Those for whom the word “microfinance”, or “microcredit”, conjures up images of village entrepreneurs around the world lifting themselves out of poverty by access to tiny, Grameem Bank-style, non-profit loans may be mystified, if not scandalized by developments in that sector during the latter part of last year.
In August a for-profit microcredit company raised $350 million in an Initial Public Offer, indicating the mainstreaming of microcredit in the finance sector. Then, in November, a highly publicized wave of suicides was blamed on microfinanciers and the Indian state of Andhra Pradesh suspended microfinance debt-collection. The Wall Street Journal spoke of a “backlash against the booming microfinance industry” and a spreading crisis.
Despite these events, several prominent economics professors resolutely declared that microcredit is not the enemy. In “Microcredit Is Not The Enemy”, a December 13 op-ed in the Financial Times, these professors, led by Abhijit Banerjee of Massachusetts Institute of Technology, defend microfinance and, in particular, call comparisons between the microfinance crisis and the subprime crisis, “badly misguided” because “microfinance institutions are highly focused on avoiding default.” In contrast to the subprime crisis, Professor Banerjee writes that this “is a crisis born of government intervention”, and aggravated by microcredit’s “rapid growth” and the “over-indebtedness of clients.”
Professor Banerjee comes to the defense of microcredit because the industry has worked to overcome two stereotypes: (1) the poor are much less likely to pay back their loans than everyone else, and (2) making money serving the poor will lead to exploitation.
It is this second stereotype that I too would like to challenge because, done properly, for-profit microcredit better contributes to the self-worth of the borrower than non-profit or hybrid models. There is a sense of worth that a for-profit loan communicates because the for-profit loan says: “I’m giving you this money because I think you can pay it back and not for other motives, benevolent as they may be.”
For those without much familiarity with microfinance or the current microfinance crisis, here is a very brief primer. Since its beginnings in the late 1970s and early 1980s, microcredit has been viewed as a much better alternative to predatory moneylenders in developing countries who can charge 100 per cent interest per year or more.
After a period of consistent yet unremarkable growth, microlending began to take off a few years back as for-profit microfinance companies entered the market — culminating in SKS Microfinance’s $350 million IPO in August of this year. Two months later, following a wave of suicides linked to indebtedness, the cabinet of the Indian state of Andhra Pradesh adopted an ordinance aimed at reducing abusive practices within the microcredit world. The ordinance has greatly reduced debt-repayments, leading to a crisis in microcredit.
Leaving aside the question of what caused the microcredit crisis, we can be sure that Professor Banerjee and his co-authors wouldn’t need to defend microfinance against comparisons to subprime if some similarities didn’t exist. Both involve excessive lending to the poor and both involve rapid growth in a relatively new and, therefore, poorly understood and poorly-regulated industry. And, both involve private companies making money by lending to the poor.
Which brings us back to my belief that for-profit microcredit offers a greater sense of accomplishment to a borrower that non-profit or hybrid lending.
Isn’t paying back one loan just as good as paying back another?
Yes and no. Paying back any type of loan provides the borrower with a sense of accomplishment and worth, but that sense of accomplishment varies depending on who lends the money, because certain relationships are different than others. Borrowing money from your parents is different than borrowing from a bank, for instance. And, while working in a family business is noble and necessary work, working at a firm without a family connection provides an opportunity to test yourself in an environment where you have no special claim on your job. The same holds true for microfinance lending. Borrowing from a non-profit is fine and often very good, but paying back that for-profit loan offers more of a sense of accomplishment since the lender is “in it for the money,” so to speak.
The growth of for-profit microcredit shows that making money serving the poor has become mainstream. At the same time, there is a healthy suspicion of those who seek to make a lot of money helping the poor because we are rightly sensitive to the potential for exploitation. And the microcredit industry has seen this exploitation in the form of over-indebted borrowers. Plus, if a person makes $100,000 in a microfinance company, for example, we are immediately confronted with the vast disparity between the $50 microloan and that $100,000 salary.
Even though for-profit microcredit has rightly come under scrutiny, the for-profit model offers a sense of accomplishment to borrowers that the non-profit and hybrid models of microcredit cannot. Yes, significant reforms need to take place in the entire microcredit industry to prevent exploitation of the poor, a practice which deserves all the ire it receives. But the poor deserve the opportunity to enter into contracts with for-profit lenders because they, like the rest of us, deserve the opportunity to participate freely in their economy.
Blake Robinson is a Financial Advisor at Fulcrum Securities, a regional financial services firm that tailors individual and institutional portfolios to clients’ ethical concerns. A graduate of Princeton University and Carnegie Mellon’s Tepper School of Business, Mr Robinson resides in New York City.