Managers at banks specializing in microfinance, the business of granting small loans to the poor, are fond of quoting the well-known adage, “Give a man a fish and you feed him for a day; teach a man to fish and you feed him for a lifetime.”

About 1,000 banks and financial institutions in emerging nations are putting that teach-a-man-to-fish adage into practice.  They are proving that if you provide small loans to select groups of poor people, especially rural women who are the largest bloc of microfinance borrowers by far, you can help them to prosper for a lifetime -- and make a superior profit for yourself.  As such, we believe microfinance ranks as one of the most encouraging global economic and social developments in decades; it’s a practical way to put altruism into action, combat rural poverty, and aid women in particular in their struggle against often repressive social conditions in emerging nations.

Philanthropy News Digest made this case -- eloquently, we think -- for the economic and social benefits of microfinance: "The world’s poor do not need vast government-led, top-down programs of relief, aid, and development; what they need is access to credit, which in turn can be used to create small businesses that lift them, their families, and their communities out of the cycle of abject economic dependence that characterizes much of the developing world. . . the difference between poverty and economic self-sufficiency may only be the price of a set of hand tools, a sewing machine, or a bolt of cloth."

Three banks stand out

We consider three foreign banks to be among the leading practitioners of microfinance: Bank Rakyat (headquarters: Jakarta, Indonesia; market capitalization: about $12.6 billion), Compartamos Banco (headquarters: Mexico City, market capitalization: about $2.3 billion), and Credicorp (headquarters: La Molina, Peru; market capitalization: about $7.2 billion). As an aside, we would note that Credicorp’s microfinance business is fast growing but relatively small, especially in comparison with the microfinance operations of Bank Rakyat and Compartamos Banco.

All three banks typically lend relatively small amounts of money by Western standards -- a few thousand dollars or less -- to people for less than a year, which enables the loan capital to be recycled quickly into more loans. The loans are largely a win-win situation for them and their borrowers.

For microfinance banks generally, the net-interest margins on the loans are high, reflecting the premium interest rates charged as compensation for the high degree of credit risk involved, since the borrowers are poor and have little or no credit history. Bank Rakyat, Compartamos Banco, and Credicorp have consistently generated some of the highest net-interest margins of any banks in their home countries over the past three years, even during the recession year of 2008.

The height of those margins is also due to this phenomenon: microfinance loans have a higher repayment rate -- more than 95% -- than that of conventional loans of commercial banks around the world, according to The New York Times. For Rakyat, Compartamos, and Credicorp, the repayment rates are even higher. For instance, nonperforming loans account for just 2.4% of Compartamos’ portfolio. The percentage is lower still for the bank’s core business, loans to women: 0.87%.

Peer pressure effective

In our opinion, the reason why the repayment rate is uncommonly high is that microfinance loans are generally made to small groups and thus capitalize on the power of peer pressure, that overriding social force that permeates village life around the world, from Prampram, Ghana to Poutasi, Samoa: if you stop paying your portion of the loan, your co-borrowers must pay for you.

The resulting combination of high net-interest margins and high repayment rates has helped Rakyat, Compartamos, and Credicorp to increase their net income by more than 20% annually in the past three years. We think all three can sustain growth in net income of more than 20% over the next two or three years.

For the borrowers, who mostly have been denied credit in the past, the loans empower them to improve the quality of their lives by doing things like purchasing dairy cows for producing milk and cheese, bamboo for weaving stools, yarn for knitting garments, kilns for crafting pottery, and human hair for making wigs and hairpieces. Not all of these business ventures succeed, of course, but studies indicate that the loans help cushion some of the worst blows of poverty, according to research by the Department of Economics at Yale University.

Even $12 helps

The microfinance-loan concept was conceived by Dr. Muhammad Yunus, an economist from Bangladesh, who established a bank in 1976 to provide tiny loans to the poor -- people such as widows, abandoned wives, laborers, rickshaw drivers, sweepers, and beggars. As the pioneer in microfinance, Dr. Yunus set out with two simple beliefs: 1) the poor could build small businesses if they were awarded credit and 2) loans as small as $12 could make a difference. For championing microfinance, Dr. Yunus was awarded the Nobel Peace Prize in 2006.

His brainchild has expanded into a $60-billion industry that we think can grow at double-digit annual rates for years to come. In our judgment, the market for microfinance is still largely underserved. Consider these projections:

*  Compartamos estimates that its potential market in Mexico is 13 million households, representing about half the nation’s population. Its current customer base: 1.3 million.

*  Microfinance may ultimately serve more people in India than the regular banking system does, according to Citigroup. Currently about 70 million people in India have microfinance loans, while about 200 million patronize the banking system.

*  The microfinance market in Indonesia is in no danger of saturation until 2019 at the earliest, Credit Suisse says.

*  Deutsche Bank conservatively estimates the current global demand for microfinance loans is $250 billion -- more than four times the amount that has been lent recently.

Let’s share

Worldwide, microfinance is a relatively young industry: banks and financial institutions began offering microfinance loans only about a decade ago. Most Wall Street analysts agree that microfinance truly arrived as an industry after 2007, when Compartamos, which was formerly a nonprofit enterprise (its name in Spanish translates as "let’s share"), raised $468 million in an initial public offering. Compartamos managers say the stock sale above all demonstrated that microfinance could be profitable and could transcend its charitable roots by attracting private capital.

Some social activists complain that the influx of private capital and profit-seeking competitors into microfinance is a dangerously corrupting influence. They point out that some new competitors are charging 100% or more on microfinance loans. Interest rates tend to be highest in countries like Nigeria and Congo, where the demand for microfinance loans can’t be met by existing lenders and where autocratic political regimes make the loans a dicey business.

In Nicaragua in 2009, President Daniel Ortega had his own unique blunt ax of a response to microfinance rates of more than 30%, a response that would be unavailable to, say, the governors of the Federal Reserve Board in the United States: he orchestrated the closing of some micro-financiers that were considered especially rapacious and backed a new institution permitted to charge only 8-10% on loans. For his part, Dr. Yunus, the founder of microfinance, has been a vocal critic of high microfinance rates: "We created microcredit to fight the loan sharks. We didn’t create microcredit to encourage new loan sharks."

Putting profits before people?

For instance, critics have accused some microfinance banks of putting profits ahead of their customers. To help address that criticism, Compartamos and more than 30 other microfinance institutions adopted a code of conduct designed to protect borrowers from financial exploitation. The code commits the signees to avoiding irresponsible lending that can lead to excessive indebtedness, à la the U.S. subprime-mortgage fiasco; adopting transparent pricing and non-abusive collection practices; protecting borrowers’ privacy; and offering more options to borrowers when they are unable to meet their loan obligations.

In our judgment, most microfinance lenders aren’t guilty of gouging the poor, and our contacts estimate that dubious microfinance institutions amount to fewer than 5% of the total. We think competition, the great business leveler, may purge many of the suspect lenders from the system. High profits tend to attract competition the way outdoor lighting attracts moths, so as more financial institutions are drawn to the microfinance field, they should help to correct any excesses in loan rates. However, it should be noted that more competition will also likely erode the average net-interest margin on microfinance loans, making them less profitable.

As we see it, the biggest prospective risks that could stifle the future growth of microfinance lending include the following: a surge in the number of defaults on loans; the lack of regulation to curb lending abuses; a rash of poor lending decisions due to a scarcity of standardized information about borrowers; the failure of micro-financiers to monitor how borrowers are actually using the loan money; and a sharp slowdown in the economies of emerging nations. We think none of these risks pose a significant threat today, and in any event microfinance’s high growth rate and strong fundamentals should offer a buffer if any of the risks happen to worsen in the near term.

In sum, microfinance may continue to achieve the financial-services equivalent of teaching a man (or more accurately, a woman) to fish and thus help reduce global poverty. And we think Bank Rakyat, Compartamos Banco, and Credicorp, among others, can continue to do well financially by doing good with their microfinance loans in the next few years.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change. They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities. Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios. Earnings growth may not result in an increase in share price. Past performance is no guarantee of future results.

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Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm with more than $16 billion in assets under management in stocks, as of June 30, 2010. Turner manages growth, global/international, core, value, quantitative, and alternative separately managed accounts and mutual funds for institutions and individuals.

As of June 30, 2010, Turner held in client accounts 5.7 million shares of Bank Rakyat, 41,651 shares of Compartamos Banco, and 3,066 shares of Credicorp.