Why Are So Few Micro-banks Profitable?

There are about 300 commercially viable microfinance institutions (MFIs) worldwide. The total investment portfolio for these institutions is estimated to be $3.5 billion and is growing at a rate of 20-30% per year. Those MFIs, however, are rarities among the 10,000 MFIs operating today. So what separates the few commercially viable MFIs from the huge host of laggards?

MFIs are hindered by internal and externally constraints. Internally, microfinance institutions must overcome:

Lack of professional capacity: MFIs are located in developing countries, and recruiting experienced management staff and loan officers can be challenging.
Lack of expertise: While the World Bank’s microfinance research organization has developed best practices standards for MFIs, the vast majority of MFIs lack the wherewithal to access and implement these standards.
Inherent challenges of serving the poor: There is a large demand for financial services in rural markets, which are difficult to serve because of transportation costs and a lack of infrastructure. Rural residents rely heavily on agriculture for income, which can be unpredictable and make lending risky.
Lack of portfolio diversity: When MFIs focus on providing one type of service—for example, a focus on loans for agricultural development to the rural poor—they are more exposed to risk. To protect themselves from risk, MFIs must provide a wide variety of services.

Externally, MFIs are constrained by the following factors:

Abundant donor capital: MFIs have little incentive to become profitable if donations sustain them. Donations eliminate the incentive to abide by best practices standards and become more efficient. When MFIs receive funding from outside donors, their focus shifts to catering to what the donors want, not what the customers want.
Government Regulations: Interest rate regulations prevent MFIs from recouping their costs and force opaque reporting.
Unfair Competition: Donor-subsidized MFIs and government programs often charge below market rates and undercut those striving for profitability.
Corruption: When local and national governments suffer from corruption and bureaucratic incompetence, it hinders the ability of all businesses—including MFIs—to run efficient operations.
Inherent challenges of emerging markets: An absence of ‘soft infrastructure’ in the developing world such as credit bureaus, human resources agencies, and market research firms severely complicates doing business.