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With microfinance, more transparency (and realism) required

Today's NYT offers yet another set of indictments against microfinance. The charges are: 1) interest rates are unfair and exploitative, 2) banks are making profits off ventures originally meant to be charitable; and 3) loan pricing is not transparent enough to consumers.

As a lender myself, I too have questioned the high interest rates charged by the major lenders - at Compartamos, the average rate is 84% - but let's be honest, lending in micro-amounts to the poor is an expensive proposition. It's considerably more expensive to lend 10 loans of $100 than 1 loan of $1,000 especially if none of those people has any credit history, nor employment history, nor even access to a bank. If a bank lends someone $100 for 1 month divided into two payments at an 18% interest rate, it will make 75 cents and that probably doesn't cover the transaction costs. I don't doubt there is abuse in the system - just as payday lenders and other loan sharks abuse financially illiterate American consumers, but interest rates that seem high by our American standards are not necessarily exploitative.

I see little merit to the argument that microfinance should solely be served by non-profits rather than banks. Mohammed Yunus, the father of microfinance really said, “Microcredit 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.” But banks can scale and they can also provide additional elements of financial include beyond microloans - insurance, savings accounts, etc. - that provide additional benefits to the currently unbanked.  If we rely only on nonprofits, the truth is that the vast majority of those currently benefiting from microfinance will go unserved.

Finally, the problem of transparency. This is real and the core of the issue and US companies like Kiva are complicit. As microfinance expands, banks have the opportunity to make responsible and honest loans to the poor that charge what they cost to serve them or, like the subprime lending industry, they can try to trick new borrowers into a cycle of debt. We need to ensure the latter doesn't happen.

The best principles that I've seen articulated for how microfinance should operate are offered by the Smart Campaign:

There is no reason that these principles cannot be met by the private sector while it also makes a reasonable profit to incentivize it to financially include the poor. It's social responsible investing and the private sector should be embracing it.

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Reader Comments (1)

Nice post. Two typos:

1. Your first point is enumerated as "2"

2. "If a bank lends someone $100 for 1 months" should be singular

April 21, 2010 | Unregistered CommenterTim
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