I worked for a microfinance organization, so it’s a little strange that I have not come around to talking about it yet, but a recent New York Times article touched on all of issues surrounding microfinance that I have been pondering. So I guess its time for me to confront my opinions.
Microfinance has been hailed by Muhammad Yunus and many others as the elusive formula to improving the lot of the world’s poor. It is thought that providing small loans to poor people will allow them to pull themselves out of poverty by virtue of no longer having working capital constraints on their entrepreneurial ventures.
One must first consider that lending to poor people is not, in and of itself, a novel idea. People with capital have always been there to lend it to those who don’t have access to it, and to take profits off the top. We called these people loan sharks, and have long stigmatized them in film. They sit in dimly lit rooms and finance a protagonist at a time of desperation. Later, when the loan goes sour, they use violent methods of collection.
There are certainly these sorts of loan sharks out there, but that is not the whole story. Some are just moneylenders, respected members of their communities, attempting to fill a capital gap because banks, the “formal” arbiters of small business finance, refused to lend in these communities. The banks considered it too costly to reach these borrowers, and the interest to be earned off of their small balances, has not traditionally been worth the effort.
Enter microfinance. It has always been an attempt to “formalize” the practice of small-scale lending, to provide safe and affordable access to capital to the segments of society forced to rely on predatory lenders. And formalize they did. MFIs simply institutionalized the practice of community lending that existed, which is why many people remain so skeptical. The interest rates still appear predatory and there are still rumors of abusive collection practices.
The question of whether or not small loans, in and of themselves, can eradicate poverty is hotly debated. After much internal debate, I have come to the conclusion that, financially speaking, it is simply not feasible. Even the cheapest microfinance organization is lending at well above 20% APR and thus for this sort of small-scale entrepreneurship to be sustainable, microborrowers would have to be earning above that. Now, imagine what Compartamos borrowers would have to earn.
But not even the largest, most efficient corporations in the world are capable of consistently earning returns like that – the market average is, at best, 10%. If it were indeed the case that microentrepreneurs could consistently earn 30-130% on borrowed capital, we’d all be hawking handmade goods on the street and selling fish out of the back our cars, and you can be damn sure that banks would be lending to us. This is why the interest rate question is so important, because if you can’t earn above the cost of borrowing, the only options are then deeper indebtedness (i.e. more microlending) or bankruptcy.
But I am still a huge proponent of microfinance.
The way I see it, microfinance is the stepping stone between the bottom of the pyramid and the true engine of wealth building, savings. Microfinance has introduced millions to formal financial services, and as MFIs struggling to become self-sufficient have turned to collecting deposits, they are introducing people to the real consumer benefits of banking, saving.
In the future, we will see that MFIs simply laid down the distribution channels, proving that the poor demanded financial services and that they could be reached affordably – that was the true innovation. And as mobile technology and other innovations bring down the cost of banking to the poor, the logical conclusion of the story, like it or not, will be the transformation or consolidation of MFIs into the traditional banks. MFIs may survive as full-time distributors, selling loans and receivables between banks and borrowers, but the net effect will be the same, JP Morgan and co. trolling around the bottom of the pyramid.
The reason this scares people is that they think banks will profiteer off of the poor. But one should remember that banks are heavily regulated with respect to the interest rates they can charge; the same cannot be said for all MFIs, especially non-profit ones. If there is any reason that banks and MFIs can get away with charging exhorbitant interest rates, it is because the local usury laws permit it.
This is not a question of greed and profit margins. It is a question of democracy, the will of the people and the rule of law. It is about what interest rates we as a society are willing to accept.
At the end of the day, if we get the laws right, we will have expanded access to financial services to all corners of the globe, with regulated lending and the opportunity to save open to all.
And isn’t that what we truly want? Because think about it: if the end of this story is not about savings, are we not just creating another generation of debt-addicted citizens? Are we not just blowing up another lending bubble?
[The caveat of all this, of course, is financial literacy and how well we educate ourselves on the responsible use of financial services. This is not limited to the poor. It should be a mandated part of high school curriculum for all]