Is Microfinance Losing Its Appeal?

Is Microfinance Losing Its Appeal?

In the 1990s when microfinance was making inroads into the global fight against poverty, campaigners touted it as a silver bullet of prosperity. The new model of providing small loans to small farmers was appealing, in part, because it goes well with the ‘wealth creation’ mantra versus the failure of simple aid. The model immediately got critical acclaim, thanks to the remarkable success of Muhammad Yunus, founder of Grameen Bank and winner, in 2006, of the Nobel Peace Prize. A couple of other successes, such as Kenya’s Equity Bank, followed suit with a somewhat mixed model than that of traditional microfinance.

As few successes sprang here and there, so did enormous failures. Microfinance started getting into the spotlight mostly for all the wrong reasons. But it also had enormous potential. Investors and some financial institutions started clamoring to get a piece of the pie and poured in money. For the most part, these investors were not altruistic or impact-driven, but rather in search of the next quick bang for the buck. Microfinance became a sort of business model, albeit different from banking. Or rather, banking on the poor.

Back in 2010, Muhammad Yunus was quoted by The New York Times saying: “We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks… 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 debate of whether making money out of the very poor is right or wrong is not settled yet. Abuse of power in an uneven relationship is certainly wrong. But revelations that investors and financial institutions were in the field just to make money triggered a healthy scrutiny on the industry overall. The findings were sometimes unsettling.

According to Microfinance Transparency, countries such as Zambia had interest rates up to 110 percent; 80 percent in Ghana; 40 percent in Colombia; 55 percent in Pakistan and 200 percent in the Philippines. These rates actually sink the poor into deeper poverty.

A lot of microfinance institutions, before the rush of investors, were charging higher interest rates than it is reasonably acceptable. People started defaulting, and in India, suicides due to debt defaults raised outrage. These issues were not particular to Asia. Africa and South America had similar issues as well. Last year, a Daily Telegraph headline summed up the mood: “Microfinance is under threat from greed — and it is the poor who are suffering.”

In many places, the industry was pushing the poor to becoming even poorer, losing property and in extreme cases like India, losing their lives. Mr. Chuck Waterfiel, founder of Microfinance Transparency and a professor at Columbia University, is among those working to bring sanity and transparency to an undoubtedly good industry. His website, Microfinance Transparency, collects and publishes data on interest rates of microfinance organizations around the world.

Asked whether microfinance is losing its appeal, Chuck Waterfiel believes that it isn’t losing its appeal but contends that if there are no interventions or watchdogs to scrutinize the actions of microfinance players, the industry might be destroyed beyond redemption. Regulators must take an active role to ensure that the poor are not being fleeced. After the turmoil that gripped the microfinance industry in India, the government introduced new regulation as the The Economist recently reported:

“The guidelines try to draw a line between profits and profiteering. Microlenders’ annual interest rates are now capped at 10-12 percentage points above their own borrowing costs, leaving most charging 23-27 percent. Some charged 40 percent during the boom; dodgy local loan-sharks, the only alternative source of credit in many rural areas, have even higher rates. Microlenders are also barred from lending to anyone with more than one outstanding loan.”
The situation is not dire everywhere. In some countries, such as Peru and Ethiopia rates are reasonable at below 20 percent and 30 percent respectively. As a relatively new poverty intervention strategy, microfinance has challenges and this continued scrutiny is good for transparency, accountability and growth. For all we know, the world might have avoided the 2008 global economic crash had there been enough careful oversight of the financial industry. The Financial Crisis Inquiry Commission blamed the “crash on greed, ineptitude or both,” faulting mainly the regulators. Microfinance can avoid a crash — it needs reforms to make its loans fairer and accessible to the poor.

But microfinance has limits. Access to small loans for tiny businesses won’t miraculously lift nations out of poverty and land them into prosperity. When it succeeds, microfinance lifts people from extreme poverty and leaves them into poverty. Other interventions are still needed, especially a focus on small and medium enterprises – the backbone for creating a middle class.

There is no one-size-fits-all solution in creating wealth or fighting poverty. Poverty springs from complex and complicated mix of factors for which different strategies have different outcomes. Microfinance, when fair and accessible, is a strategy that primarily deals with extreme poverty and has limits going further. People shouldn’t lose faith in microfinance but rather seek to improve the industry and protect the poor from potential exploitation (exorbitant interest rates).

Co-author Andy Kristian Agaba is founder and CEO of Hiinga, a microfinance institution investing in smallholder farmers in East Africa.