Outsize Returns From Investing in Microfinance

In April, Mexico's Banco Compartamos went public, raising $450 million. By the end of the first day's trading, the bank was worth more than $1.8 billion, and the people who had invested money in the bank during its early days found themselves sitting on enormous profits. It was a glorious day for Mexcian capitalism – except for one small problem: Banco Compartamos is a microfinance institution, devoted to improving the lives of the poor. What was it doing, then, improving the lives of already-rich private shareholders instead?

Development group CGAP was one of the early supporters of Compartamos, although it gave grants rather than equity capital, so it made no profit on the IPO. The group has now released a comprehensive report by Richard Rosenberg about what happened, and whether the outsize IPO profits came at the expense of the poor people Compartamos was founded to serve. In a word, it seems, the answer is yes.

The Compartamos numbers are stunning. It has a return on equity of more than 50% – something more or less unheard-of in the banking world. The interest rates that it charges borrowers are more than 100% per annum. When it went public, it did so at a price-earnings multiple of 27, and then started rising from there. When the company went public, private individuals, including Compartamos's directors and managers, owned more than 32% of the company; they're now wealthy people indeed.

Compartamos's shareholders, when the bank went public, had paid just $6 million for their equity in the company between 1998 and 2000. Their return on that investment was 100% per year, compounded for eight years.

Now, profit is not necessarily a bad thing. But excess profits like these must ultimately come from somewhere, and in Compartamos's case they seem to have come from its customers. In 1995, during the Mexican tequila crisis, Compartamos was forced to raise its lending rates to 100%. But when the crisis ended, the high rates didn't – and Compartamos's outsize profits fueled its very fast growth. That fast growth, says Rosenberg, can be defended from a development perspective.

But the bank's lending decisions were not being made purely with development goals in mind. The report concludes:

It is hard to avoid serious questions about whether Compartamos’ interest rate policy and funding decisions gave appropriate weight to its clients’ interests when they conflicted with the financial and other interests of the shareholders.

Other observers, with less of a history with Compartamos, might be less charitable still. In a narrow sense, the bank serves the poor: the poor are its clients, after all. But in a broader sense, it now concentrates on serving its shareholders, who are going to want to see its enormous profits go up, rather than down. It's good that Compartamos is making money. But it doesn't need to be making this much money.