Microfinance Part 1

Microfinance! Microloans! Microenterprise OH MY! The panacea to cure all poverty!   A few years back I heard about the phenomenon that was sweeping the development world, and even crossing over to the celebrity advocacy world.  Bono was calling for it, politicians on both ends of the ideological spectrum were touting it, even the gorgeous sweetheart, Natalie Portman, is a ambassador and spokeswoman for a microfinance organization. The idea is simple.  Give a small loan to the poorest of poor that fall through the financial cracks of commercial banks.  Some people are so poor that they are incapable of manifesting adequate collateral, and are thus deemed too risky and too much hassle to be the recipient of a loan.  Long story short, along came the Bangladeshi economics professor, Muhammad Yunis. He created an experiment and used his own cash to issue loans to women entrepreneurs on a tiny scale. Yunis found it was a huge success, and started the Grameen Bank. He would prove to be the pioneer and trailblazer that would kick-start an explosion that would result in millions and millions of loans being issued in slums and villages on every continent.

There are many different variations to administer microloans, but most lenders follow a few tenants. Loans are typically given to groups.  Groups can range from as small as 5 people to as large as 30.  The group all pays at the same time, and if the group defaults on the loan, then they will not be issued any further loans. If one person is unable to repay her share then others will pay for her. This creates a group liability because nobody wants to pay another persons’ burden, the group will create a peer pressure effect where they will do their darndest to make sure every member holds on to their end of the bargain.  The group will also support and encourage each other by giving advice, bouncing ideas off each other, and cultivating friendships and community.  Lending organizations love giving to groups because it shifts the burden of administration largely to the groups.  It is so much easier for a loan officer to visit a group of 15 people once a month, than to make 15 individual trips to 15 people.  It is also necessary to lower administrative costs because often times loan officers have to spent a lot of time and resources to travel to remote villages to collect loans.  Also, with giving to the poor, they are often instructing undereducated and at times illiterate people, so the loan officers have to spent costly time to educate them on business and budgeting concepts.  As previously mentioned, poorer people also have more risk, and lending organizations turn to group liability to help absorb the costs of missed payments.

It is also estimated that some %90 of all loan recipients are women.  Women are the backbone of the developing world’s culture (just like my mom and wife have been the solid bedrocks to my life. Amazing women, straight up).  They work the fields, earn the wages, and take care of the family.  They are also typically the most fiscally responsible of the two genders.  Unfortunately they are not who hold the power in relationships.  Men so often hoard money for their own pleasures, and if the woman objects, they run the risk of being abused verbally, physically, and even sexually.  Many microlenders give to women with the social goal to empower them, but also because they many times have the best rate of repayment.

It’s easy to see why microfinance became all the craze.  Repayment rates for many organizations were better than some commercial banks, so it appears to be self-sustaining. Conservatives love it because it’s a “hand up, rather than a hand out”.  People are able to lift themselves up by their own bootstraps.  Liberals also love it because it has huge potential to be socially empowering to woman, and many social programs can be enacted concurrently to disbursing loans.  Stories after stories of success were highlighted where women were able to lift themselves up out of poverty.  Woman would buy a sowing machine with their first microloan, and then in subsequent loans would build a business and employ multiple other woman.  People gobbled it up. Huge aid organizations and tiny NGOs alike designed and implemented programs.  Governments, philanthropists, venture capitalists all threw huge amounts of money at this miracle cure to poverty.  The end to material suffering was over!

Wait a second. Time out.

Solving the world’s greatest problem couldn’t be that easy, could it?

Let’s look at it this way. Are you an entrepreneur? Do you even aspire to own your own business? Would you be willing to take out a loan to do this?  Some of you would obviously answer yes to this, but I personally have no desire whatsoever to do what it takes to launch my own business.  I definitely don’t have the know-how to manage people, suppliers, budgeting, marketing, and all the other myriads of aspects of running a business. Even if I were to have all that knowledge and drive to succeed, there’s still the chance that the business simply won’t work.  The fact is, not every person is meant to be an entrepreneur.  All these microfinance organizations put out these heartwarming success stories. That’s awesome. There are truly remarkable stories coming out of microenterprise and I want to celebrate that.  The problem arose though because the movement in large part grew on anecdotal evidence rather than hard quantitative, randomized study that shows causation.

The pristine and promising name of microfinance eventually started to take some hit in the last few years for a number of reasons.  Just as there were heart-warming stories of success of the loans, eventually the gut-wrenching stories of failure emerged.  It’s hard enough hearing stories of people stuck in poverty, but when they are pitched deeper into poverty through the debt they take on, it can be truly demoralizing.  It cannot be understated that taking on debt is a huge risk.  This is especially true for the poor, who have many less buffers from shock than we do.  When school fees take up well over %50 of you income, when war, famine, or natural disaster strike, when easily treatable diseases become life threatening, or when an irresponsible husband siphons money for alcohol, even the most prudent and savvy business person cannot cope with such a razor thin line of disaster.  The microfinance name also took a huge hit when stories came out of India that the pressure of debt became so great on some that there became repeated instances of suicide.

In addition to the horror stories mentioned above, peoples’ attitudes began to cool toward microfinance when for-profit lenders saw the economic bubble growing in the microfinance industry. Instead of benevolent organizations such as Muhammad Yunis’s Grameen Bank, some predators came looking to make profit.  I am not saying that all for-profit microlenders are swindlers and cheats, because they are not, but it muddied the waters. In fact some large nonprofits opened themselves up to public investments and gained for-profit status.   In some countries, just like with our current financial crisis, there was an oversaturization of lenders that were pushing bad loans on people, many people became multiple borrowers, and many people defaulted on their loans and the bubble burst.  All of these issues converged and critics started to paint microfinance to be glorified payday loan sharks; usury at it’s finest.

So hold on.  At first it was a cure, now it’s a curse?

In reality, microfinance is neither.  Under the right circumstances loans can be a great and empowering thing, but under the wrong circumstances they can have disastrous consequences.  Diligent researchers are exploring when it is successful and when it is not.  It is important to have a balanced view of the subject, and to maintain an open, yet critical framework.  Child Voice has tried microfinance with some of their former graduates with mixed results.  Brad, another intern and I, have the pleasure of exploring what worked, what didn’t, and how we can improve upon the program.  This blog is too long, so I will post another blog soon and I will let you know what we have been up to!  I will just say, it has been truly inspiring to learn of the stories the girls have gone through and are continually facing. STAY TUNED!!

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