Micro finance is now big business

In recent years, the idea of giving small loans to poor people has become the darling of the developing world, hailed as the long elusive formula to propel even the most destitute into better lives.

Actors like Natalie Portman and Michael Douglas lent their boldface names to the cause. Muhammad Yunus, the economist who pioneered the practice by lending small amounts to basket weavers in Bangladesh, won a Nobel Peace Prize for it in 2006. The idea even got its very own United Nations year in 2005.

But the phenomenon has grown so popular that some of its biggest proponents are now wringing their hands over the direction it has taken. Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 per cent or more.
“We created micro credit to fight the loan sharks; we didn’t create micro credit to encourage new loan sharks,” Yunus recently said at a gathering of financial officials at the UN. “Micro credit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.”
The fracas over preserving the field’s saintly aura centres on the question of how much interest and profit is acceptable, and what constitutes exploitation. The noisy interest rate fight has even attracted Congressional scrutiny, with the House financial services committee holding hearings this year focused in part on whether some micro credit institutions are scamming the poor.

Rates vary widely across the globe, but the ones that draw the most concern tend to occur in countries like Nigeria and Mexico, where the demand for small loans from a large population cannot be met by existing lenders.
The average in Mexico itself is around 70 per cent, compared with a global average of about 37 per cent in interest and fees, analysts say. Mexican micro finance institutions charge such high rates simply because they can get away with it, said Emmanuelle Javoy, the managing director of Planet Rating, an independent Paris-based firm that evaluates microlenders.

Underlying the issue is a fierce debate over whether micro loans actually lift people out of poverty, as their promoters so often claim. The recent conclusion of some researchers is that not every poor person is an entrepreneur waiting to be discovered, but that the loans do help cushion some of the worst blows of poverty.

“The lesson is simply that it didn’t save the world,” Dean S Karlan, a professor of economics at Yale University, said about micro lending. “It is not the single transformative tool that proponents have been selling it as, but there are positive benefits.”
Still, its earliest proponents do not want its reputation tarnished by new investors seeking profits on the backs of the poor, though they recognise that the days of just earning enough to cover costs are over.

“They call it ‘social investing,’ but nobody has a definition for social investing, nobody is saying, for example, that you have to make less than 10 per cent profit,” said Chuck Waterfield, who runs mftransparency.org, a website that promotes transparency and is financed by big micro finance investors.

Distribution
The micro finance industry, with over $60 billion in assets, has unquestionably outgrown its charitable roots. Elisabeth Rhyne, who runs the Centre for Financial Inclusion, said in Congressional testimony this year that banks and finance firms served 60 per cent of all clients. Nongovernmental organisations served 35 per cent of the clients, she said, while credit unions and rural banks had 5 per cent of the clients.

Private capital first began entering the micro finance arena about a decade ago, but it was not until Compartamos, a Mexican firm that began life as a tiny nonprofit organisation, generated $458 million through a public stock sale in 2007, that investors fully recognised the potential for a windfall, experts said.

Although the Compartamos founders pledged to plow the money back into development, analysts say the high interest rates and healthy profits of Compartamos, the largest micro finance institution in the Western Hemisphere with 1.2 million active borrowers, push up interest rates all across Mexico.

But poor borrowers are often too inexperienced and too harried to understand what they are being charged, experts said. In Mexico City, Maria Vargas has borrowed larger and larger amounts from Compartamos over 20 years to expand her T-shirt factory to 25 sewing machines from 5. She is hazy about what interest rate she actually pays, though she considers it high.

The micro finance industry is pushing for greater transparency among its members, but says that most micro lenders are honest, with experts putting the number of dubious institutions anywhere from less than 1 per cent to more than 10 per cent. Given that competition has a pattern of lowering interest rates worldwide, the industry prefers that approach to government intervention.

Yunus says interest rates should be 10 to 15 per cent above the cost of raising the money, with anything beyond a ‘red zone’ of loan sharking. “We need to draw a line between genuine and abuse,” he said. “You will never see the situation of poor people if you look at it through the glasses of profit-making.”

Many experts label Yunus’s formula overly simplistic and too low, a route to certain bankruptcy in countries with high operating expenses. Costs of doing business in Asia and the sheer size of the Grameen Bank he founded in Bangladesh allow for economies of scale that keep costs down, analysts say. “Globally interest rates have been going down as a general trend,” said Emmanuelle.
But experts also acknowledge that banks and others who dominate the industry are slow to address problems.

Like Mexico, Nigeria attracts scrutiny for high interest rates. One firm, LAPO, Lift Above Poverty Organisation, has raised questions, particularly since it was backed by prominent investors like Deutsche Bank and the Calvert Foundation.
Godwin Ehigiamusoe, LAPO’s founding executive director, defended his company’s high interest rates, saying they reflected the high cost of doing business in Nigeria. For example, he said, each of the company’s more than 200 branches needed its own generator and fuel to run it.

At Kiva, which promises on its website that it “will not partner with an organisation that charges exorbitant interest rates,” the interest rate and fees for LAPO was recently advertised as 57 per cent, the average rate from 2007. After ‘The Times’ called to inquire, Kiva changed it to 83 per cent.

Questions had already been raised about Kiva because the website once promised that loans would go to specific borrowers identified on the site, but later backtracked, clarifying that the money went to organisations rather than individuals.
Promotion aside, the overriding question facing the industry, analysts say, remains how much money investors should make from lending to poor people, mostly women, often at interest rates that are hidden.

“You can make money from the poorest people in the world — is that a bad thing, or is that just a business?” asked Waterfield of mftransparency.org. “At what point do we say we have gone too far?”
The New York Times