Tag Archives: Microfinance

What Do I Think of Microfinance? Pt. 2

This is part two of a two-part post on microfinance.  Part one can be read here

In the last post, I gave a rundown of the mechanics of microfinance and explained the criticism of high interest rates.  Another criticism came from development economists like Dean Karlan, founder of Innovations for Poverty Action and pioneer in the utilization of randomized controlled trials for determining the efficacy of development interventions, and Jonathan Morduch, who, in his seminal book, Portfolios of the Poor, found that microfinance had limited impact in increasing incomes for clients.  They found that, contrary to conventional wisdom, microfinance was actually most beneficial in “smoothing consumption.” Most people living $2 a day do not actually earn $2 every day.  Instead, they might earn $10 one day and nothing for the rest of the week.  So the consistent capital offered by a microfinance loan actually allowed them to feed their families and pay school fees when no money was coming in.

My opinion on the effect of microfinance has largely remained unchanged.  First, I understand and recognize the necessity of charging high interest rates.  In order to maximize their impact, MFIs must be profitable to some degree and operated largely unsubsidized if they are to be sustainable.  If this means charging higher interest rates, so be it.

Regarding the criticisms from the development economists, a randomized controlled trial conducted over a two-year time frame is hardly a sufficient time frame to determine whether microfinance is an effective tool of poverty alleviation.  The effects are generational.  If a microfinance loan allows someone to keep their child in school consistently and maybe even graduate high school when they otherwise would have pulled them out to work on the family business, the impact on the community will not be felt until that child is grown and is sending money back from his or her well-paying job in the city in the form of domestic remittances.  This is a 20-year time frame, at the minimum.  To my knowledge, no longitudinal study comparing communities served by microfinance with those that are not has yet to been done.

Secondly, there are some incredible success stories of clients bringing themselves out of poverty as a direct result of microfinance loans.  I know because I met some of them – the ones who started with a loan to build a small stall to sell vegetables, and expanded to purchase a small restaurant, a piggery, and a motorcycle repair shop.  These stories cannot be discounted and, even if they were all that microfinance had to show for its efforts, that to me is enough.

Thirdly, microfinance institutions offer benefits beyond simply credit.  I have documented on this blog many times the different products offered by NWTF and other institutions.  Mass weddings for those who could never afford it, life and health insurance for families who are constantly in danger of falling deeper into poverty with a single illness, and financial literacy trainings to help them better run their businesses.  MFIs also act as a distribution channel for products that might never reach the base of the pyramid market.  Clean cookstoves, solar products, and other products can be sold to the hundreds of thousands of microfinance clients who, at least once a week, convene with a potential salesperson.

Lastly, and most importantly, I believe in the free market and the right for people to choose what they think is best for them.  Most recently, I worked for a company whose mission – to provide an affordable, low-cost alternative to public education – is fundamentally libertarian (namely, school choice is a good thing).  Criticizing microfinance institutions for misleading clients and offering a service that is flawed is, to my mind, patronizing to the clients who subscribe to the model.  If the women taking loans from microfinance institutions felt they were being exploited, they would cease to take them, just as parents would pull their kids from Bridge schools if they felt their child was not being educated.

People in the development world too often underestimate the ability of the people they purport to serve to make rational decisions.  I don’t, and, if I did, I might have the same criticisms.  But I do, and have stated my reasons for doing so many times on this blog.

To try to document all of the benefits I see to microfinance would take far more time than I would like to allot in this segment of my re-cap of the last three years.  In future posts, I will elaborate on other issues in microfinance.  But I am comfortable saying that, to this day, I feel the same way about microfinance as I did two years ago, when I extolled its praises all over this blog.

In my next few posts, I will talk about my thoughts on agriculture development.

Develop Economies’ Music Recommendation

Saving as a Group

The following is a guest post by Gemma North, an associate with Saving for Change, a community finance program run by Oxfam America.

?In 2009, I worked for a microfinance institution called CREDIT in Cambodia.  On a field visit, I met a borrower who sold clothing and knick knacks to tourists visiting the nearby Angkor temple complex.  She explained that her loan had helped her to expand her business and, as a result, she was planning on taking her kids out of school to work with her to continue increasing sales.  Sometimes the effects of providing the outcomes are not always ideal.  Microfinance expands the choices of the poor, and those choices are entirely their own.  Perhaps having the borrowers’ children involved in the business made the most sense for the household at the time.

The impacts of microfinance vary, but clearly a market for credit exists for the poor.  But there is also a need for savings mechanisms among the unbanked and under-banked (both internationally and domestically).  To generalize, in the developing world, the rural and urban poor have few formal outlets for savings.  They save money by investing in assets (livestock, jewelry, etc.), storing cash at home, organizing a savings club, keeping it with a “money guard” (a person who holds the money, usually free of charge), or a relative.  These savings are susceptible to theft, loss due to natural disaster (from fire or flood, for example), or demanding family members.  Perhaps the greatest temptation is to spend money on non-essential purchases.

Challenges in other settings can be cultural or psychological: individuals come from countries where there is a general distrust of banks and financial institutions; or, because of their low-earnings, individuals do not always realize they may have some discretionary income that can be put aside.  Because the barriers to saving are numerous, there is an opportunity in providing a secure place for people to save.

Saving for Change, a microsavings organization started by a former microfinance practitioner, offers a solution to this problem.  The program, which is being implemented in Mali, Cambodia, El Salvador and Senegal, helps the rural poor to form and operate savings groups and provides training on financial literacy and basic accounting.  The groups elect their own officers; create participation guidelines and bylaws; and determine their weekly savings amount, loan interest rate and record-keeping mechanisms.  The program is adaptive – for example, some non-literate groups have devised an accurate oral accounting system based on group memory and counting sticks or rocks).  Participants in the program are able to save enough to purchase inventory for a store, pay for school fees, purchase seeds for planting or a cow for labor, or buy a plot of land to build a house.  If a member needs a large sum of money quickly, they can borrow it from the group’s fund.  By repaying the loan and added interest, they contribute to the growth of the communal savings, which is disbursed to the group members at the end of the saving cycle (which can be timed to coincide with a period when all the group members need more money, such as when food is scarce or before a major festival).

There are many advantages to this system. A communal savings organization based on mutual trust allows people to overcome the barriers to saving.  Women are able to accumulate funds independently of their spouse.  The model is similar to traditional savings groups (such as tontines), building on familiar and existing systems, which increases the speed and ease of uptake.  Expansion often occurs due to word-of-mouth, with groups forming spontaneously or with help from existing groups.

In order to expand the program, implementing organizations train volunteers to start new groups in other communities.  At an expense of $20 per client, the per-user cost is a fraction of what microfinance institutions spend to offer similar services.  As a result, Saving for Change and similar models are able to reach individuals that are underserved, if not completely neglected by MFIs.  More often than not, participants in savings groups, the poorest of the poor, live in areas that are too costly for MFIs to reach.

Providing credit is important, but providing a mechanism for saving is essential for achieving financial independence.  When individuals save on a regular basis, they are able to build up a large sum allowing them to cover larger expenses or make investments (such as a daughter’s wedding or fertilizer for the upcoming season), or create a cushion against catastrophic events, helping them to maintain and build on their existing assets.  Mechanisms to promote saving–communal loan funds or savings groups–can help expand financial self-sufficiency in less-served areas among the poor.

Next Billion Post: Energy to the BOP Made “Simple”

For my second post at Next Billion, I wrote about a company called Simpa Networks.  Simpa was founded by Jacob Winiecki and Mike MacHarg, two people I have known since I started out in the development game.  Here is a tangential story about the smallness of the world.

I used to work for a consulting firm in Boston.  I wanted to work in development but wasn’t sure how to get in the door.  I knew I was interested in solar energy and read about a lot of exciting things revolving around energy solutions in the developing world.  I went on NextBillion, a blog about market-driven solutions to poverty alleviation, and looked up posts on solar energy.   I came across a post on a Brazilian NGO called Ideaas, an organization that focuses on clean energy for the poor.  Mike MacHarg had posted a comment about integrating micropayments into the Ideaas business model.  He had a Duke email address, so I reached out to him to talk about what he was doing.  He happened to be passing through Boston on the way to a wedding in Vermont, so we met up for coffee.  He introduced me to Jacob Winiecki, who he’d been working with at Arc Finance, another NGO focusing on rural energy delivery.   We talked on the phone, I told him I was applying to Kiva.  Arc Finance, as it turned out, was trying to work with Kiva to get an energy loan portfolio going on the website.  They were piloting a solar lantern program with an MFI in the Philippines and wanted to get the loans up on Kiva’s site.

A month later I was accepted to the Kiva Fellows program and given my assignment in the Philippines.  As it turned out, I was placed with NWTF, the very same MFI that Arc Finance was doing a pilot with.  So, when I got down to Bacolod, I worked together with Kiva, Arc Finance, and NWTF to get the loans up on the website.  We were the first MFI in Kiva history to post clean energy loans.

Now, things have come full circle.  Jacob and Mike started Simpa, and I am writing a profile on the company for the website that started the cycle a year and a half ago.  You can read my full piece here.  Below is the transcript of an interview I had with Jacob Winiecki to write the piece.

Continue reading

The Changing Microfinance Industry in India

When most people think of microfinance (which most people do not), they envision a poor person in a faraway country borrowing a few bucks to buy a goat.  In an article titled “Microlender Forecloses on Goat,” The Onion proves once again that it has its finger on the pulse:

Representatives from One World Finance, a U.S.-based microcredit provider, confirmed Monday that they had initiated foreclosure proceedings on a goat in southern India following a borrower’s repeated failure to make her $2.20 monthly loan payments. “I tried to work with Ms. [Subha] Thangam on this, but once she fell a full $6.10 behind, I had to repossess the goat,” said loan officer Michael Conrad, who stated that he was just doing his job and that it was “not [his] fault” if certain subsistence farmers were living beyond their means. “I’d love to recoup the entire $22 loan at auction, but given the glut of foreclosed and abandoned goats in the area, I’d be lucky to get even half that.” Conrad also acknowledged that the owner had left the goat in “pretty bad shape” and had even stripped it of its hair for potential resale on the paintbrush market.

The article uses microfinance as an allegory for the housing and foreclosure crisis in the United States.  But, in parts of the world right now, microfinance is starting to look more and more like the recklessly over-extended financial sector prior to the economic meltdown in 2008.  In India, in particular, analysts are concerned that the glut of investment in the microfinance sector over the last several years could be feeding a bubble similar to that of the subprime mortgage in the U.S.

When I was in the Philippines, I attended a few microfinance conferences and had the chance to speak with representatives from a few microfinance investment funds from India and elsewhere.  In the eyes of investors, the Philippines could be the next big thing.  The microfinance market in India is overheated, they’d say, with a slate of recent IPOs and a huge amount of private capital flowing into the industry.  Collectively, the portfolio size of all the microfinance institutions in India grew from $252 million to over $2.5 billion in less than two years.  There are tens of thousands of organizations offering microfinance services, but fewer than a hundred have the scale to tap into the capital markets.  A dearth of good investments and an increase in the number of funders has probably driven up the price for good MFIs and simultaneously forced investors to look down-market at institutions they might not have considered in the past.

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Subprime Time: Microfinance Debt Hits the Stock Exchange

Tell me more about this microfinance.

Right now, the hot topic in microfinance is the initial public offering (IPO) of SKS Microfinance, one of the largest microfinance institutions in India with a portfolio size of over US$1 billion.  This isn’t the first time a major microfinance institution has gone public, but it is more interesting because the CEO is a disciple of Muhammad Yunus, who believes what organizations like SKS are doing undermines the social mission of microfinance.  But there is other interesting financial news in the microfinance world that is flying under the radar.  This, for example:

NYSE Euronext and Microfis plan to set up the first organised market for listing and trading of bonds based on debt from international microfinance institutions and solidarity businesses as defined by the Economic Modernisation Act (LME).

The new NYSE Euronext market segment will offer investors a range of products in an environment that is secure and transparent.  Microfis will handle origination, analysis and tracking of high-quality assets, as well as their transformation into tradable securities and their syndication.  Scheduled for launch in the last quarter of 2010, the market segment is dedicated to responsible finance. Continue reading

The Argument Against Subsidized Interest Rates

Microfinance institutions (MFI) the strive for operational and financial sustainability.  The former is an indicator that the MFI can, at the very least, break even based on its current operations and sources of funding, including loans, grants, and donations.  The latter takes into account where an MFI gets its money.  Since money from donors is basically free, an MFI that receives grants and is just barely breaking even would be unsustainable were that source of money to dry up.   In a perfect world, MFIs would not need to rely on any donor funding and could get all of their capital through loans at commercial rates.  To reach that point, MFIs need to operate efficiently and reduce the costs of doing business, but also charge interest rates that will allow them to make enough money to cover their costs.   When subsidized interest rates are introduced, it be damaging to the microfinance market as a whole.  Joanna Ledgerwood explains this dynamic in the Microfinance Handbook, the bible of microfinance practitioners:

Subsidized lending programs provide a limited volume of cheap loans.  When these are scarce and desirable, the loans tend to be allocated predominantly to a local elite with the influence to obtain them, bypassing those who need smaller loans (which can usually be obtained commercially only from informal lenders at far higher interest rates).  In addition, there is substaintial evidence from developing countries worldwide that subsidized rural credit programs resulti n high arrears, generate losses both for the financial institutions administering the programs and for the government and donor agencies, and depress institutional savings, and consequently, the development of profitable, viable rural financial institutions. Continue reading

Interview with Erik Wurster of E+Co

In researching my article on carbon financing in the developing world, I had the opportunity to speak with Erik Wurster, the carbon finance manager at an organization called E+Co.  E+Co has been on the forefront of this industry and has been one of the leading innovators.  Newsweek recently highlighted their efforts to distribute clean-burning cookstoves – a topic I have discussed in this journal – in Ghana.  It provides a great overview of how this complicated process works.  In an article for Next Billion, Tracy Smith of E+Co describes the company’s focus:

E+Co, a mission-driven clean energy investor in developing countries, is working to implement strategies that enable Wall Street investors to put capital to work in developing countries through the carbon markets.  Unlike more traditional carbon finance developers, however, E+Co strives to ensure that dollars flowing from carbon credits make it to the bottom of the pyramid.

I asked him a series of questions about some challenges facing organizations trying to break into this space.  Be warned that it contains more technical jargon than I usually have in the Journal.  I have included the answers to all of his questions here.  Continue reading

The Volatility of $2 a Day

Portfolios of the Poor: How the World Lives on $2 a Day has become one of the most talked-about book in the world of development.  It is an analysis of how poor – specifically, the poorest – people live.  The authors chronicle how people make and spend their money – tracking the inflows and outflows to better understand the daily routine.  The subjects keep detailed financial diaries of everything having to do with money in their lives.  The results are as illuminating as they are beneficial in the practice of development.  Here is the description from the website:

Portfolios of the Poor: How the World’s Poor Live on $2 a Day (Princeton University Press, 2009) tackles the fundamental question of how the poor make ends meet. Over 250 families in Bangladesh, India, and South Africa participated in this unprecedented study of the financial practices of the world’s poor.

These households were interviewed every two weeks over the course of a year, reporting on their most minute financial transactions. This book shows that many poor people have surprisingly sophisticated financial lives, saving and borrowing with an eye to the future and creating complex “financial portfolios” of formal and informal tools.

Indispensable for those in development studies, economics, and microfinance, Portfolios of the Poor will appeal to anyone interested in knowing more about poverty and what can be done about it.

The reason research like this is so useful and even groundbreaking is that it blows the doors off the misconception that the poor live on $1-2 a day, everything. Continue reading

Where's My Money, Fool: Conditional Cash Transfers

In this journal, I have discussed the different structural problems that a country faces in improving things like education, healthcare, and the economy overall.  A strong education system requires an adequate number of schools and teachers.  Likewise, good public health programs need to provide reasonable access to doctors and medical facilities.  Also, for healthcare in particular, people need to be educated about nutrition and preventive measures to avoid costly hospitalizations down the road.  But even with all of the components in place, not everyone will avail of these services.  Some people will choose to be the proverbial non-drinking horse, though usually out of necessity rather than willful ignorance.  That is because there is an opportunity cost to sending kids to school – if the child is working or watching his siblings while the parents work, going to school means lost income for the family.

Playin' with my my money is like playin' with my emotions.

So even if you have all the tools in place, it still might not be enough to effect the desired change.  One solution to this problem is conditional cash transfers (CCT).  In exchange for doing something, a person receives money.  In other words, you pay them to do the things you want, which happen to be the things that are ultimately in the best interest of them, their family, and country as a whole.  In this case, something means sending your child to school, immunizing your family, or any other behavior that will result in an improvement in “human capital.” Continue reading

Why Government Microfinance Doesn't Work

"I've got this thing and it's fucking golden!"

One of the reasons a lot of people find microfinance attractive is that it is a fundamentally capitalist approach to economic development.  Done right, it can be sustainable and even profitable.  By focusing on a social mission, successful microfinance institutions (MFIs) can reach more clients by leveraging capital, similar to commercial bank.  And just like the Ice Queen warns in Atlas Shrugged, government intervention in capitalist programs spells disaster.  Whether or not this is true for other industries (it’s not), it is most definitely the case in microfinance.  Successful government-run microfinance institutions are the exception, not the rule.  And not only are governments generally bad at administering loans, they can be destructive to the market as a whole.  On the CGAP website question 13 of the FAQ is “Do governments do a good job of delivering microfinance?”  The answer is thorough:

There are several highly successful government MFIs, such as Bank Rakyat Indonesia’s microfinance department. However, the vast majority government microfinance programs do a poor job of delivering retail credit. Such programs are usually subject to political influence, high default, continuing drain on national treasuries, and sometimes lending based more on the borrowers’ influence than their actual qualifications. Among government programs reporting to international databases, only 1/8 of clients are being served sustainably.

To begin thinking about why government microfinance doesn’t work, it is important to think about the types of governments serving microfinance communities and the nature of government in general. Continue reading