Impact Investing: Beyond Microfinance Business Model
While impact investing could provide steady income and some potential upside with successful investments, but most impact investors that I have met are attracted to the sector because of something beyond money. The primary source of motivation of impact investors is to give back to society through financial management skillset, with the potential upside of being able to help making history by discovering 2–3 breakthrough business model innovations for low-income people.
What constitute a “breakthrough innovation”? For impact investing, there has been only one globally applicable breakthrough so far: the Grameen-style microcredit business model, originated in Bangladesh, or commonly just called “microfinance”¹ and its variations, often collectively called the “financial inclusion” sector.
Financial Inclusion Dominates Impact Investing
Microfinance clearly gave a boost to the fledgling impact investing movement. A quick analysis of numbers from GIIN’s database shows that microfinance and other financial services² constitute 46 percent of AUMs (Assets Under Management) of impact investors in the emerging market in 2018, with energy as the second largest sector with 19 percent allocation.
Not only microfinance dominates allocation of impact investment assets, a McKinsey report from 2018 also found that of the 48 exits in India between 2010 and 2015, 31 were in financial inclusion, with nearly 80 percent of the exits in financial inclusion were in the top two-thirds of performance. Only half of the deals in clean energy and agriculture generated a similar financial performance, while those in healthcare and education have lagged³.
Because of the outsized success of the financial inclusion sector, impact investing practitioners, including Vishal Mehta of Lok Capital, went to argue that the commonly held view about impact investing: “Returns did not have to be sacrificed for impact”, is largely driven by what had been witnessed from the near-universal success of microfinance models around the world.
With the microfinance model being widely adopted in almost all developing countries⁴, the challenge faced by impact investor is in discovering the next breakthrough models that can be adopted and replicated to benefit low-income communities while delivering similar level of financial returns that microfinance has brought so far.
The Grameen Model and History
To understand about when and how the next breakthrough models would come, it is important to dig up more about how GrameenBank model emerged in the first place. To begin with, Grameen’s website provides the following description of the fundamentals of the business model:
A bank unit is set up with a Field Manager and a number of bank workers, covering an area of about 15 to 22 villages. The manager and workers start by visiting villages to familiarize themselves with the local milieu in which they will be operating and identify prospective clientele, as well as explain the purpose, functions, and mode of operation of the bank to the local population. Groups of five prospective borrowers are formed; in the first stage, only two of them are eligible for, and receive, a loan. The group is observed for a month to see if the members are conforming to rules of the bank. Only if the first two borrowers repay the principal plus interest over a period of fifty weeks do other members of the group become eligible themselves for a loan. Because of these restrictions, there is substantial group pressure to keep individual records clear. In this sense, collective responsibility of the group serves as collateral on the loan.
There are many sources of the history of GrameenBank, including several books authored by Dr. Muhammad Yunus, the founder of the bank. Here is a quick summary with the relevant timeline:
- 1974 — Dr. Muhammad Yunus, an economics professor and later a Nobel laurate, started to investigate poverty issues in his home country Bangladesh.
- 1977 — Yunus started to make very small loans, totaling USD 27 (856 Bangladeshi taka) to 42 women in villages. To his surprise, everyone paid back. In the same year, he started his pilot project in Jobra village, working as a branch of Bangladesh Agricultural Bank.
- 1983, Yunus started GrameenBank to replicate his experiment in Jobra. The business model evolved, with multiple products including savings and other non-loan products, but the main idea is still to provide microloans to group of poor women.
- 1995, GrameenBank had become self-reliant and stopped taking donor money⁵. By that time, replications of the business model in Bangladesh and other countries have already taken place. GrameenBank also expanded to other social business sectors within Bangladesh.
- 2006, GrameenBank and Dr. Yunus received Nobel Peace Prize. Impact investors invest in Grameen replicators in different countries.
- 2007, Banco Compartamos (Mexico), a Grameen replicator, went IPO, giving IRR of 53 percent to their investors. Banco Compartamos then became poster boy of mission drift for overcharging their customers.
- 2010, Grameen replicator SKS Microfinance (India, now called Bharat Financial Inclusion) went IPO that was oversubscribed 14x. Subsequently until 2012, there was a microfinance crisis in Andhra Pradesh, India, potentially triggered by race of Indian MFIs to follow SKS towards IPO. The SKS IPO pushed it to grow to a level that is really not possible, given its size, without becoming essentially an irresponsible lender.
- 2015, Replicators Equitas and Ujjivan went public in Mumbai Stock Exchange with a much more positive reception. In Indonesia, BTPN Syariah went public in 2018. There are many other large MFIs that decide to stay private for the time being, including CARD (Philippines), MBK, Bina Ventura (Indonesia), and Arohan (India).
Impact Investors Just Could Not Create Another GrameenBank
We have seen so far that impact investors have a good, albeit a bit patchy, track record of financing and helping to scale up microfinance institutions that are more or less the replicators of GrameenBank model. However, would today’s impact investors be able to find another innovator of the caliber of GrameenBank? Since we do not know yet what and how the next breakthrough innovations look like, let us flip the question and ask: If we bring our resources and expertise back to 1980s, would impact investors be able to identify GrameenBank and Dr. Yunus as innovators and support them accordingly? My answer is no, and here are three reasons why.
1) Impact investors do not have the patience to wait 20+ years
It took Grameen almost 20 years from conception until reaching financial sustainability. There are very few, if there is at all, impact investors that have the patience to wait for 20 years for an equity investment to give financial returns. There were also no exit markets for financial inclusion companies to allow for an earlier exit.
And GrameenBank was not in a hurry. As Dr. Yunus himself said:
“A guiding principle to our work is to start low-key and in a small way. Why hurry? If poor people have survived without Grameen for all these centuries, they can survive without us for many years to come. Our objective is to develop a system that works, not to rush out a service at breakneck speed. Whenever Grameen starts functioning in a new location, it is never in a hurry to do anything. This is important for our success. First, we do not want to offend anyone who might be antagonistic towards us or suspicious of us. But also, we believe it is better to progress slowly and steadily and get things right, than to go quickly and make mistakes.” (emphasis mine)
We could imagine a situation of a modern-day investor, as a board member in Grameen, would push management to scale up quickly, even though it may not be profitable to do so. On the contrary, Grameen was so prudently managed that it has always been profitable every year of its existence, except in 1983, 1991, and 1992.
2) Impact investors do not invest in entrepreneurs with Dr. Yunus profile and context
Technically Dr. Yunus was a government appointee and had never owned shares of GrameenBank. The majority owner is the borrowers (94 percent shareholding) and the government. After all the hard work and his superstar status today, his financial net worth is “only” USD 10mn⁶. Modern-day investors would not invest given Dr. Yunus’ situation in 1980s, thinking that his incentives are “not aligned with the business objectives” and that he “does not have skin in the game” and would give up when the first major obstacle came. He also did not come from a business background, a major disadvantage in the eyes of investors.
3) Impact investors do not want to give away their successful business models for free
GrameenBank has a 230-page manual for wannabe replicators that can be freely downloaded from the Internet⁷. Since it is not possible to learn just from a manual, anyone can also come for a training in Bangladesh with Grameen Trust, who was established to help speed up replications and can even provide replicators with capital. Grameen does not hold intellectual property on its model, so technically you can implement their business model right away or even modify and claim it your own⁸.
Perhaps the next breakthrough innovation has already existed in the marketplace, but the company or its investors are not sharing it to the level that can be replicated by others like Grameen did. After all, there are no financial benefits of sharing, and it is always good to have the option of replicate a good model yourselves through expansion.
Another possibility is that there are and there would be any other breakthrough business models like Grameen. Microcredit is naturally a pull product as almost everybody needs credit in one form or the other. Other financial inclusion models like savings and insurances are having hard times attracting the poor. Delivery of microcredit is also relatively easy as it does not involve physical product. Energy, education, healthcare, agriculture supply chain, and waste management business models either have structural issues to be resolved or are very contextual hence difficult to replicate. If this is the case, impact investing is in a big trouble as microfinance and its related business models are going to be saturated at some point, and the goals of helping the poor escape poverty will be extremely difficult to realize⁹.
Not All Hope Is Lost
Discovering the next breakthrough innovation might be challenging, but there are also factors that massively helping our cause. Compared to the 1980s, today’s digital technology is more advanced and available even in rural areas, the financing available is much more massive, and there are many more smart people care about innovations for the poor. However, impact investors must keep in mind that all the resources in hand would not be effective if we are not willing to broaden our search for the next breakthrough. As we have seen with GrameenBank in 1980s/1990s, innovations can happen in most unlikely places and come in a form that is peculiar and non-intuitive to our traditional investing approach. Impact investors should also come up with win-win schemes to replicate the business models of their successful portfolio companies.
There will be no second GrameenBank, and the next breakthrough might come in a totally different shape compared to Grameen, but we can certainly enrich our approaches to impact investing by incorporating their ways of innovating. If we adopt better ways of nurturing impact enterprises, and with a little bit of luck, we might soon be able to discover our own breakthrough business models.
[1] There are other models of microfinance, but Grameen-style and its variations are the most popular and also the most replicated model
[2] “Other financial services” is currently larger than “microfinance”, but business models in this category are either extensions or evolution of the original microcredit model
[3] With a limited sample of only 17 exits outside financial inclusion, however, it is too early to be definitive about the performance of the other sectors.
[4] In 2019, there are more than 10,000 microfinance institutions worldwide. If we talk about the number of borrowers and savers, then the number goes up to more than 70 million. And the total loan portfolio amounts to an estimated $40 billion. More than 130 million people have been helped by it. Source: Digipay
[5] Various donors and providers of subsidized loans supported GrameenBank throughout the year, including Ford Foundation, International Fund for Agricultural Development, Bangladesh Central Bank, NORAD, the Norwegian agency, SIDA Swedish
[6] This amount is more than enough for a comfortable retirement, but miniscule compared to the values he created for the community and for the investors through Grameen and its replicators
[7] No questions asked when you want to download. You don’t even have to leave your email address
[8] Not all replicators are closely following Grameen model. There are 2 well-known schools within microfinance — (a) SHG (Self-help group model) — this is the closest to Grameen as it nurtures the groups first by inculcating saving habits and then releasing debt as a leverage on savings. This is a slower model of growth but more solid as these SHGs can actually become so mature over 4–5 loan/savings cycles that they can be linked to banks directly. This was the successful bank-SHG programme in the India. However more private companies that were the intermediaries here were not-for-profit as their business models were meant for long term interventions and not quick scale up — growth — profits. (b) JLG (Joint liability model) — Most well-known names from the list followed this model where small groups are formed for the purpose of taking loans with joint liability, without the first step of nurturing as per SHG. Groups tend to be very opportunistic in this case but the model moves much faster in terms of growth in assets. This appealed most impact investors followed by commercial investors and has led to high returns and IPOs. Grameen has always been very wary of this model as it borrows select attributes from Grameen model, but ignores others that are important from long term perspective.
[9] Many critics of microfinance argue that the sector alleviates extreme poverty and reduce vulnerabilities, but not able to sufficiently lift people out of poverty as there are limited financing support to the poor after they “graduate” from microloans
