Working Paper
Donors' Support for Microcredit as Social Enterprise

The donor community has enthusiastically embraced the concept of microfinance as a promising mechanism to attain the objectives of poverty alleviation and microenterprise development. Amid the high expectation, a myth has been inadvertently created that they could be the ultimate solution to poverty reduction. The objective of the paper is to examine the nature of support rendered by the donor community to microfinance programmes and the effectiveness of this particular outlet of official aid for microenterprise development and poverty alleviation. To this end, the paper first examines economics of microfinance as an instrument of microenterprise development and poverty reduction as well as its delivery mechanisms. The paper then assesses empirical evidence of the performance of microfinance institutions and their impacts on poverty alleviation and microenterprise development. Given this background, the paper discusses main features and trends in donor support and policy implication of the analysis for the donor community. Given donors’ desire for creating and sustaining microfinance institutions as social enterprises, performance-based support is provided by donors to microfinance institutions with strong financial incentives to reach the twin targets of financial sustainability and the outreach of the poor. The paper argues that this might have produced unintended negative effects on the very objectives of poverty reduction and microenterprise development. There is an inherent tension in the two operational targets set out. Microfinance institutions are expected to be ‘subsidy-independent’ in an unrealistically short time framework and able to generate substantial surpluses over time to fulfil their social mission on an ever-expanding scale. The tension between the two targets at the conceptual level is directly translated into incredible pressures and stresses on both microfinance institutions and their clients in the fields. We also suggest there is a need to improve the design of microfinance programmes on the deeper understanding of the symbiotic relationships that have been evolving between financial and real sector development. The performance of microfinance and microcredit programmes always reflects, as well as impacts upon, the development of real economies. Rather than recommending the standardized best practice through financial engineering, there is a room for a substantial diversification of financial products and loan portfolio in offer to meet the need of the wide variety of microenterprise activities.