Lucka 22: Microloans – Can you and I empower the poor?

Kiva - The Pedro Story. Picture:zipckr

Micro-credit – the once glistening halo of the proposed panacea for poverty – seems to have all but lost its shine. But as many microfinance institutions (MFI) have caused scandals world-wide there is an alternative. In order to avoid ludicrous interest rates, companies are now offering you and me to become personal investors of underprivileged people around the world. Would you like to support a farmer in Bolivia? Or perhaps a shopkeeper in Tanzania? Have your pick! Could this be a viable alternative to traditional MFIs?

By: Benjamin Sjögren

The idea

Six years ago Muhammed Yunus, the developer of the concept of micro-credit, received the Nobel Peace Prize together with the Grameen Bank. Their idea, tracing back to the 70’s, of easier access to credit for the lower social strata of Bangladesh at marginal interest rates and no collateral was revolutionary. The Nobel committee motivated their choice as follows: “[for creating] economic and social development from below. Lasting peace cannot be achieved unless large population groups find ways in which to break out of poverty. Micro-credit is one such means”.

The praise for MFIs as an effective engine for pro-poor growth seemed justified. This was until reports started coming in of MFIs giving loans at outlandish interest rates. The perhaps most instrumental part of the viability of microcredit, low interest rates, was quickly forgotten as finance institutions realized that there was money to be made from poor people. To paraphrase a poignant humorist: “If you want to get rich – go after the poor. They may not have a lot of money but there sure are lots of them out there”. The relatively informal nature of micro lending leads to less regulation and consequently more opportunity to exploit people in desperate need of money. Furthermore, costs of administering loans in the developing world are higher percentagewise as the amounts are smaller but the costs are roughly constant no matter the amount of money being handled. MFIs have a global average annual rate of 37 percent but many countries average twice as much while some MFIs have rates in the three-digits. Basically, micro credit has meant a more established platform for loan sharks to abuse. “We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks”, says Muhammed Yunus. As a result, countless impoverished people are further marginalized as all their belongings are stripped away from ruthless MFIs. Many see no choice but to take their own lives.

The effects

Another question is how big of an impact micro-credit has on lifting people out of poverty. As it is, the data suggests that it has no considerable effect. In some cases it helps and in other cases it doesn’t but overall there is no evidence that shows that microfinance programs have positive impacts. Its appeal lies in the fact that we believe that we can help empower poor people to lift themselves out of poverty with ingenuity and entrepreneurship. But the fact is that the image of the poor as all being budding entrepreneurs is also a bit disingenuous. Many use micro-credit for instant consumption rather than a way to start up businesses which means that the loan yields no extra income that can repay the loan with interest. Consequently, they become worse off than they were before the loan. Furthermore, in many places where micro-credit is available there is little interest among the poor to get a loan in the first place. The notion of poverty as simply being a lack of money seems to be at the core of the idea of micro-credit. Naturally, poverty is a phenomena much more complex than that. Not only is the economic aspect important but social, political and human rights are also fundamental pillars in fighting poverty. Hopefully micro-credit can one day be a more powerful tool in the tool box of a more holistic approach to fighting poverty.

Picture: Kiva

Kiva – person-to-person lending

Be that as it may, many still have strong hopes for the concept of micro-credit. The recent development is person-to-person micro-lending sites. The organization Kiva set the trend in 2005 as they introduced the concept of empowering individuals like you and me to give interest-free loans to hardworking but underfunded entrepreneurs around the world. We get to browse their website, and others like it, for stories about Feliciano in El Salvador who wants to buy cows or Mirembe in Uganda who wants to improve her stock for her shop. We can then choose to finance them with at least $25 at no interest and with no guarantee of repayment. Their repayment rate to date is 99 % and as most lenders get their money back they will often use it to finance another entrepreneur. This seems an excellent way of excluding high interest and loan sharks. And if I, for example, were to not get back the $25 I lent to a women’s group in Paraguay my life will quality will not diminish in the slightest. And at the very least I have earned myself some feel-good points.

However, when one digs a bit deeper a somewhat different story is found. Although Kiva do not explicitly lie their perceived image is perhaps somewhat misleading. The supposed person-to-person connection between lender and borrower does not really take place as such. Instead, Kiva partner up with field partners, such as MFIs, non-profit organizations etc, around the world who are the actual organizations that supply the loans. In fact, the people that we can help finance on Kiva’s website have already received their loans despite Kiva’s graphs telling us that only $50 out of the $1075 that Yolanda in Ecuador asked for has been raised. Hence, you are not connected with the person of your choice but rather with the funds of the MFI who supplies the loans to people of their choice. Naturally, borrowers should not have to wait for Kiva users to decide if they want to lend money for them to be able to expand their business. Loans could not feasibly work like this as opportunities that loans bring are often temporary and timing is often of the essence.

A group of borrowers on Kiva's website. Picture: zipckr

So if I did not help the women in Paraguay directly at least I helped an organization that provide people like them loans. However, this means that I and many like me supply MFIs with interest-free capital which they in turn lend with interest at an average of 35 %. A point of interest is that roughly 20 % of Kiva’s Field Partners are for-profit lender, with a strong social mission, but Kiva claim that their profit is almost 0 % and it is merely to cover the costs of running the organization. Also, the repayment rate of 99 % purported by Kiva is most likely erroneous as their Field Partners most likely will cover up defaulted loans as to maintain a reputable partnership with Kiva.

A better alternative?

There are many websites, such as Zidisha and Microplace, that offer services similar to those of Kiva. Although I feel that the image of a person-to-person connection between borrower and lender is contrived it still seems to hold more promise than traditional MFIs as a large part of the capital is supplied to the MFIs at no interest which means lower interest for the borrowers. Hopefully, this arrangement can also maintain a loan shark-free environment when millions of dollars go through the system. Only time will tell. And if the false “connection” between me and the women’s group in Paraguay can help raise money I cannot help but feel that it is worth it. People would probably not, to say the least, be as excited about lending impersonal MFIs the same amount of money. For now, the ends seem to justify the means.