The Big Trouble In Small Loans
Monday, June 9, 2008
Rafael Llosa’s company has been lending money to some of the poorest people in Peru for 30 years. It used to be a fairly lonely endeavor. Giving tiny loans to impoverished women to make ceramics or to farmers to buy milk cows was hardly seen as a great business.
Except that it was.
In 1998 the organization Llosa runs, now called Mibanco, converted from a nonprofit into a bank, demonstrating what other microfinance institutions around the world knew too: that the poor are good risks who repay loans on time; get enough of them together, you can not only chip away at poverty but also turn a profit.
Today Llosa has a very different marketplace to contend with. Success at Mibanco has piqued the interest of the commercial banks, which historically have shunned the 45% of Peruvians below the poverty line. Now big banks are going after Mibanco’s clients with low-rate loans and–realizing it takes special know-how to work with the unbanked–hiring away Mibanco’s employees as well. “They are very good competitors,” says Llosa.
And he’s getting more of them, from directions he never could have anticipated. Last year the Spanish multinational BBVA raised some $300 million to invest in microfinance, then reached across the Atlantic to snap up two Peruvian firms. “Everyone wants to do this now,” says Llosa. “And it’s not only Peru. This change is everywhere. Everywhere microfinance is working, it’s happening.”
What’s happening? To be blunt about it: the pinstripes are chasing the poor. Microfinance, once a relative cottage industry championed by antipoverty activists and development wonks, is on the verge of a revolution, with billions of dollars from big banks, private-equity shops and pension funds pouring in, driving growth of 30% to 40% a year. Financiers are convinced that there’s huge money to be made in microfinance.
That would seem to be a fantastic turn of events, transforming microfinance institutions into more sophisticated operations that can reach millions more people. In the dusty Indian village of Veeravelly, in the state of Andhra Pradesh, for example, loans from SKS Microfinance have led to a spate of small businesses and, in turn, money for onetime luxuries like refrigerators and solid roofs. A more competitive, more developed industry means lower loan rates and new services like savings accounts, mortgages and insurance. “Clients are coming into our offices and saying, ’O.K., if I go to another microfinance institution, I can get a longer term or a lower interest rate,’” says Braco Erceg, assistant director of Mikrofin in Bosnia, one of the world’s most competitive microlending markets.
But alarm bells are going off too. The emergence of players who are out purely for profit has raised the possibility that, far from nurturing the poor, microfinance schemes could end up milking them, especially in countries where lenders don’t have to clearly disclose interest rates. When the Mexican microfinancier Banco Compartamos went public last year, revealing its loans carried rates of about 86% annually, the development consortium Consultative Group to Assist the Poor (CGAP) and others scorned it for having put shareholders ahead of clients. Says Elizabeth Littlefield, CEO of CGAP: “There is some risk that the mainstreaming of microfinance will threaten the very essence of microfinance’s core mission: to help poor people lead better lives.” At a time when governments, financial institutions and investors are paying more attention to the developing world, the microfinance revolution illustrates the benefits and costs of marrying profitmaking with poverty relief.
The Case for Big Banks
Vikram Akula, for one, thinks money-making and good works can be mutually beneficial. Akula runs SKS Microfinance, India’s largest microfinancier, which is at the forefront of the new-money trend. Last year SKS sold an $11.5 million stake to the private-equity shop Sequoia Capital in a first-of-its-kind deal. Talk of a projected 23% return on equity snapped many financiers to attention.
This year SKS plans to reach 4 million customers like those in the village of Veeravelly, who have been using loans for projects like buying buffalo and opening a welding shop. “Unless we have capital markets interested in microfinance, there’s no way we could get to that many borrowers,” says Akula. A deal in which Citigroup will buy $44 million in loans off SKS’s books, for instance, is expected to help SKS reach 200,000 people across 7,000 villages. Among the beneficiaries are women like Parajata, a widow in Veeravelly who was working as a day laborer and barely earning enough to feed her children before a 50,000-rupee ($1,200) loan let her open a grocery shop and start earning enough to periodically buy her kids new clothes. “There has been a dramatic change in my life,” she says.
Yet as money floods in, Akula has tales of brewing conflict. Consider the time a bank chairman asked if SKS could raise its interest rates. Akula said yes (in most markets it has a monopoly) but that SKS wouldn’t do so because it would be exploitative. The banker scoffed that Akula didn’t understand economics. Akula shot back that the banker didn’t understand customers, who would turn on SKS if they felt abused. “We’re maintaining a loyal customer base that will stay with us as they get out of poverty,” says Akula.
As long as investors have a long-term view, Akula argues, the social and financial missions of microfinance intertwine. “We’re not giving away money here; we expect a return,” says Gary Hattem, a managing director of Deutsche Bank, which runs four microfinance funds. “But we do keep our eye on the social-impact side of this. It’s very humbling when you go to places where the people coming in to borrow smell like the cows they’re raising.”
Yet the pressure to turn a profit often forces microfinanciers to change their business models in ways that depart from the industry’s original purposes. As Al Amana, Morocco’s largest outfit, has shifted from grants to commercial funding, its average loan size has roughly tripled; smaller loans to the most desperate borrowers are costlier to service. One consequence of commercialization is that a lower percentage of loans go to women because they tend to take out smaller sums, according to a recent study by Women’s World Banking.
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