Microfinance: Lending a hand

5 minute read
Kathleen Kingsbury

When Melecio Penafiel wanted to expand his tailoring shop in Guayaquil, Ecuador, last May, he didn’t go to the bank or ask his relatives for help. His seed money arrived via the Internet. Using the website Kiva.org a Bay Area software engineer named Nathan Folkert lent Penafiel the $500 he needed to buy two new sewing machines, fabrics and thread for higher-quality suits. Folkert has never met Penafiel but says making the loan “felt like I was giving him a shot at the American Dream.”

Folkert is what’s known in the philanthropic world as a “microfinancier.” Pioneered by last year’s Nobel Peace Prize winner Muhammad Yunus, microfinance is the making of tiny loans to credit-poor entrepreneurs. Yunus began in 1976, with $27 loans to impoverished farmers, financed from his own pocket. Today about 10,000 microfinance institutions hold more than $7 billion in outstanding loans. As Yunus told TIME last October, “At the rate we’re heading, we’ll halve total poverty by 2015.”

Yet there’s surprisingly little evidence that promise can be met. No long-term study has measured how often borrowers graduate to the middle class. “Is microcredit a cure for entrenched poverty?” asks Northeastern University professor Rashmi Dyal-Chand, who focuses on microfinance. “There aren’t the statistics to prove that yet.”

Even without such hard data, microcredit has captured the imagination of philanthropists. The Bill and Melinda Gates Foundation, with an endowment of $33 billion, has pledged as much as 25% of its total spending to its “global development” program, including microfinance. Such programs account for only a small slice of the nearly $250 billion Americans gave to charity in 2006, but they’re becoming more popular, partly because microfinance has a reputation for transparency and efficiency.

“Potential donors are worried that charity will be wasted or create dependence,” says Jonathan Morduch, an economics professor at New York University. But the most influential microlenders–Yunus’ Grameen Bank, FINCA, Acción International–are self-sustaining and profitable. They strip away the bureaucracy common to aid programs of governments and large foundations, and repayment rates of 97% are the norm.

Unfortunately with so much money flowing into microfinance, many donors have lost patience with investing in long-term development infrastructure. Dyal-Chand estimates that at least half of development aid has been diverted to microlending over the past two decades. “There’s nothing sexy about hospitals, schools, roads, sanitation projects,” she says. “But those are all the things the truly poor desperately need.”

Some development experts warn that microcredit programs do little to alleviate overall poverty, even in countries like Bangladesh, where they are well established. About 45% of the country’s population lives below the poverty line, down just 2 points in the past two decades. In southeastern Bangladesh, recipients often use microlending to pay off old debts or buy consumer goods, not to generate income, according to a 2004 study by the aid group CARE Bangladesh. When it came time to pay up, the study found, borrowers were often forced to go into further debt. “If these new philanthropists did their homework first,” says Thomas Dichter, an aid worker who recently examined microfinance projects in 20 countries, “they would see microcredit doesn’t do much good and may even be harmful.”

In Bolivia, for instance, the attractive returns in microfinance have saturated the market with new consumer-credit providers that operate without strict controls. “Screening processes are much less careful, and people can find themselves drowning in debt,” says Elizabeth Littlefield, director of the World Bank’s Consultative Group to Assist the Poor. Microfinance investors, however, argue that the market isn’t saturated enough. More lenders would bring down the interest rates that investors often must charge to cover costs–which are sometimes as high as 60%. “Scaling up will bring lower costs for all borrowers,” says Geoff Davis, CEO of the microfinance fund Unitus.

Development experts also worry that the stream of international money supporting microfinance is crowding out locally owned banks that might serve the poor. Citigroup, ABN Amro and HSBC, for example, have pumped a combined $200 million into microfinance groups that offer saving accounts, insurance and mutual funds. This influx of capital is “preventing the creation of a sustainable, savings-based financial system in poor countries,” says Littlefield. Microlenders counter that the costs of starting a bank are so high that without them, the poor would have no alternative. “To build a bank in Africa, you need $5 million to start, and then another $3 million in minimum equity capital,” says Chris Crane, CEO of Opportunity International, an Illinois-based Christian microlender. Crane’s network of 12 microbanks worldwide has nearly $160 million in savings accounts and insures more than 3 million lives.

Whatever its limitations, supporters of the microcredit sector say its power to help individuals is real. “Women who come out of poverty spend extra income on health care, housing or sending their children to school,” says Gowher Rizvi, a former Ford Foundation exec who gave Grameen its first grant. “That’s worthwhile if it’s even one family.” Back in Ecuador, Penafiel was able to pay back his Kiva.org loan five months later, and had a little left over to cover his six kids’ school fees. It isn’t quite the American Dream, but it’s a start.

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