Can microfinance be both moral and profitable?

by Nin-Hai Tseng, reporter


FORTUNE -- There's a debate brewing in the world of do-gooder banking, pitting the father of microfinance Muhammad Yunus against a few entrepreneurs who have put an unlikely spin on Yunus' model of lending to the poor.

Earlier this week, India's biggest microlender, SKS Microfinance Ltd., made its debut on the Bombay Stock Exchange. Shares surged 18% on their first trading day.

An IPO is a rare and controversial step for a major microfinance company to take, since these lenders typically rely on donations, governments and international organizations such as the World Bank for funding. Only a handful have raised public money on the idea that helping small entrepreneurs like farmers and basket weavers gain access to financing is not only the right thing to do, but also a profitable venture.

But after SKS's strong reception, others will likely follow its lead to the public market. SKS founder Vikram Akula says going public is perhaps the only way to shore up more capital to serve more of India's poor. He wants to prove critics wrong, including Yunus, who argues an IPO would essentially mean profiting off the poor. The Bangladeshi banker and economist has been credited for pioneering microfinance, and in 2006, his founding of Bangladesh's Grameen Bank earned him and the bank a Nobel Peace Prize.

"Microcredit should not be presented as a money-making opportunity," he told The Wall Street Journal in July. "It is an opportunity to make an impact on poor people's lives."

The industry faces a sticky dilemma: to pursue morals or profits. But public microlenders argue they can have both. By getting stockholders involved, SKS raises more capital, which leads to more loans for India's poor. And more loans could eventually drive down interest rates charged to poor borrowers.

But somewhere, the economics of scale gets lost. These are high-risk borrowers. They have few, if any, assets to use as collateral. Some might own land, but don't always have titles proving this. It's hard to see how interest rates could fall much, if at all. Indeed, the pressure of answering to public shareholders could have the opposite effect, leading to higher rates for borrowers.

Microcredit was intended to help lift the poor out of poverty. If the industry's new goal is to grow profits, the noble attempt to help fund small businesses in the world's neediest area risks slipping into something as shady as a payday lender in East Harlem. It will be a fine line to navigate.

Akula, a U.S. citizen and Yale University graduate, has accomplished no small feat. Microlending is a nascent area of banking and he has managed to garner the backings of some big name investors, including George Soros' Quantum Ltd., venture capitalist Vinod Khosla, and Infosys Technologies founder N.R. Narayana Murthy. What's more, microlending is still in its infancy, and to the credit of Akula and the few microlenders that have gone the IPO route, the model deserves to be tested and retested.

But shareholders care about financial returns on investments. And while the thought of doing something good for greater society might be enough to lure some investors, will that be enough for others? To top of page