Microfinance Loses its Wall Street Luster

NEW YORK ( TheStreet) -- Citigroup ( C), Morgan Stanley ( MS), JPMorgan Chase ( JPM), TIAA-CREF and other U.S. financial companies with ties to the microfinance industry are treading carefully in the wake of recent scandals, but early evidence suggests the industry will survive in one form or another.

Microfinance refers to the provision of tiny loans to poor people in third world countries. Though interest rates can climb beyond 100% in certain cases, some studies have shown repayment rates are often far better than has been seen with more traditional loans.

European institutions involved in microfinance include Barclays ( BCS), Deutsche Bank ( DB) and Standard Chartered.

None of the those institutions, however, nor the four U.S. companies mentioned earlier, are especially eager to discuss microfinance. Calls to several banks were unreturned or spokespeople said they were unavailable.

Morgan Stanley, which did a pioneering microfinance collateralized loan obligation in 2007 the Financial Times named "sustainable deal of the year," was the only firm contacted by TheStreet that would comment for the record. 

"We remain committed to the microfinance sector and its potential to produce positive social impact," said a spokeswoman.

Milford Bateman, a fellow at the Overseas Development Institute in London, and one of the more outspoken critics of microfinance, believes Wall Street won't talk because of recent high-profile scandals.

"There are too many things going on at the moment. Its a very sensitive time," he says.

"Microfinance has a real feel good quality about it, or at least it did until recently, so they were keen on it from that point of view. But what really came out in the last five or six years is how superprofitable microfinance can be," Bateman says.

That led to market saturation, in Bateman's view. He says crises unfolding in microfinance in certain ways mirror the subprime lending crisis in the U.S.

"They basically all piled in together," Bateman says of the financiers, "without any recognition that there isn't really anywhere a problem of the unbanked. That's part of a fiction that the World Bank has come up to justify this huge run to the cliff side so that they could make so much money out of this."

Bateman argues the typical microfinance borrower is a woman selling tomatoes in a marketplace alongside lots of other women selling tomatoes. These businesses aren't scaleable, he argues, so they can't grow in order to justify the high interest rates they must pay to borrow.

The highest profile of the recent scandals involves the Indian state of Andhra Pradesh. Borrowers there have largely stopped paying loans to microlenders including SKS Microfinance, an Indian outfit started by Sun Microsystems co-founder Vinod Khosla. Khosla is a Silicon Valley legend whose Khosla Ventures recently fired former British Prime Minister Tony Blair as a senior adviser.

Andhra Pradesh has clamped down on the microlenders, who are being blamed for profiting off the backs of the poor and driving borrowers to suicide. However, some commentators, such as Reuters blogger Felix Salmon, argue the state has its own agenda as a competitor to the microlenders.

Further controversy comes from a Danish documentary accusing Grameen Bank and its Nobel-prize winning founder, Muhammad Yunnus, of misappropriating funds in the 1990's. A statement on the bank's website says the charges are false, though the Bangladeshi Prime Minister said they required an "extensive investigation" before she went on to accuse microlenders of "sucking blood from the poor in the name of poverty alleviation."

But, despite these issues, and a recent headline in The New York Times declaring the "imminent collapse" of India's microcredit industry, microfinance appears to have firmer roots than many people realize.

A recent JPMorgan report traces the start of the microfinance industry to the 1970s, with the launch of Grameen and other pioneering institutions.

The report acknowledges "recent problems related to excessive growth," and devotes some attention to the Andhra Pradesh crisis, but calls microfinance "one of the most developed," of so-called "impact investment sectors," which include areas like affordable urban housing, clean water for rural communities and primary education. 

It is also one of the largest of impact investment sectors, according to the report, which argues "the potential private sector investment opportunity in microfinance is $176 billion." However, while a chart provides a number showing the "potential profit opportunity" for all the other impact investment sectors, when it comes to microfinance, it states merely: "not measured."

The JPMorgan report says there have been 307 microfinance deals worth $661 million, and it argues most markets show less than 20% penetration. It calculates penetration by dividing the number of borrowers by the number of adults. By that measure, India shows just 5% penetration, while Bosnia and Herzegovina shows the highest penetration rate at 60%.

But investors shouldn't expect to get rich in microfinance, says Christina Juhasz, director of the capital markets group at Women's World Banking, a microfinance group. "Microfinance is a robust asset class with diversification benefits and the potential for fair returns. Windfall returns shouldn't be expected," she says.

But the existence of WWB, and several other dedicated microfinance organizations with strong ties to Wall Street, would seem to suggest the industry won't disappear so easily.

And even if the banks may be somewhat shy about offering up a defense of the industry, prominent financial services executives such as Eugene Ludwig, CEO of Promontory Financial Group and US Comptroller of the Currency from 1993 to 1998, show no such hesitation.

"Microfinance has transformed tens of millions of low and moderate income people's lives. That's demonstrable: it can be tracked numerically, it can be tracked anecdotally, and it is vastly larger as a movement than any single institution. But like any revolution, these things don't happen without growing pains," he says.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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