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Setting Standards for Microfinance

Published on August 12, 2008

In an effort to head off a potential crisis in the fast-expanding microfinance industry, its leaders are adopting global truth-in-lending standards and creating a system for comparing loan terms offered by competing lenders. To manage the effort, a new self-monitoring organization, MicroFinance Transparency, is being set up as the industry’s policeman. The goal is to prevent companies from taking advantage of poor people with high interest rates and misleading credit offers.

Click here to read the BusinessWeek article

Setting Standards for Microfinance 

In an effort to head off a potential crisis in the fast-expanding microfinance industry, its leaders are adopting global truth-in-lending standards and creating a system for comparing loan terms offered by competing lenders. To manage the effort, a new self-monitoring organization, MicroFinance Transparency, is being set up as the industry’s policeman. The goal is to prevent companies from taking advantage of poor people with high interest rates and misleading credit offers.

The initiative was announced on July 28 at a microcredit conference in Bali by Chuck Waterfield, a professor at Columbia University who spearheaded the initiative, and Nobel Peace Prize winner Muhammad Yunus, who launched the microcredit revolution in Bangladesh 30 years ago with his Grameen Bank. “Microfinance emerged as a struggle against loan sharks, so we don’t want to see new loan sharks created in the name of microcredit,” Yunus tellsBusinessWeek.

If the industry doesn’t curtail abuses and confusion, it faces the prospect of government crackdowns and donor funds drying up. Since Yunus pioneered the idea of lending small amounts of money to poor people without demanding collateral, the phenomenon has spread worldwide. These days, thousands of organizations are making loans to tens of millions of borrowers—usually to help them set up or expand small businesses.

REPORTS OF HIGH INTEREST RATES

Today, there are basically two kinds of microlenders: nonprofit outfits like Grameen and for-profit lenders, including traditional banks that are making forays into this market.

Starting last year with an exposé of lending practices in Mexico by BusinessWeek (12/13/07), a steady drumbeat of articles critical of high interest rates charged to poor people have appeared in various publications. Yunus said he was alarmed by the direction the industry was taking (BusinessWeek, 12/13/07). “I felt so bad,” he says. “I made this thing and they came in and abused it. What a way to discredit a whole idea!”

Waterfield, who has been researching and writing about microcredit for decades, said he became concerned about the industry after Mexico’s Banco Compartamos (BMOSF), which had once been a nonprofit organization, switched to a profit-seeking enterprise, and then went public early last year. The IPO netted a windfall for its backers and attracted Wall Street money.

There are several sticky issues here. Organizations that seek profits and rich returns for investors have to charge interest rates high enough to produce those yields. Compartamos, for instance, charges more than 100% annually on its typical loans, according to Waterfield’s analysis. In addition, Waterfield says, much of the microcredit industry markets loans to poorly educated borrowers in ways that are hard to understand and tend to underplay the impact on their family finances. “Organizations that want to make a lot of money can set a very high price that doesn’t look like a high price,” says Waterfield.

Compartamos defends its practices. The bank published a 14-page “Letter to our Peers” in early July explaining why it charges what it does. The letter argues that Compartamos must set high interest rates because its operational costs are high, $152 per client per year on loans that average just $450.

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