The Microfinance Sector: Its Success Could be its Biggest Risk

The success of microfinance has led to increased attention from socially responsible/ethical investors and capital markets investors. Its success has hinged on its business model, good asset quality, which typically compares favorably with the asset quality indicators of mainstream banks, reasonably stable financial performance indicators and some evidence of resilience to broader external macroeconomic shocks. Investors have also been drawn to the sector by the role microfinance plays in the development of a country’s financial systems and economy, and on its ability to bring the poor into the mainstream economy.

However, the sector’s track record is short and its success could increasingly expose it to greater risks. In particular, strong growth and increased need for external funding has put pressure on the internal control systems, and placed new demands on quality of management and corporate governance structures, which MFIs struggle to meet. As MFIs seek to manage this growth, they increasingly choose to transform from not--for-profit to for-profit institutions, from NGO status to being deposit gatherers, seeking regulation and better access to funding, and thus open themselves to transformation risks and mission drift which drives them away from their target low-income, customer base.

[Author's abstract]