The Microfinance Business Model: Enduring Subsidy and Modest Profit

Abstract

Recent evidence suggests only modest social and economic impacts of microfinance. Favorable cost-benefit ratios then depend on low costs. This paper calculates the costs of microcredit and other elements of the microcredit business model using proprietary data on 1,335 microfinance institutions between 2005 and 2009, jointly serving 80.1 million borrowers. The costs of making small loans to poorer clients are high, and when revenues fall short of costs, subsidies are necessary to deliver services to those clients on a sustainable basis. Using a method that accounts for the opportunity costs of all forms of subsidy, the analysis finds that the median institution receives five cents of subsidy per dollar lent and $51 of subsidy per borrower (in PPP-adjusted terms). Relatively low levels of median subsidy suggest that even modest benefits of microcredit could yield impressive cost-benefit ratios. The distribution of subsidies is highly skewed, however: the average subsidy per dollar lent is 13 cents, and the average subsidy per borrower is $248. The data show that subsidies per borrower are substantially higher for commercial microfinance banks and some non-bank financial institutions that make relatively large loans. MFIs organized as non-governmental organizations (NGOs), in contrast, generally rely less on subsidy.

Determinants of the Performance of Microfinance Institutions: A Systematic Review

“…The non‐profit NGOs are still the main type of MFIs, representing almost half of the total number of MFIs (D'Espallier et al ., ). The median level of financial sustainability does not differ much between non‐profit and/or NGOs on the one hand and for‐profit or microfinance banks on the other hand (Cull et al ., ). The remaining group of MFIs consists of smaller, start‐up organizations, which are still far from being financially sustainable and are therefore (heavily) dependent on subsidies.…”

“…At the same time, however, there remains variety in MFIs in terms of their financial sustainability. According to Cull et al (2016), only half of the MFIs listed in the so-called MIX Market data set are financially sustainable. 3 The number of financially sustainable MFI is probably even smaller since the existing data set may be biased towards more profitable and established MFIs.…”

To profit or not to profit? Assessing financial sustainability outcomes of microfinance institutions

“…Another example is Caudill et al (2009) who argue that MFIs become more efficient over time and less dependent on subsidies. However, Cull, Demirgüç-Kunt, and Morduch (2018) found a puzzling result: The more subsidized MFIs were not the NGOs but the more commercialized institutions.…”

Toward a realistic theory of social entrepreneurship (NGOs) grounded on microfinance research: Selling dreams to society

“…MFIs provide loans at higher rates than banks, thus indicating that clients subsidize the MFI (Becchetti and Pisani, ; Cull et al, ). However, these interest rates are still lower than they would be in the absence of government and private donors or impact investors.…”

“…However, these interest rates are still lower than they would be in the absence of government and private donors or impact investors. According to Cull et al (), overall subsidy calculations, after accounting for the opportunity cost of equity, indicate that these subsidies are persistent and may be endogenous to the business model of the MFIs (Cull et al, ). In this manner of calculating subsidies, both for‐profit and NGOs are receiving subsidies either from private (impact) investors or from governments.…”