Microfinance, the long tail and mission drift

Abstract

Poor people were excluded from financial services until microfinance institutions (MFIs) emerged. The mission of MFIs is to alleviate poverty, contributing to women empowerment especially in rural communities. Microcredits can be analyzed under Pareto's 80/20 Principle. Their clients are situated in the long tail of the wealth distribution function. This niche market is not very attractive, because of its high administrative costs, lack of deposits and the need for compensating low revenues with fluctuating subsidies. Some MFIs have drifted from their mission. This paper presents a model to explain microfinance and mission drift, tested with hypotheses. The results from the empirical study show a pattern of mission centered MFI: a small NGO, with labor productivity, receiving donations and obtaining a high margin. The need for reducing interest rates is concluded. According to the long tail theory, this can be done through the use of efficient technology, as the e-commerce sector has achieved. According to the long tail theory, this can be done through the use of efficient technology, as the ecommerce sector has achieved.

The relationship between the performance and legal form of microfinance institutions

“…To obtain the desired results, the institutions have to balance the demands of financial performance with those of social performance, aiming towards operational self-sufficiency and investor returns, and at the same time enabling poorer customers to access financial system services in a sustainable way (Serrano-Cinca & Gutiérrez-Nieto, 2014). In light of the above, it can be perceived that MFIs face a dual situation in which financial results are not enough to warrant investments and the social role is not sustainable without returns on the costs involved.…”

“…Most MFIs have a social mission, such as reducing poverty, increasing female autonomy, or stimulating small businesses, which is always related with improving the quality of life of the poor (Serrano-Cinca & Gutiérrez-Nieto, 2014). Due to the social appeal that microfinance can have, many MFIs have access to lines of credit with more attractive interest rates, subsidies, and donations from people and institutions (Hermes & Lensink, 2011).…”

“…Problems related with microfinance have already been reported in various locations: in India, an increase in customer poverty due to excess debt has been observed (Guérin, Roesch, Venkatasubramanian, & Kumar, 2013); in Kenya, higher interest rates charged to customers are associated with higher default rates in communities (Kodongo & Kendi, 2013); in Ghana, heightened customer debt due to the population's lack of financial knowledge and loans without any productive purpose have been reported (Schicks, 2014). The high cost of serving poorer customers, together with the pressure from donors and investors for the institutions to achieve economic sustainability, can result in higher interest rates being charged, which in turn can create social problems related with microfinance (Serrano-Cinca & Gutiérrez-Nieto, 2014).…”

“…Even when MFIs have donations and subsidized resources, reducing costs enables a reduction in the rates and fees charged to customers, thus reducing any penalization of the poorest (Serrano-Cinca & Gutiérrez-Nieto, 2014) and, since the availability of donations and lines of credit with lower costs is not unlimited, the market prefers those MFIs that manage to maximize the benefits of the resources used and favors the most efficient ones (Ghosh & Van Tassel, 2011). Signs of efficiency are even more important in the context of microfinance due to the low savings ability of the customers, making MFIs more dependent on external funds (Serrano-Cinca & Gutiérrez-Nieto, 2014).…”

“…This may be making NGOs and cooperatives adopt more commercial practices that, allied with the advantage of operating with financial benefits and without any of the legal constraints of profit-orientated financial institutions, would result in greater financial performance. The profitability of these institutions is a warning sign if we consider that some MFIs are accused of practicing high interest rates and credit and collection policies that verge on being abusive, which in the case of socially-orientated MFIs could be mitigated by reducing profits so that they do not diverge from their social mission (Bédécarrats, Bastiaensen, & Doligez, 2012;Serrano-Cinca & Gutiérrez-Nieto, 2014). In this context, it could be questioned whether expansion through retaining surplus earnings is the best solution when assimilation or merger with other financial institutions is also an option.…”