The Big Trouble In Small Loans
By Barbara Kiviat
Time Magazine, June 6th, 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.
As a growing number of microfinance firms go public, qualms about putting the financial interests of shareholders above the needs of clients have mounted. Already the flood of new money has come under criticism from longtime microfinance advocates for focusing too much on the largest firms operating in the most profitable countries. According to CGAP, 75% of cross-border funds go to Latin America and Eastern Europe, the world's most developed microfinance markets--the low-hanging fruit. That could leave out the poorest of the world's poor, who are predominantly in Asia and Africa. Says Alex Counts, CEO of the nonprofit Grameen Foundation, which helps develop microfinance institutions: "You might need to invent the microfinance industry all over again."
Segmenting the industry, though, might not be so bad if it allows more of the poor to get access to credit. Let multinational corporations take the top microfinance institutions to the next level, and leave the bottom of the pyramid to development groups and regional banks. That's what Ecobank is doing in Africa. The Togo-based company, with operations in 22 countries, has for years acted as a banker to microfinance groups, taking deposits and writing loans. Over that time, Ecobank has grown hip to the business model and last year launched a microfinance institution of its own, in Nigeria and then in Ghana. Senegal and Cameroon are next. "This empowers the bottom of the African market," says Ecobank microfinance head Rotimi Nihinlola, "and is a good opportunity to grow our business."
Entrepreneurs or Consumers?
Yet making loans to poor people, while an important tool, is hardly a poverty cure-all. Property rights, the rule of law--these things matter too. "You cannot overidealize what microfinance alone can do," says Clara Akerman, president of the microfinance group WWB Colombia. Most outfits started with lending simply because local laws prohibited nonbanks from offering deposit accounts. When people do have the option to save instead of borrow, saving is often what they prefer.
With marketing savvy introduced into the equation, poverty-alleviation experts are concerned that people will be talked into loans they wouldn't otherwise want. "Most genuinely poor people are not happy with carrying debt," says international-development expert Thomas Dichter. "The danger of all this new money is that microcredit institutions will feel compelled to go out and generate more borrowers."
But the new money is also expanding the scope of microfinance beyond small loanmaking. As institutions compete for customers, they are rolling out other services. In Mexico, Citigroup has written more than 1 million life-insurance policies in conjunction with Compartamos, and in India it offers customers savings accounts and ATM access in partnership with microfinancier BASIX. "Not everyone will be an entrepreneur, but most of us have to save for something," says Bob Annibale, head of Citigroup's microfinance unit. Microfinanciers around the world are racing to offer the first real micromortgages. "That we are now talking about creating financial systems that include the majority of people in developing countries is a real departure from what has existed for centuries," says María Otero, CEO of microlender ACCION International.
Part of those financial systems, though, are consumer loans, and that is a sticking point for microfinance purists. There is nothing inherently wrong with buying TVs and microwaves on credit, but as lending to poor people has gone mainstream, certain markets, like Mexico, have been flooded with loans that have nothing to do with providing capital to aspiring entrepreneurs--just racking up household debt. That's especially worrisome, since most developing countries don't have strong consumer-protection laws. "Everyone has realized you can make money," says Damian von Stauffenberg, principal of MicroRate, which evaluates microfinance firms. "Before, no one who wanted to get rich quick was going into microfinance. Suddenly you have loan-sharking operations assuming the microfinance mantle."
Back in Peru, Mibanco now offers consumer loans. It pretty much has to. "Our main business is for microcompanies, but people also want to buy a TV or a refrigerator, and we need to have the capacity to give a loan," says Llosa. "If we don't, they will go to another institution."
That is just one small slice of how Mibanco is changing in the face of competition. In 2004 Mibanco had 30 branches; today it has 81, as the firm pushes into remote areas--the coasts, the mountains--trying to hold off commercial banks. Mibanco has started offering savings accounts and has gone to the likes of North Carolina--based Wachovia to finance growth, which helps Mibanco reach more than 5,000 new clients a month. All of that ostensibly benefits borrowers.
But there are other changes to Mibanco's operations that aren't quite so easy to categorize. To grow quickly and preserve market share, Mibanco is offering incentives to current customers to get friends to sign up. That's hardly insidious--as anyone with a gym membership can tell you--but it does flick at the concern that lenders might start driving demand. And now Mibanco is contemplating an ipo. "We have two objectives," says Llosa. "One of them is to have a social impact, but we also look to be profitable. If we decide to only have a social impact, we won't have resources to grow."
Recent history says that when a financial trend gets popular, it gets riskier too. Think subprime mortgages. That may or may not be the case with big banks and microfinance. What is clear is that this pair won't be parting ways anytime soon.
With reporting by With Reporting by Omer Farooq/Veeravelly