Can doing good pay?
Rethinking our approach to development: the alternative path offered by microfinance, social bonds, and a search for innovative solutions.
The roots of modern microfinance can be traced back to the 1970s, when Nobel Prize winner Muhammad Yunus began experimenting with small-scale lending to poor households in rural Bangladesh. His work culminated in the founding of the Grameen Bank in 1983, altering the lens through which many think about development. By pioneering a grassroots way to lend to the poor in Bangladesh, predominantly women, Yunus challenged the perception that poor households were unbankable, demonstrating that absence of collateral and formal wealth did not necessarily imply a lack of entrepreneurial potential.
The genius came in his creation of a new lending practice: “group lending” or “joint liability lending”. He realised that despite collateral and financial constraints, the villages in Bangladesh all shared a similar intangible asset: a network of interdependence and trust. And by creating a system of joint liability, in which defaulted loans could affect other members’ access to future loans, Yunus aligned borrowers’ incentives with those of the bank, while leveraging existing networks of community trust. This was met with considerable success, with an average overdue rate of only 1.6% in the first decade of its existence.
The concept of micro-lending, alongside microfinance more generally, addressed an underlying concern with traditional aid solutions; that it could function as a neocolonial extension of imperialism, perpetuating Western control through deepened economic dependency. The birth of microfinance, conversely, appeared to offer a model centred on opposite principles: self-sufficiency and a newfound focus on self-help rather than direct income redistribution.
By the 1980s and 1990s, microfinance had evolved from an innovative, bottom-up approach to development into a commercial opportunity with substantial profit-making potential, signified clearly by Banco Compartamos of Mexico’s 2007 initial public offering which resulted in $470 million of gains to existing shareholders, almost a third of which ultimately accrued to private individuals. Gains of this magnitude reveal the appealing win-win proposition offered by commercial microfinance entities, aligning social and financial incentives - the perfect neoliberal dream. Markets could be used to solve the problems that charity alone seemingly could not.
However, the IPO was not met with this optimism on all sides of the debate. Many, Yunus among them, were shocked at the profits received by private shareholders, which they argued came at the expense of the bank’s low-income clientele, who at times faced interest rates in excess of 90%, fuelling hefty profit margins. The role of commercial, legally for-profit organisations in microfinance and poverty alleviation more generally is undoubtedly blurry, but perhaps the choice between abandoning profit and surrendering to it is misleading, when the real question is how to design microfinance to harness the scalability and investor incentives that profit provides without losing sight of its core social goals.
Evidently, the status of being a “for-profit bank” does not equate simply to earning a profit. The core difference lies in what is done with that surplus: whether it is distributed to investors or retained and reinvested into the organisation. This distinction matters, and it is here where much of the tension lies. The industry’s drive towards profitability does not necessarily imply a drive towards commercialisation. Indeed, it is a misconception that for-profit organisations are producing the bulk of the profit in the industry, with one study finding that 91% of borrowers served by non-governmental organisations were served by profitable institutions, compared with 92% of borrowers served by for-profit banks.
Curiously, Compartamos’ high interest rates did not represent a clear trend among for-profit microfinance institutions. The dataset used in the study revealed that, at the median, non-governmental organisations charged borrowers around 25% per year, compared with 13% for commercial banks, although these figures clearly do not capture the most extreme rates, which could exceed 80% or even 100% annually. Rates also vary substantially by country, with Sri Lanka reporting an average of around 17%, compared with figures exceeding 80% in Uzbekistan. These variations stem from a combination of operating costs, public policy preferences - with some countries placing greater emphasis on usury ceilings than others - and competitive intensity.
The surprisingly higher interest rates charged by some non-governmental organisations can partly be explained by their cost structures. With fewer active borrowers on average, and more importantly, smaller loans being given to customers, these institutions face lower returns to scale than their for-profit counterparts. Nonetheless, this raises further questions about the justifications given by some for-profit entities for charging sky-high rates. If larger customer bases and bigger loans generate economies of scale, there should, in theory, be less need to pursue ever-higher margins.
Interestingly, this was not the case for Compartamos, which offered particularly small loans relative to per capita gross national income. Compartamos’ argument that a profit-maximising approach would allow it to expand its reach to potential borrowers is convincing in itself. Yet ultimately, the question is at whose expense that expansion occurs: their existing customer base. Moreover, the justification loses some of its conviction when considering that the IPO itself did not directly inject new capital into the bank: it was primarily a sale of existing shares. Rosenberg’s 2007 analysis found that the organisation could have reduced its interest rate to around 65-70% while still maintaining a level of profitability comparable to other banks.
The argument offered by proponents of these approaches is that the alternative of not providing financial options at all, as was previously the case for many, could not be a morally preferable outcome, therefore justifying commercialisation. However, this chain of reasoning is tenuous to say the least. It risks creating a false dichotomy in which any financial access is assumed to be preferable to no financial access, regardless of the terms on which it is provided. A similar logic could be used to justify extremely low wages on the basis that the alternative is unemployment. The existence of a worse alternative does not automatically make the available alternative fair.
The critique of commercialisation, however, extends beyond high interest rates and controversial shareholder dividends. When companies lend to low-income individuals in poorer countries, disparities in financial literacy and bargaining power can leave borrowers particularly vulnerable to exploitative practices. The 2010 Andhra Pradesh crisis in India demonstrated how serious these risks could become, prompting intense scrutiny of lending practices and ultimately significant state intervention.
This brings us back to the question of agency. Can borrowing really be more empowering than receiving traditional aid, when a reduction in donor dependency is swiftly replaced by dependency on creditors?
Yes - borrowers have greater control over how they use their money, making their own decisions without a guarantee of success as they assess whether to expand a handicraft business, invest in livestock or open a small shop, for example. But this empowerment is conditional upon being treated fairly by creditors - not necessarily “fair” in the sense of treating a borrower identically to a Western consumer, but equitable fairness, recognising the instability of their circumstances and the unequal bargaining power between lender and borrower.
So, what is the solution?
Commercial and socially minded microfinance models do not have to exist in opposition. It is not a binary choice. The justification for commercial companies seeking to maximise profits in order to attract greater investor support is not misguided in itself: capital is necessary for expansion, and expansion is necessary if financial inclusion is to reach more people. The problem lies in assuming that social goals must be sacrificed to secure that capital.
They do not, if socially minded investors are the ones being targeted.
The growing fields of impact investing, direct giving and innovative financial instruments such as social bonds, women’s empowerment bonds and blended finance demonstrate that there is an investor base willing to consider more than financial returns alone. An investment does not necessarily need to match the returns of the S&P 500 to be attractive: for some investors, a combination of financial return, diversification and measurable social impact creates its own value. The opportunity is therefore not to eliminate profit from development, but to redefine what investors are being rewarded for.
International bodies must also cooperate to establish regulatory frameworks capable of preventing predatory pricing and protecting consumers through transparency requirements and restrictions on aggressive collection practices. Yet regulation must avoid becoming so burdensome that it disables the very markets it is intended to protect. The objective should instead be broad but firm guidelines; enough to constrain exploitation, but sufficiently flexible to allow innovation and competition.
It was right for microfinance to capture the world’s attention in the late twentieth century, despite the controversies and falling optimism of the past couple of decades. It may not have been the solution to global poverty, nor has it resolved the wider problems surrounding traditional development strategies. But perhaps it was never meant to be the destination.
Instead, it represents the first generation of market-based development: an experiment in whether the incentives of markets can be redirected towards social goals. Its greatest contribution may therefore be less the loans themselves than the questions it forces us to ask about development. And the realisation it prompts that doing good is not a zero-sum game, and does not require someone else to give something away. Instead, we can design systems in which capital, incentives and social progress reinforce each other.
So yes - doing good can pay. Emotionally as well as financially. But only if we build the right frameworks and strategies to prevent unnecessary trade-offs while keeping fundamental social goals at the forefront.
By Dia Abdul-Rahim
