In recent years, the idea of giving small loans to poor people became the darling of the development world, hailed as the long-elusive formula to propel even the most destitute into better lives.
Actors such as Natalie Portman and Michael Douglas lent their boldface names to the cause. Muhammad Yunus, the economist who pioneered the practice by lending small amounts to basket weavers in Bangladesh, won a Nobel Peace Prize for it in 2006. The idea even got its very own United Nations year in 2005.
But the phenomenon has grown so popular that some of its biggest proponents are now wringing their hands over the direction it has taken. Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100% or more from their impoverished customers.
“We created microcredit to fight the loan sharks; we didn't create microcredit to encourage new loan sharks,” Yunus recently said at a gathering of financial officials at the United Nations. “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.”
The fracas over preserving the field’s saintly aura centres on how much interest and profit are acceptable and what constitutes exploitation. The noisy dispute has even attracted congressional scrutiny, with the US House financial services committee holding hearings this year focused in part on whether some microcredit institutions are scamming the poor.
Rates vary widely across the globe, but the ones that draw the most concern tend to occur in countries such as Nigeria and Mexico, where the demand for small loans from a large population cannot be met by existing lenders.
Unlike virtually every Web page trumpeting the accomplishments of microcredit institutions around the world, the page for Te Creemos, a Mexican lender, lacks even one testimonial from a thriving customer—no beaming woman earning her first income by growing a soap business out of her kitchen, for example. Te Creemos has some of the highest interest rates and fees in the world of microfinance, analysts say, a whopping 125% average annual rate.
The average in Mexico itself is around 70%, compared with a global average of about 37% in interest and fees, analysts say. Mexican microfinance institutions charge such high rates simply because they can get away with it, said Emmanuelle Javoy, managing director of Planet Rating, an independent Paris-based firm that evaluates microlenders.
Exorbitant charges: Rosa Gonzalez Abad at her food stall in Mexico City. She took her first microfinance loan nearly 10 years ago. In recent years, many microfinance lenders have been charging hefty interest rates. Adriana Zehbrauskas / NYT
“They could do better; they could do a lot better,” she said. “If the ones that are very big and have the margins don’t set the pace, then the rest of the market follows.”
Manuel Ramirez, director of risk and internal control at Te Creemos, reached by telephone in Mexico City, initially said there had been some unspecified “misunderstanding” about the numbers and asked for more time to clarify, but then stopped responding.
Unwitting individuals, who can make donations of $20 (Rs892) or more through websites such as Kiva or Microplace, may also end up participating in practices some consider exploitative. These websites admit they cannot guarantee every interest rate they quote. Indeed, the real rate can prove to be markedly higher.
Underlying the issue is a fierce debate over whether microloans actually lift people out of poverty, as their promoters so often claim. The recent conclusion of some researchers is that not every poor person is an entrepreneur waiting to be discovered, but that the loans do help cushion some of the worst blows of poverty. “The lesson is simply that it didn’t save the world,” Dean S. Karlan, a professor of economics at Yale University, said about microlending. “It is not the single transformative tool that proponents have been selling it as, but there are positive benefits.”
Still, its earliest proponents do not want its reputation tarnished by new investors seeking profits on the backs of the poor, though they recognize that the days of just earning enough to cover costs are over.
“They call it ‘social investing’, but nobody has a definition for social investing, nobody is saying, for example, that you have to make less than 10% profit,” said Chuck Waterfield, who runs Mftransparency.org, a website that promotes transparency and is financed by some of the big microfinance investors.
Making pots of money from microfinance is certainly not illegal. CARE, the Atlanta-based humanitarian organization, was the force behind a microfinance institution it started in Peru in 1997. The initial investment was around $3.5 million, including $450,000 of taxpayer money. But last fall, Banco de Credito, one of Peru’s largest banks, bought the business for $96 million, of which CARE pocketed $74 million.
“Here was a sale that was good for Peru, that was good for our broad social mission and advertising the price of the sale wasn’t the point of the announcement,” Helene Gayle, CARE's president, said in an interview. Gayle described the new owners as committed to the same social mission of alleviating poverty and said CARE expected to use the money to extend its own reach in other countries.
The microfinance industry, with at least $60 billion in assets, has unquestionably outgrown its charitable roots. Elisabeth Rhyne, who runs the Center for Financial Inclusion, said in congressional testimony this year that banks and finance firms served 60% of all clients. Non-governmental organizations served 35% of the clients while credit unions and rural banks had 5% of the clients.
Private capital first began entering the microfinance arena about a decade ago, but it was not until Compartamos, a Mexican firm that began life as a tiny non-profit, generated $458 million through a public stock sale in 2007 that investors fully recognized the potential for a windfall, experts said.
Though the Compartamos founders pledged to plough the money back into development, analysts say the high interest rates and healthy profits of Compartamos, the largest microfinance institution (MFI) in the western hemisphere with 1.2 million active borrowers, has pushed up rates across Mexico.
Microfinance Information Exchange, a website known as the Mix, where at least 1,000 MFIs worldwide report their own numbers, says Compartamos charges an average of nearly 82% in interest and fees. The site’s global information comes from 2008, the most recent year available.
In Nicaragua, President Daniel Ortega, outraged that interest rates there were hovering around 35% in 2008, announced that he would back a microfinance institution that would charge 8-10%, using Venezuelan money. There were scattered episodes of setting aflame microfinance branches before a national “We’re not paying” campaign erupted, widely believed to be mounted secretly by the Sandinista government. After the courts stopped forcing small borrowers to repay, making global financial institutions hesitant to work with Nicaragua, the campaign evaporated.
Push for transparency
The industry is pushing for greater transparency among its members, but says most microlenders are honest, with experts putting the number of dubious institutions anywhere from less than 1% to more than 10%.
Damian von Stauffenberg, who founded an independent rating agency called Microrate, said local conditions had to be taken into account, but any firm charging 20-30% above the market was “unconscionable” and profit rates above 30% should be considered high.
Yunus said interest rates should be 10-15% above the cost of raising the money, with anything beyond that a “red zone” of loan sharking. “We need to draw a line between genuine and abuse. You will never see the situation of poor people if you look at it through the glasses of profit-making.”
Yet by that measure, 75% of MFIs would fall into Yunus’ “red zone”, according to a March analysis of 1,008 microlenders by Adrian Gonzalez, lead researcher at the Mix. His study found that much of the money from interest rates was used to cover operating expenses and argued that tackling costs, as opposed to profits, could prove the most efficient way to lower interest rates.
Many experts label Yunus’ formula overly simplistic and too low, a route to certain bankruptcy in countries with high operating expenses. Costs of doing business in Asia and the sheer size of the Grameen Bank he founded in Bangladesh allow for economies of scale that keep costs down, analysts say. “Globally, interest rates have been going down as a general trend,” said Javoy of Planet Rating.
Many firms say the highest rates reflect the costs of reaching the poorest, most inaccessible borrowers. It costs more to handle 10 loans of $100 than one loan of $1,000. Some analysts fear a pronounced backlash against high interest rates will prompt lenders to retreat from the poorest customers.
But experts also acknowledge that banks and others who dominate the industry are slow to address problems.
Scrutiny for lenders
Like Mexico, Nigeria attracts scrutiny for high interest rates. One firm, Lift Above Poverty Organization, or Lapo, has raised questions, particularly since it was backed by prominent investors such as Deutsche Bank AG and the Calvert Foundation, which promotes community development.
Lapo, considered the leading microfinance institution in Nigeria, engages in a contentious industry practice sometimes referred to as “forced savings”. Under it, the lender keeps a portion of the loan. Lapo collected these so-called savings from its borrowers without a legal permit to do so, according to a Planet Rating report. “It was known to everybody that they did not have the right licence,” Javoy said.
Under outside pressure, Lapo announced in 2009 it was lowering its monthly interest rate, Planet Rating noted, but compulsory savings were quietly doubled to 20% of the loan. So, the effective interest rate for some clients actually leapt to nearly 126% annually from 114%, the report said.
©2010/THE NEW YORK TIMES
Elisabeth Malkin in Mexico City contributed to this story.