The concept of microfinance is the subject of many concerns, preconceptions and controversies. This controversy projects an image of microcredit as being a branch of financing that is ultimately not socially responsible, and that instead plays a part in making recipients poorer, as they become victims of a vicious spiral of over-indebtedness. Let Babyloan talk you through the main points of discussion.

For ‘credit’, read ‘over-indebtedness’

The phenomenon of over-indebtedness is endemic to the credit industry, in all its forms. Its causes may be economic, social or environmental. Issues with over-indebtedness emerge in certain areas where people have a weak understanding of financial issues, and where competition between microfinance bodies is severe.

In many countries, the microcredit sector has experienced crises of over-indebtedness. These crises are often born out of Microfinance Institutions (MFIs) surrendering to a “race for clients”, in order to increase their profitability and to attract lenders.

But today microcredit agents are more conscious of these risks and are actively involved in fighting against over-indebtedness. Credit registers have been implemented in certain countries, allowing MFIs to share their list of clients and to assess their actual levels of debt.

At Babyloan, one of our main field partner selection criteria involves the implementation of very strict procedures to prevent over-indebtedness. We are therefore committed to choosing partners who demonstrate a strong sense of social responsibility and who do not become involved in a “race for clients”, instead carefully evaluating their borrowers’ debt capacity and ability to make repayments.

 

Abusive interest rates?

One particular controversy often surrounds microcredit, relating to the interest rates paid by microentrepreneurs while repaying microcredit facilities. However, these rates do have an explanation.

Providing financial services to individuals who are isolated and excluded from traditional banking systems is expensive. Indeed, it is one of the main reasons why classic banks do not grant small loans, as the CGAP explains: “The administration of a €100 loan, for example, requires the same staff and resources as a €10,000 loan, which considerably increases the cost per transaction.”

In practice, microcredit involves high operational costs (social support, risk management, client visits, releasing liquidity, etc.) because – besides simply granting the credit – supporting and following up with the micro-entrepreneur is at the heart of the MFI-client relationship. The reality of these high operational costs engenders high interest rates for the services. The average interest rate of 27% charged by MFIs around the world reflects the accumulation of these costs.

By offering a low cost source of financing, Babyloan’s long term aim is to drive down the interest rates charged to microentrepreneurs. For example, Cambodian partner Chamroeun has been able to lower its interest rates thanks to Babyloan.

 

Is microfinance speculation?

Another controversy that surrounds microcredit relates more generally to the microfinance sector: that of financial speculation.

As with any financial sector, microfinance is open to abuse. Certain Microfinance Institutions have sidelined the poorest beneficiaries in favour of more profitable clients, while others have strayed from their social mission by becoming banks or listing themselves on the stock exchange.

That being said, it is worth bearing in mind that, out of around 10,000 Microfinance Institutions registered throughout the world, to this day more than 90% have still not reached financial equilibrium. Although certain MFIs have strayed from their mission, the majority are still small or very small entities that are working hard to achieve financial self-sustainability. Many key figures in the field of microfinance, alarmed by the changes in direction of certain MFIs, have been doubling their efforts over the last few years to encourage socially responsible microfinancing.

Not one of Babyloan’s local partners extracts abusive levels of profit from their microcredit activities. All of our Microfinance Institutions are motivated by the act of supporting poor sections of society to help them gradually leave poverty behind.

All of the various controversies surrounding microcredit, and which more generally gather around the microfinance sector, keep us attentive to ensuring that we remain on the right track. However, they do not cast doubt over the positive impact of microcredit on the people who benefit from it.