Microfinance as 'social business' can become viable with institutional support in form of legal status and a regulator monitoring over them. But, remember, a social business is merely a non-loss and non-dividend business, but it definitely is not meant to be devoid of best business practices. Being a business it should have in-built mechanisms to adjust itself with the market. This means that social businesses, like microfinance institutions (MFI), must operate in a professional way to survive in the market.
However, since microcredit is a useful tool against poverty, the government should avoid creating conditions with in-built disincentives in its system. For example, there should be minimum role for subsidies. The reason: subsidies harm the basic purpose of microcredit, making their clients risk-averse and dependent upon subsidies. It reduces incentives for pursuing independent economic activities.
Likewise, a fixed cap on interest rates for their services is also not advisable as they may reduce flexibility of MFIs to innovate and expand their credit flow to the poor. However, if there are fears that MFIs would charge exorbitant rates to poor clients, there could be provisions for more reasonable interest rate caps. There can be a flexible interest rate caps, say, the government decides something like the cost of mobilising and managing the fund plus 10 or 15 per cent.
Fears about the absence of support of subsidies drying up the much needed fund flow from financial markets to the sector is very much exaggerated. Theoretically, they may seem so. But, empirical evidence may provide much needed back up for microcredit sector to attract fund flows in it. More than 98 per cent repayment rates, as proved by Grameen Bank in Bangladesh, is a credible guarantee that would assure fund flows at reasonable rates to the microcredit sector.
In case of difficult financial market situation, when interest rates go up, a well managed MFI should have a capacity to absorb these market shocks within itself. There could be several ways to manage it. First, if the financial market borrowing rates go up, the deposit rate would also go up, attracting more deposits to their coffers. Second, MFIs can also temporarily raise their lending rates to diffuse the pressure on excess borrowing from them. Third, MFIs can structure the range of their financial services and products in such a fashion that gives them scope for manoeuvre. In case of Grameen Bank, when interest rates go up, a variety of financial products offered by us helps us guard the interests of client and the bank too. In case of a very tough situation, we have to temporarily suspend all low margin financial products apart from using the last option of squeezing our margin rates to help absorb this market shock.
This does not mean that there would be not pitfalls in microcredit sector. There would be definite chances of management failure of some MFIs that may be a disaster for the microcredit sector. One management failure would create a bad reflection of MFIs' performance in financial market. It may generate undesirable insecurity over them, leading to rise in fund mobilisation costs. This may do harm to the entire microcredit flow to rural poor.
But a market or government instituted arrangement that compulsorily insures MFIs against management failures may prevent the effect of one management failure affecting the entire sector. A compulsory insurance would ensure a desired sense of security over fund flows to the microcredit sector. This could be one of the possible arrangements that would assist MFIs in borrowing funds from financial markets. Thus, an effective regulator monitoring an efficiently managed microfinance sector can prove to be a useful to 'social business' operations in markets.