Making over the multi-billion microfinance industry

He started by plunging into his savings and topping it off with an interest-free loan of less than $150. He then bought a phone recharging and tuck shop, quadrupling his monthly income from around 200 Bangladeshi takas — or less than $2.50 — to 800 takas. After he grew his savings and learned about personal financial management, he started a side-game of agricultural upgrades: he bought a goat that he later sold for a cow, after which he purchased three more cows to sell in a nearby market.

“Two months back he married off his little sister and was quite happy about it, because before he didn’t have the money to arrange the wedding,” says Armin Zaman Khan, an executive member at CommunityAction, a student-led organisation that provides poor Bangladeshis with interest-free microloans.

So go some of the successful start-up stories in the developing world, where hundreds of microfinance institutions lend as much as $70bn annually to financially strapped but aspirationally rich entrepreneurs. Around 600 organisations have loaned $12bn to more than 10 million low-income clients in Latin America and the Caribbean alone, according to the Inter-American Development Bank. In India, this sector has been valued at $5 to $7bn annually.

Now, some organisations with links to microfinance institutions are looking to spur similar activity in the Middle East and North Africa. Kiva is a non-profit that boasts a network of more than 160 microfinance partners that have helped loan $368m since 2005. “We’re hoping to expand over the next couple of years [in Mena], so Kiva can be one of the main players,” says Michael Looft, Kiva’s regional director for Europe, Asia and the Middle East.

Credit for sparking the global microcredit movement largely goes to a Bangladeshi economist and banker — Muhammad Yunus — who created Grameen Bank. In 2006, they jointly won the Nobel Peace Prize “for their efforts to create economic and social development from below.” All of a sudden, creditors from around the world started aggressively courting small-fry entrepreneurs and touting default rates of just one to two percent.

But heated growth in the industry has also ignited a financial firestorm of controversy. Some microfinance institutions have been criticised for charging high interest rates that can range from 15 to 50 percent but top 100 percent, most notably in unregulated markets. Other organisations have been attacked for aggressive collection methods that have “resulted in cases of forced prostitution, child labour, suicide, and nationwide revolts against the microfinance community,” argues a new book from Hugh Sinclair, an industry insider who wrote Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor.

“Microfinance went through the same mistakes as banks,” says Celia de Anca, director of the Saudi-Spanish Center for Islamic Economics and Finance in Madrid. “It became a business and it was fashionable, so everyone went into it. Now, there’s a lot of criticism against them.”

Even Yunus has come under fire. Last year, he was forced out of the bank he founded, reportedly because he did not comply with a certain rule when he created Grameen. Meanwhile, his country’s prime minister, Sheikh Hasina, has accused some microlenders of “sucking blood from the poor in the name of poverty alleviation.”

Lenders say they have no choice but to charge high administrative costs to reach remote areas, or because they can’t invest money from clients the same way normal banks do. “It’s really hard because every market is different,” says Looft. “In some places you see high interest rates but they’re serving a bunch of islands and their costs are so high.”

Even so, some players in this sector have responded by trying to distance their lending practices from others that have been knocked for high costs.

Article continued on next page…

CommunityAction, for example, notes that its loans are entirely interest-free, and that it expands its client base of entrepreneurs through donations and zakat contributions. The organisation also emphasises that it is “not a conventional financial institution,” says Khan.

Initially, many microfinance institutions designed their financial products for whole communities. If one entrepreneur could not pay the money back, others would be expected to cover the outstanding loan, says de Anca. The peer pressure encouraged residents to support each other, and step up to help before one of their own failed at a venture. “I think [lenders] misunderstood the idea, and they started giving loans to one person,” says de Anca. “Of course, with one person the risk is enormous — you put like 90 percent interest because that’s the only way to make it profitable.”

As more loans rolled out targeted at individual entrepreneurs — basket weavers, farmers, shop owners and the like — they required individuals to put up assets such as a home as collateral in case someone defaulted. Inevitably, some people did and lost everything.

Behind the scenes, some advocates of the microfinancing movement say they are trying to clean up parts of their industry. One area of focus: questioning the promotion of low default rates as a metric for success.

Kiva, which has an online platform where anyone can support an individual entrepreneur with a microloan, boasts a 98.97 percent repayment rate for loans provided by these people as well as partner microfinance institutions. Yet Looft says some of the bigger lenders in Kiva’s network could be neglecting a pool of poor people because they lack credit histories or sufficient assets to put up as collateral. In short, they are the riskiest of microloan recipients.

“The question is always are we reaching the poorest of poor,” says Looft. “Our partners — they make a decision of who they put on Kiva, and we want them to put people on here that need it the most. We try not to emphasise the repayment rate.”

Kiva says it is also applying pressure on some of its partner lenders to lower their interest rates. One microfinance institution recently left the group’s network because it refused to cut its costs.

This month, graduate students from IE Business School in Madrid are visiting Ghana to offer pro-bono services to microfinance institutions, some of which are looking for ways to boost transparency, cut interest rates and create personal finance programmes in response to recent regulations that have rolled out to better protect entrepreneurs. An organisation called Financieros sin Fronteras links the students with microfinance institutions in Ghana, where it is trying to professionalise the sector “so that those excluded from the conventional banking system can have access to quality financial services at affordable prices and tailored to their needs”.

Part of the organisation’s solution includes getting capital for microfinance institutions through institutional investors, rather than commercial banks. That’s because interest rates charged to entrepreneurs could be lower — by about half — than what might otherwise get charged. It all adds up for small-scale start-up owners, whether they owe $20 to $150 in loans for farm equipment or street vendor stalls, or $250 for ventures in urban settings.

“Our goal in the end is to put [lenders] in contact with institutional investors, because the sources of funds that they have in Ghana have really high interest,” says Maria Luque Calvo, executive manager of Financieros sin Fronteras.

“And, if those funds have really high interest, they have to charge that interest plus other things to their clients, so at the end their impact is not that big.”