Many institutions around the world are turning to microfinance both as a strategy to help lift the poor out of the poverty trap and to make a decent return on investment. While the business gains from lending money to those who earn only about one or two dollars a day may seem limited, some of the major international banks are now turning their attention to this sector.

In a new case study, INSEAD Adjunct Professor Mahboob Mahmood highlights the work of the Kashf Foundation in Pakistan. It’s a non-profit organization which has been posting dramatic growth while focusing on providing microcredit and social support services to women entrepreneurs at the bottom of the so-called wealth pyramid.

Since its launch in 1996

Since its launch in 1996, Kashf has grown to become the third-largest microfinance institution in Pakistan with some 69 branches, more than 135,000 customers and about 90 million US dollars in outstanding loans.

Kashf was modelled along the lines of Bangladesh’s Grameen Bank, which along with its founder Muhammad Yunus, won the Nobel Peace Prize in 2006 for its work in poverty alleviation. But microfinance isn’t just being used in South Asia to help lift the poor out of poverty, it’s become a global phenomenon.

Mahmood says there are currently over 20,000 microfinance institutions operating around the world, with institutions in South Asia and in Latin America being the early movers and market leaders.

“The whole area of social enterprise is burgeoning – and microfinance in particular – and the interesting thing is that a number of mainstream commercial banks have begun looking at microfinance as part of their overall emerging markets strategies. This creates both opportunities for traditional microfinance institutions, as well as challenges,” Mahmood says.

Citibank and Standard Chartered are among the major international banks looking to develop microfinance strategies, Mahmood says. “I think one of the big issues for the larger institutions – both the international ones, as well as the larger local ones – has been how to provide financing to the ‘missing middle’, small enterprises, medium-sized enterprises, individuals with small businesses and so on.” So although the major banks are expected to target those living on a dollar or two a day, they still see microfinance lending “as part of the overall solution because successful micro-entrepreneurs can grow into the sorts of customers that could be interesting.”  In addition, the major banks are also interested in providing capital to microfinance organisations such as Kashf, he says, and he believes this goes well beyond a mere public relations exercise.

“I think it’s increasingly becoming an integral part of their strategies for expanding in the emerging markets, but it’s very early days because, so far, most of these institutions have focused largely on the multinational client base, the large corporate client base and governmental (agencies). So it’s one piece of a larger strategy of expanding in these markets as these markets mature.”

If the experience of Kashf is anything to go by, microfinance is an area which should see sustainable growth in the years ahead. Kashf aims to have more than half a million clients by 2010 and net loans outstanding of some US$160 million. But at the same time, it’s also facing increasing competition.

“I think the competition’s going to intensify as we go along,” Mahmood says. However it’s still early days for the market, he adds, “in the sense that only a small fraction of people who could get microfinance are actually getting that kind of funding.”

Microcredit isn’t charity. The women are responsible for the repayment of loans by the others in their ‘solidarity groups’ and they’re expected to pay interest rates of around 20 per cent. But while that figure may seem high, it’s far better than the interest rates “north of 100 per cent” they may have faced otherwise, Mahmood says.

“It’s a steeper rate of interest than a credit card, but transaction costs are very high because you’re dealing with very small amounts of loans which have to be monitored and serviced on a bi-weekly basis, so you can imagine the costs of managing that type of portfolio are tremendous. I think, however, the pressure on bringing down rates will increase as more institutions step into the fray.”

In a documentary accompanying the case study, several women speak of their experiences of how microfinance has had an impact on their lives, by helping them to set up small businesses – and for the most part, the feedback’s positive.

Mahmood says microfinance isn’t a ‘silver bullet’ and won’t be able to alleviate poverty by itself. However, hand in hand with other strategies, it can help to make a difference and, going forward, he says he expects to see “a whole series of businesses attacking poverty either for purely commercial reasons or for social and commercial motives.”

“There’s been a debate developing as to whether microfinance really makes a huge difference, because providing little bits of money to people may make them a little bit better off, but not a lot. I tend to disagree because I think the entrepreneurial dynamism it can unleash and the recasting of the role of women can have a much bigger impact than the actual financial benefit that microcredit may provide.”

“So I think microfinance has two potential benefits: one is the immediate financial impact that it could deliver to somebody, the other is the longer term social and economic impact that it could create by resituating the role of women and others who are recipients of microfinance.”