow
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Microfinance
1. Financial services for the base of the socioeconomic pyramid (BoP)
Traditionally: working capital loans & savings Today: All (incl. housing, remittances, insurance)
2. BoP: 4.0 billion of worlds 6.4 billion people
Individuals earning ~$3,000 or less a year
1Billion
1.4Billion
1.2 Billion
1.6 Billion
1.2 Billion
Base of the
Pyramid
Microfinance
Sweet Spot:
C, D, E+
Approx. 3.25 Billion
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Why does Microfinance Matter?
POVERTYLACK
OFINCOME
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Majority of Worlds Income is Earned in the Informal Sector
POVERTY
INFORMAL SECTOR Income of
>70% of EconomicallyActive Population of the
World(OIT, 2002)
INCOME
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Financing the Informal Sector
POVERTY
INFORMAL SECTOR= Income of
>70% of EconomicallyActive Population of the
World(OIT, 2002)
INCOME$
MONEYLENDER
LAST LINKDISTRIBUTION
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Microfinance: A Response to Traditional Sources of Funds
POVERTY
INFORMAL SECTOR= Income of
>70% of EconomicalLyActive Population of the
World(OIT, 2002)
MICROFINANCE
INCOME
STRETCHESINCOME
EXPANDSINCOME
INCREASESINCOME
MONEYLENDER
LAST LINKDISTRIBUTION
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Economic Fate & Citizen Empowerment are Linked
POVERTY
INFORMAL SECTOR= Income of
>70% of EconomicalLyActive Population of the
World(OIT, 2002)
MICROFINANCE
INCOME
BASIS FORCIVIC
RIGHTS
STRETCHESINCOME
EXPANDSINCOME
INCREASESINCOME
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POVERTY
SIGNIFICANTIMPACT
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
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Higher Income: Access to the Key Drivers of Better Futures
ADDITIONALINCOME
MICROFINANCE
STRETCHES
INCOME
EXPANDSINCOME
INCREASESINCOME
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Microfinance Today: Part of the Financial Sector
1. 2000 2010: IPOs - Publicly-traded shares in stock exchanges
Strong microfinance component 2003: BRI Indonesia 2006: Equity Bank Kenya
Pure microfinance
2007: Compartamos Banco Mexico 2010: SKS India
2. Industry Scale:
3. Mainstream:
$1 billion overhang in funds raised to invest in microfinance
Institution No. Clients (000) Loan s ($MM)
BancoSol 146 $ 435
Mibanco 581 $1,306
Compartamos 1,900 $ 750
Grameen 8,300 $ 956
SKS 7,700 $ 980
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Yet Microfinance Penetration is Just Beginning
1. Families Reached: Approx. 150 MM Active Clients - Credit
Loan portfolio: Approx. $45 billion to $60 billion
2. Just the basic product: Working Capital loans
Savings lagging Other financial products & services just beginning
3. Just the easiest to reach clients
Remote rural areas lagging
4. Total Market Basic WK Loans : Approx. 545 MM families - $272 billion
Est. C, D, E+ segments: 3.25 bilion, @ 4/family = 813 MM families Assume 2/3 are potential credit clients: 545 MM families Assume potential: $500/loan
5. Basic WK Loan Penetration:
No. of Active Clients: < 28% Portfolio Volume: < 20%
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Of the 150 MM Active Clients, 130 MM are served by less than 90 MFIs
By and large, they are commercial, regulated financial institutions
Leading MFIsRegulated Efficient Self-Sustaining High Returns
Most profitable Most Solvent
High Growth
Capital Markets
Financial
Investors
Corporations
Public
National Banking/
Financial Authorities
Market: Base of the PyramidLarge: significant volume Growth segment Sustainable asset quality
Financial Instruments
Deposits
FinancialServices
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Multitude of MFIs, but Industry defined by Leaders
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Today: Rapid Change Continues Unabated
Major M/F markets: All key factors behind success of incumbents are in flux:
1. Heightened Competition
Conventional banks are entering the market- Peru: 44 of 55 institutions regulated by Bank Superintendency are in M/F
New players from non-banking origins- BoP retail chains, with consumer finance base
Developed microfinance ecosystem- M/F expertise and infrastructure becoming readily available
Globalization: National boundaries no longer barriers- Global players & international expansion of MFI leaders
2. Technology Front office: e.g: non-bank branches, mobile payment systems Back office: redefinition of scale beyond local markets, new methodologies
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The Promise of the Future
1. Competition & Technology: Together, finally solving the M/Fs paradox:
Financial Svces at very ToP and at BoP share same approach: High Touch Banking
2. Going from todays 150 MM clients to tomorrows 500 MM:
From a high-cost to a low-cost operating platform, while preserving asset quality Expanding the reach of the front office while concentrating processing to maximize
economies of scale of the back office
3. Tomorrow: Models that disrupt todays microfinance establishment
Just as todays models disrupted yesterdays traditional banking
4. Holy grail: from high touch to no touch
Radical reduction in costs Quantum leap in pricing and coverage
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The Threat of the Future
1. Todays high visibility of microfinance: High Numbers Reached
1st & 2ndDecades: NGOs, development donors, philanthropy: do-gooders 3rd Decade (1990-2000): M/F banks under bank regulation: credible numbers 4th Decade (2000-2010): Finally, numbers that make M/F relevant in national development
2. High numbers are essentially the result of commercial microfinance Large, commercial institutions deriving profit from serving low-income populations:
Combustible political mix Government oversight is unavoidable
- Debate unlikely to be restricted to financial sector regulatory circles
3. Regulatory oversight of Microfinance: Essential
Markets without regulations: The Jungle Positive regulation: M/F thrives to the benefit of all parties, especially the clients Negative regulation: Can push M/F back to 1st and 2nd Decades
4. How serious is the threat?
Compartamos Banco (Mexico) SKS (India)
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Microfinance: The case of Compartamos Banco
1. 1990: Initiative of a social NGO
Initial operations in Chiapas & Oaxaca (rural)
2. 2000: SOFOL Compartamos
Single purpose regulated finance company:microfinance
Partners: Compartamos NGO, ACCION, Profund,private Mexican investors
3. 2002: First bond issue
4. 2006: Bank: full-banking license
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Microcredit loans to rural population 93% of loans
1. Group loans to rural women From 12 up to 50 women Served by Compartamos Promoters (loan
officers) 3 training sessions before disbursement
2. Self-administration
Members indicate amount to borrow &save/week
Elect leadership of group
3. Weekly meetings with Compartamos
Group treasurer collects payments &deposits
Shows Promoter slips of prior weekspayments and deposits
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The IPO of Compartamos Banco
1. At December 31, 2006
National coverage (29 of 32 states) Active clients: 616,528 (Growth rate: ~50% / year) Loan Portfolio: $217 MM, average loan size: $446 Asset Quality: Portfolio at risk > 30 days: 1.1%, loss rate: 0.6%
ROE: 56%
2. IPO in Mexican Stock Exchange: 19 April 2007
Secondary offering of 30% shares 13x oversubscribed by institutional investors in USA, Europe & Latin America Market capitalization: $1.5 billion
3. IRR at IPO: > 112% compounded annual return Initial investment in 1998: $6 million
4. Friday, 18 Feb 2011: Market Cap: $3.25 billion
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SKS
1. 1997: NGO established by Vikram Akula
2. 2005: Converted into a for-profit
$1.6 MM from individuals and social impact investors (Unitus, SIDBI)
3. 2007-2009: Commercial Investors 2007: Sequoia US VC firm: $11.5 MM 2008: $37MM 2009: $75 MM Sandstone US/India VC firm buys 12% stake
With thanks to Prof. Shawn Cole, Harvard Business School
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Year Assets (USD) Borrowers
1998 45,177 19
1999 103,338 191
2000 116,045 1,068
2001 508,567 5,080
2002 1,387,165 11,127
2003 4,089,187 24,799
2004 9,130,883 73,635
2005 26,811,799 172,970
2006 78,797,574 513,1082007 336,831,099 1,629,474
2008 596,162,206 3,520,826
2009 897,871,054 5,795,028
2010 980,000,000 6,780,000
SKS Growth
With thanks to Prof. Shawn Cole, Harvard Business School
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SKS Performance
INDICATORS SKS FY2010
Portfolio Growth FY 08-FY 09 54%
Portfolio CAGR Last 5 Years 166%Portfolio At Risk 30 Days 0.40%
Portfolio Yield 25.7%
Debt to Equity 3.2
ROA 5.0%
ROE 22.0%
With thanks to Prof. Shawn Cole, Harvard Business School
Source: CGAP, based on MIX & SKS
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
SKS IPO
1. July 28 to August 2, 2010: Issue shares for $350 MM
Primary (New shares): $155 MM Secondary (Existing Shareholders): $195 MM
2. Anchor Investors:
JP Morgan Morgan Stanley ICICI Prudential Quantum Fund
3. Underwriters: Citigroup, Credit Suisse, Kotak Mahindra
4. Market Capitalization: $1.5 billion
With thanks to Prof. Shawn Cole, Harvard Business School
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Andhra Pradesh (AP) Crisis: The Setting
1. The home state of the leading Indian MFIs
2. Co-existing with extensive AP Government Self-Help Group M/F Program
Little or no threshold other than SHG membership to borrow Below market rates, high use for consumption vs microenterprise Tied to Government rural bank (NABARD) and Priority Sector Lending (PSL) Extensive local politician involvement
Institution Clients Portfolio($ MM)
GlobalRank
(By Clients)
SKS 5,795,028 $960.8 4
Spandana 3,662,846 $787.3 6
SHARE 2,357,456 $490.9 7
BASIX 1,114,468 $223.2 14
Source: Prof. Shawn Cole, Harvard Business School
2009 Data
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
The Road to the 2010 Crisis
1. August 2: SKS IPO
Oversubscribed 13x, valuation $1.5 billion
2. August 9: Reserve Bank of India expresses concern over high rates
3. Fall: Press stories: Suicides attributed to microfinance debt
4. October 15: Andhra Pradesh State Government Microfinance Ordinance
All MFIs must register with State within 1 month, with local district officials Government has no obligation to register, may cancel registration at any time Refund of any payments > 200% of initial amount disbursed
o In practice, no MFIs charged such high rates All collections must take place in a local government HQ
o Inconsistent with MFI business practiceso Later revised to public places
Source: Prof. Shawn Cole, Harvard Business School
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
The Debate
Critics Allegations
1. MFIs: Usurious rates Vs Govt SHG Program: 3%
2. MFIs poaching SHG clients SHG: tiny amounts Slow processing
3. MFIs encourage multiple loans
4. MFIs: Coercive Collection
5. MFIs: Focus on growth
MFI Response
1. Crisis: Invention of local media Owned by opposition parties Local political issues Ordinance: result of political crisis
2. No suicides actually linked to M/F Prior allegations of suicides:
Bank loans, droughts, floods, high-yield cotton, and microfinance
3. No systematic rise of M/F suicides As M/F has spread
24Source: Prof. Shawn Cole, Harvard Business School
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Since the Ordinance
1. AP High Court refuses to stay State Govt Order (Oct. 22)
Permits collections for one week
2. Central Government Finance Minister: MFIs should self-regulate (Oct. 26)
Central Government generally supportive of MFIs
3. SKS holds meetings in only 59% of AP centers (week ending Oct. 29)
4. Largest MFIs agree to cap rates at 24% (Nov. 3)
5. Response of Indian Central Bank (Reserve Bank of India-RBI):
Microfinance: No longer a isolated niche- Conventional banks have M/F exposure: PSL portfolios- SKS: Publicly listed financial institution
The RBI Board establishes Malegam Commission (Oct 15)
25Source: Prof. Shawn Cole, Harvard Business School
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Malegam Comm Report Jan 2011 Main Recommendations
1. Microfinance: Separate category with its own regulations
2. Best Practices:
Transparency Code of Conduct Credit Information Bureau
3. Pricing Caps:
Overall maximum interest rate: 24% Margin Caps: 10%-12%
4. Product Design
Maximum Amount of M/F Loan: Rps 25,000 ($550) Obligatory tenors:
Rps 15,000 ($330) or less: 12 months, with voluntary prepayment at no fee Above Rps 15,000: 24 months, with voluntary prepayment at no fee
No collateral
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Evaluating the Malegam Recommendations
Positive:
1. Thoughtful, analytical and well-researched: Some key best practices
2. Interest Rate Caps: Set at levels that allow better MFIs to survive
Negative:
1. Mandated price and product design: Punish best performers (MFIs & clients)
Clients: cannot fund success beyond $500/loan or recognize build-up of assets No reward for better due diligence or analytical skills, innovation or segmentation
2. Perverse unintended effects
Price caps punishes outreach to poorer and more rural clients Margin caps protects incumbent, dissuades new entrants Reduced flexibility makes disruptive models very difficult
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Fundamental Issue: What is the role of Profits in M/F?
1. Theme of this conference: Sustainable Business & Social Impact
M/F as a vibrant business: easy to understand No different than any other business
2. What is the relationship between commerce & social value?
Less well understood Lack of wide consensus as to the right measures Without measures: weak accountability
3. At the core are two radically different interpretations
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Direct Trade-off:High Commercial Returns & High Social Impact
1. High commercial returns are made possible by high prices
2. Key to social value is price; the higher the price, the lower the social value
C
O
M
ME
R
C
I
A
L
R
E
TU
R
N
S
High
Low HighSOCIAL VALUE
Rationale:
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Clear & Direct, but Deeply Flawed
1. Commercial returns are the function of 3 key management levers:
Only one of which is affected by price (ROS):
Accordingly, ROE can increase while price falls so long as it is more than offset byAsset Turn & Leverage (efficiency in the use of assets and capital)
2. Social Value: Solely a function of price if only current clients are concerned
But if impact is defined systemically, then it must be measured in relation to:- the target population as a whole: those served and those still unserved- Through time: not just now but what will happen in the future
This is especially true in microfinance, when only 150 MM of 540 MM people are served
Net Income Revenue Total Assets Net IncomeROE = --------------- X ----------------- X ------------------ = ----------------
Revenue Total Assets Equity Equity
(ROS) (Asset Turn) (Leverage) (ROE)
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Definition of Success for Social Programs: BEST
1. Best: The most effectiveoption
2. Economical: At the lowestprice for the end-user
3. Solidarity: For allthose that need it
4. Today: As urgentlyas possible
This applies to all social interventions, and M/F is no exception.
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
SOCIALLYSUSTAINABLE
SOCIETYMICRO
FINANCE
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
ACCESSBY ALL
TO
Achieving the full potential of society
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What to do is, by andlarge, known and
simple
The challenge is tomake it available tothe majority of the
world
BEST:TRANSFORM THE
LIFE CHANCESOF THE PEOPLE
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
MICROFINANCE
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
To achieve BEST: S2E2
SCALE
SUSTAINABILITY
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ACCESSBY ALL
TO
TRANSFORM THELIFE CHANCES
OF THE PEOPLE
SOCIALLYSUSTAINABLE
SOCIETY
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
MICROFINANCE
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
To achieve BEST: S2E2
SCALE
SUSTAINABILITY
CONTINUOUSEFFICACY
CONTINUOUSEFFICIENCY
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ACCESSBY ALL
TO
TRANSFORM THELIFE CHANCES
OF THE PEOPLE
SOCIALLYSUSTAINABLE
SOCIETY
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
The war against poverty since WWII
The major warriors, fighting at their best
1. NGOs: Give birth to ideas that can
change the world
2. Philanthropy: Nurture those ideas sothey develop
3. Developmental Agencies: Support
those ideas so they can be field-
tested
4. Governments: Take the proven ideas
that are most promising and deploy
them nationally
None of them, individually or
collectively, are structured for scale
or sustainability
National scale & a measure of
permanence, but not structured for
continuous efficacyor continuous
efficiency
cannot provide simultaneously and consistently
what is necessary to win. 35
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
MICROFINANCE
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
Delivering S2E2: Business
SCALE
SUSTAINABILITY
CONTINUOUSEFFICACY
CONTINUOUSEFFICIENCY
PRIVATEENTERPRISE
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ACCESSBY ALL
TO
SOCIALLYSUSTAINABLE
SOCIETY
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
MICROFINANCE
EDUCATION
HEALTHCARE
HOUSING
BASICSERVICES
But not through one single enterprise but an Industry
SCALE
PERMANENCE
CONTINUOUSEFFICACY
CONTINUOUSEFFICIENCY
VIAINDUSTRIES
(NOTFIRMS)
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ACCESSBY ALL
TO
SOCIALLYSUSTAINABLE
SOCIETY
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
The Social Role of Profit and Industries
1. The only way to create an industry:
A commercial activity Above average returns This is the social role of profits
2. Making markets work for the BoP Competition is the only way to guarantee through time that the value-added
created by a commercial approach flows not only to investors and managers but tothe customers at the base of the pyramid
This is the social role of an industry
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
BancoSol (Bolivia)
0.284
0.240
0.230
0.217
0.221
0.2120.211
0.203
0.198
0.198 0.197
0,18
0,2
0,22
0,24
0,26
0,28
0,3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
In
terestRate
Year
Average Weighted Interest Rate Loan Portfolio
Source: BancoSol
Interest Rates 2000 - 2010
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
Bolivia Microfinance Industry:The Lowest Interest Rates for the BoP in Latin America
Source: Asofin
Dec1998
Dec2010
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School
An Empirical Observation: High Commercial ReturnsCan be Integral to High Social Impact
1. High commercial returns create industries
2. Industries produce S2E2 to ensure BEST for the Base of the Pyramid
C
O
M
ME
R
C
I
A
L
R
E
TU
R
N
S
High
Low HighSOCIAL VALUE
Rationale:
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Michael Chu, Harvard Business SchoolMichael Chu, Harvard Business School Copyright President & Fellows of Harvard College.
Michael ChuHarvard Business School
MICROFINANCE: INCLUSION & SUSTAINABLE BUSINESSFinancieros sin Fronteras IE Business School, 22 February 2011
Microfinance: Today and Tomorrow
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A Reflection on Randomized Evaluations in Microfinance
Randomized clinical trials
Origin: Medicine, e.g. penicillin
1. Single solution: vs infection
2. Bulls-eye metrics: evol. Infection
3. Uniform: penicillin = penicillin
4. Generalizable
5. Random sample OK
6. Timeframe appropriate
Microfinance
1. Poverty: multiple interventions
2. Working Cap, PPE, Housing
3. Heterogenous: MIF A MIF B
4. Segmentation
5. Targeted selection: Key
6. 12 to 18 Mos: 2-3 6-mo. loans