MICROCAPITAL STORY: Philip Vassiliou of Legatum Capital Publishes Editorial Supporting For-Profit Microfinance in The Economic Times

In a recent Economic Times editorial, Philip Vassiliou, managing director of Legatum Capital, an international investment firm, argues that, “to reach its full potential, the microfinance sector must embrace free market principles of competitive pricing and commercial incentives.” He also believes that “modifying these incentives, however noble the intention, will only damage the natural development of the sector.” His comments come at a time of fierce debate over the benefits of commercial microfinance.

Those in favor of for-profit microfinance believe that only profit-maximizing companies will be able to attract enough capital to reach all of those in need of financial services. Those opposed to commercialization believe that companies who seek to maximize profit will drift away from the original goal of helping the poor and that companies cannot accomplish both goals a once. To learn more about the ongoing debate, please read this previous Microcapital story.

In the article, Vassiliou quotes Michael Chu, the former ACCION CEO and Harvard Business School professor, as stating that profit-maximization in microfinance is necessary because “poverty can only be truly addressed if you meet four conditions: you must have huge scale to reach the billions who are in poverty; solutions must be enduring and last over generations; solutions must be truly effective and make a difference; and all this must happen efficiently.”

Vassilou continues by approaching the initial public offering (IPO) of Compartamos, an extremely controversial Mexican microfinance institution (MFI). He argues that although the company’s “interest rates and costs of funds were equivalent to those of its eight peer MFIs in Mexico in 2006,” the company had much higher income due to better efficiency. He uses this example to contend that “arbitrarily regulating MFIs will stifle the natural incentives of MFIs, restrict competition, and impede the commercial capital that the sector needs to scale.” Critics of Compartamos, including Nobel Prize Laureate Muhammad Yunus, say that high interest rate of up to 90 percent take advantage of the poor, not help them.

According to the article, Compartamos has had a return on equity (ROE) of 45 percent, an outreach of 850,00 people and a market capitalization of 1.8 billion since its 2007 IPO. Further information can be found on the companies MIX Market profile. To learn more about the controversy surrounding Compartamos, please read this previous MicroCapital story.

According to the World Bank, demand for microfinance is nearly USD 300b, implying that, at a 5:1 debt to equity ratio, USD 45b in equity is still needed to meet global demand. Vassiliou argues that charity and aid alone cannot access enough funds and that profit-seeking investors are the only way to infuse enough capital into the microfinance sector. He also argues that the increased competition from private institutions will eliminate many of the concerns of critics of commercial microfinance. In Bolivia, for example, “interest rates in Bolivia have fallen from 70-80% in the early 1980s to a current average of 28%, thanks to increased competition and commercialization.” He continues by explaining that “Bolivian MFIs have also become far more efficient – the median operating expense ratio for the top four MFIs in Bolivia is down 33% compared to 1996, while the number of clients served by these MFIs over the same period has increased four-fold.” This type of data demonstrates how competition among profitable MFIs can lead to the most efficient and widespread availability of microfinance services.

The author of this article, Philip Vassiliou, is a managing director of Legatum Capital, a Dubai-based international investment firm. The privately held company has made substantial investments in microfinance. Legatum invested USD 20m in the Unitus Equity Fund II, USD 8.4m in Intellecap and USD 25m million for a majority interest in Share Microfin Ltd, which, according to their website, is the largest single equity investment ever in the microfinance sector. Legatum has made further investments in microfinance infrastructure.

Philip Vassiliou has extensive experience in the investment world. Previously, he worked in the Group Investments and Sovereign Global Development divisions of Sovereign Global, Legatum’s predecessor. Prior to joining Sovereign, he worked Dubai Development Investment Authority (DDIA) and Goldman Sachs.

By Greg Casey, Research Assistant

Additional Resources:

Economic Times: “Microfinance must embrace the free market”

MicroCapital Story, August 1, 2008: Nobel Laureate Muhammad Yunus Speaks Out Against For-Profit Microfinance from Asia-Pacific Microcredit Summit

MIX Market: Profile for Legatum Ventures

MIX Market: Profile for Compartamos

MicroCapital Story, April 7, 2008: New York Times Reports on Controversial Microfinance Giant Banco Compartamos of Mexico

Legatum Capital: Team

Legatum: Microfinance Investments