Microfinance : A Lot for a Little

By Lauren Wilcox | World Ark Contributor

Sometimes, a small amount of seed money, a microloan is all it takes to break the cycle of poverty. The growing microfinance movement is planting seeds of health and financial independence around the world, and both borrowers and investors are reaping the benefits.

A borrower from the Grameen Bank tends her crop in Dhaka, Bangladesh. Muhammad Yunus won the Nobel Peace Prize in 2006 for his grassroots efforts to end poverty by lending money to people in need, which earned him the nickname "banker of the poor."

In search of a better understanding of what was happening, Yunus ventured into a nearby village, where he met women surviving on the profits from bamboo stools, which they made and sold for pennies a day. Their profits could be greatly increased, they told him, if they were not indebted to the local lender, who loaned them the money to buy their supplies and also bought their finished stools at a set price.

To help the women pay off their debts and buy a supply of their own materials, Yunus loaned 42 villagers a total of $27. No longer in debt to the lender and able to sell their stools to the highest bidder, the women increased their daily profits from a few cents to more than a dollar.

From this initial experiment came the seeds of a much larger project: the Grameen Bank, which Yunus founded after discovering that no local banks would loan to these villagers. To date, the Grameen Bank has successfully loaned more than $5.3 billion in very small loans to 7 million borrowers, most of them extremely poor. In 2006, Yunus won the Nobel Peace Prize for his work with the bank.

Throughout the ’80s and ’90s, as the Grameen Bank grew, so did a worldwide movement. Small institutions sprang up throughout Latin America, Asia and Africa, dedicated to making collateral-free, microloans to the very poor. microfinance, as the practice is called, is now a viable practice around the globe.

Yunus believes microfinance can eradicate poverty entirely; it is his oft-quoted goal that every country will eventually have its own “poverty museum,” as more and more of the world’s poorest improve their finances through small businesses. But microfinance also has its skeptics who criticize its high interest rates and the lack of hard data supporting its claims. Some critics doubt it can ever be more than a way to make money off the poor. Still, its potential to change lives seems irrefutable. As the practice continues to grow and evolve, the challenge will be to build a global system that is as effective, and as fair, as possible.

How it Grew

Microfinance, at its root, is deeply egalitarian. It evolved from the notion that credit is a service that should be extended to everyone, not just people above a certain income, or who have a certain amount of collateral, or who are able to read and sign their name— all requirements that banks routinely enforce.

A man makes footwear from tires at the open-air Ngara market near Nairobi. The Kenyan government receives millions of dollars in aid to fight poverty, but little of it is available to small traders unless they can put up collateral.

“Microfinance had to break myriad rules of banking just to exist,” said Sam Daley-Harris, who runs a grassroots nonprofit called RESULTS and has helped organize worldwide summits on microcredit. Daley-Harris likes to quote Yunus’ description of how the Grameen Bank developed its lending principles: “ ‘Whatever banks did, I did the opposite. If banks lent to the rich, I lent to the poor. If banks lent to men, I lent to women. If banks made large loans, I made small ones. Banks required collateral, and my loans were collateral-free. If banks required a lot of paperwork, my loans were illiterate-friendly. If you had to go to the bank to get a loan, I went to the village. That was my strategy.’ ”

The surprising thing was that such principles worked. The rules of mainstream banking seemed to have more to do with preconceived notions of what a good borrower would be than with the reality. In fact, the very poor, though unfamiliar with formal banking practices, were often savvy money managers. They were quite familiar with the concept of savings, usually keeping small amounts of livestock or jewelry to sell in case of emergencies. And by necessity, they were often resourceful, experienced entrepreneurs with livelihoods that depended on whatever tiny enterprises they could make work where they lived. Most important, as Yunus and other microfinanciers have found, the poor could be extremely reliable borrowers. Grameen Bank reports say the overall repayment rate on their loans is 98 percent.

So why have banks historically been so reluctant to make these loans? All prejudices about borrowers aside, for banks using a traditional lending model, the profits simply weren’t worth it. With an annual interest rate of 5 or 10 percent, a microloan, generally defined as between $25 and $400, would hardly generate enough interest to cover a bank’s costs. Even a higher interest rate, say 20 percent, would earn the bank only $20 over the course of a year on a $100 loan. In addition, microloans tend to take more work to secure. The very poor often live in hard-to-reach rural areas, are skeptical of banks and are often illiterate. None of these, of course, creates insurmountable problems, but they are often enough to make the poor seem like untenable lending prospects to mainstream banks.

Small Goes Big

As the fledgling practice evolved, Yunus and others engaged in similar efforts around the world began refining their early attempts into a more structured and sustainable approach. From these efforts emerged several characteristics of microfinance that, while still evolving, define the practice today.

Yunus and many of his colleagues found that loaning to women produced better results for the family than loaning to men, perhaps because women were more directly involved with providing for their children. Initially, said Daley-Harris, Grameen Bank intended to loan equally to men and women, but after several years, he said, “they realized that when a microloan comes into the family through a woman, the proceeds from the business more often accrue to the well-being of the family. The family ate better; the children were put into school…. It was more powerful to have the loans go through the woman.” Today, 96 percent of Grameen Bank’s borrowers are women, and other organizations around the world, like Pro Mujer in Latin America and Jamii Bora in Kenya, are finding similar success in making the majority of their loans to women.

Another characteristic of microfinance—one that draws sharp criticism—is that in order for microfinance to be sustainable, interest rates on the loans remain quite high, and quite variable, from percentage rates in the midteens to as high as 80 or 90 percent. This is primarily due to the scale of the endeavor, doing a large volume of business in very small, labor-intensive increments. But it is complicated by regional differences in government regulations, like taxes, and by the relative scarcity of microfinance lenders. Alex Counts, CEO of Grameen Foundation, calls it “a monopoly situation.” Competition helps. Interest rates tend to be lowest in countries where microfinance lenders have been around the longest and are the most numerous.

More than Money

As microfinance becomes a more established practice, lenders are finding that in addition to providing funds to entrepreneurs, microcredit can be used to address other issues facing the very poor. A Swedish woman named Ingrid Munro, who started the microfinance institution called Jamii Bora in Kenya in 1999, discovered that of the borrowers who were defaulting on their loans, most were

Bangladeshi women wait for a volunteer to distribute their loan money collected from a microfinance agency at Manikganj, Bangladesh. Microfinance lending is transforming the rural economy and giving millions of women the chance to pull their families out of poverty.

In a similar vein, the Microcredit Summit Campaign, run by Daley-Harris’ RESULTS Educational Fund, started a pilot program in India to provide health education to borrowers through their microfinance lenders. While money lending and health education might seem an unusual pairing, it actually makes good sense: Health educators can take advantage of the microfinance lenders’ infrastructure to easily reach many more people than they might have otherwise. And from a financial standpoint, because poor health threatens financial stability, improving people’s health can make them more likely to pay back their loans.

A Money Maker?

Visionaries first embraced extending credit to the very poor as a way to end poverty. But as microcredit grows in popularity, it is increasingly becoming a way to generate income for investors. The chasm between these two schools of thought is narrower than one might think, in part because lack of capital is a major barrier to the growth of microfi - nance. If microfinance becomes just another investment, microlenders might finally have access to the funds they need to reach millions, or even billions, of people.

But some fear that as microcredit becomes marketdriven, the loans will fail to make it to the very poorest people, who tend to be the most expensive to reach. microfinance programs dependent on investors may become inhospitable to more social-minded programs like health education and could ultimately stray from the original goal of eradicating poverty. Is it impossible to find a happy medium between the two perspectives? Are microfinance’s social agendas and its financial needs mutually exclusive? Grameen Foundation CEO Counts thinks not, although the strategies he proposes to unite the two may sound somewhat unorthodox in the business world.

For one thing, he says it is important for microfinance lenders to use a profit model that focuses on doing a high volume of business and earning low profit margins, which is an inversion of the traditional way of thinking about profits. But it is better, he says, for lenders to make a large number of small-profit loans rather than try to squeeze more profits from each loan by charging higher interest rates.

Another key, he says, will be to ensure that investors in microfinance treat it not as a get-rich-quick plan, but as a long-term proposition, one that has the potential to reap its greatest rewards by successfully seeing people out of poverty.

“Over the long term—and particularly with the profits you can earn serving people after they’ve emerged from poverty—maximum poverty reduction and really earning commercial returns are consistent and reinforcing,” he said. “But with more of a speculator’s mentality, I think they’re not consistent, and our financing partners should not be people who just want to dip in, make some money and get out.”

Ultimately, Counts said, he sees microfinance as a way of reaching the very poor. “[Microlenders’] most important assets are not their loan portfolios, but their high-quality relationships with the world’s poor,” he wrote in an article in the Stanford Social Innovation Review called “Reimagining microfinance.” By using these relationships to deliver services like education and health care, and by maintaining long-term financial relationships, he believes that microfinance can, by improving the prospects of its borrowers, improve its profits as well.

Writing the Rule Book

Some of microfinance’s most interesting developments came in recent years, as the industry gained momentum and caught international attention. For one thing, industry leaders worldwide focused on making the industry’s practices more accountable and fair.

A Bangladeshi woman feeds cattle at her Dowita village home near Dakar. She now earns a decent living for her family by selling milk from cows bought with a microloan.

Industry leaders are also crafting ways to measure microfinance’s success.

A new Progress out of Poverty Index (PPI) allows microfinance institutions to quantitatively measure the effect their work is having on clients. The index is a simple scorecard of eight or so questions, such as whether or not the client’s household has a television set, what materials the house is made of, and if children in the household attend school. Microfinance institutions use the scores to get a sense of borrowers’ standard of living and to track progress over time.

Banking on the Future

Beginning in 2005, one U.S. organization has offered a novel way to connect borrowers with capital. Called Kiva, this nonprofit uses the Internet to connect lenders in the United States with entrepreneurs in developing countries. The lenders, who offer amounts of $25 or more, can handpick who their money goes to: a tailor in Cambodia, a 20-year-old beautician in Eastern Europe or a baker in Togo supporting her five children. Repayment rates for these loans are extremely high, as they are elsewhere in the industry.

Like Daley-Harris, Yunus, Counts, Munro and the other people who believe microfinance can one day put an end to poverty, the founders of Kiva take pride in the individual successes that make microfinance’s abstract notions so concretely rewarding. Kiva spokesperson Fiona Ramsey tells the story of one borrower, a man whose hands were cut off in the war in Sierra Leone, who was forced to beg for a living until he began working with a local microlender. The man signed his loan agreements by dipping his stumps in ink, and then worked his way up from selling soap and other sundries to running an entire store selling clothing and shoes. Today, he supports his three children and sends his younger brother to school.

Like many microlenders, the founders of Kiva believe business and a social agenda are not mutually exclusive. Indeed, Ramsey says that Kiva does its best work by harmoniously combining the two. “That’s something we enjoy doing, combining what might be thought of as conflicting ideas and putting them together.” This way of thinking extends, Ramsey said, to “changing the idea that you must be rich to help someone, and enabling the poor to be a part of the solution to poverty.”

“We often talk about how one day you will have a Nigerian lending to someone in Chicago,” Ramsey said. “Let’s mix up the way you think of the poor.”