Smart Subsidy for Sustainable Microfinance

This article begins by noting that worries about the dangers of excessive subsidisation have driven microfinance conversations since the 1980s. It suggests that from this time the goal of serving the poor has been twinned with the goal of long-term financial self-sufficiency on the part of microbanks.

The starting point for the article in considering smart subsidies is recognising that the same forces driving efficient outcomes in free markets – i.e. hard budget constraints, clear bottom lines, and competitive pressure – can also be deployed in contexts with subsidies. Furthermore, it argues that if deployed well, there are circumstances in which subsidies can increase the scale of microfinance outreach, access to commercial finance, and depth of outreach to the poor. At the same time, however, the article does highlight that over reliance on subsidies and poorly designed subsidies can limit scale and undermine incentives critical to building strong institutions. The concept of a “smart subsidy” stems from the proposition that subsidies are neither inherently useful nor inherently flawed. The article states that a smart subsidy maximises social benefits while minimising distortions and poor targeting.

The article begins by setting out three reasons for an opening to broader deployments of subsidies. Firstly, it notes that use of subsidies remains an ongoing part of the financial strategies of many microfinance institutions (MFIs). Secondly, it points to the argument that subsidisation is unlikely to end soon. Finally, the article sets out a number of analytical concerns. The discussion then moves on to suggest that smart subsidies should “crowd in” funding from donors rather than “crowd out”.

The article also considers the importance of subsidies in the start-up phase, both for institutions as well as for customers. For institutions, the article presents the argument that start-up subsidies have the relative advantage of being for a limited time-period and relatively transparent, thus reducing the fear of dependency. However, the paper does also put forward the case that the notion of a “start-up” subsidy could be expanded to incorporate major expansions. From the customers perspective, the article points to the example of BRAC (in Bangladesh) subsidising potential clients, through its Income Generation for Vulnerable Group Development (IGVGD) program, who were not yet ready to borrow from microlenders at “market” interest rates.

The conclusion stresses that in general, subsidies should be time-limited and rule-bound. It also notes though that if smart subsidies are deployed in the hope of producing demonstrable social impacts, those impacts should be measured using rigorous statistical analyses.

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