A Rift in Microloan-World

Last week’s Economist had an interesting blurb on the disagreements within the Microloan community around Compartamos bank in Mexico

SINCE CompartamosBanco, a Mexican lender to the poor, went public a year or so ago, a rift has been growing in the booming microfinance industry. To supporters of traditional charitable microfinance–providing loans and other financial services to help lift people out of extreme poverty–the Compartamos initial public offering has come to symbolise an aggressive move by capitalists to profit from the poor. To its backers, on the other hand, the success of Compartamos, despite the recent lacklustre performance of its shares, symbolises how the profit motive can help lift many more people out of poverty than charity alone could ever do.

In an earlier Sepia Mutiny piece, I noted that while nearly all parties heap praise on the specific mechanisms of microcredit, there is some interesting dissonance around the narrative and goals of the system

While I’m a huge fan of microloans in general, I fear that for many, the lesson drawn is that micro-loans somehow subvert “traditional” capitalism (whatever that may be). It’s a flame that Yunus certainly fans and that many, but clearly not all, boosters latch onto…instead of reenginering capitalism to help the poor, microloans are far more profoundly reengineering charity to help the poor help themselves. Why point out this seemingly semantic difference? It’s about identifying the long term goal and the moral high ground…. Microloans are ideally a new on-ramp helping these individuals participate in the virtues of Global Capitalism (and eventually graduate into traditional banking) rather than some sort of bypass.

And sure enough, the High Priest of Microloans, Mohammed Yunus, is one such critic who seeks the “bypass from capitalism”….

In a different interview, he flatly excommunicates Compartamos from the microcredit church

Yunus, 67, says he fears that his innovation has been twisted to benefit investors, rather than the poor. But he has particularly unforgiving words for microlender Compartamos. At one point during a conversation, Yunus objected to the mention of Compartamos and microfinance in the same sentence.”When you discuss microcredit, don’t bring Compartamos into it,” he instructed. “Microcredit was created to fight the money lender, not to become the money lender.”

Objective criticism of Compartamos focuses on the high interest rates charged to the poor.

..it is charging interest rates of over 100% a year, little different from what illegal loan sharks demand, and that it is deliberately making it difficult for poor borrowers to understand how much they are paying for their loans.

Just to be clear, deliberately hiding info from poor borrowers is potentially outright fraud and should certainly be prosecuted through normal means if the accusation is, in fact true. (although I suspect, that much of the activity being blamed here is likely to fall into the “shady” category rather than “illegal” — much like the fine print “gotcha’s” on just about any contract.)

But on the subject of interest rates, much of the problem directly stems from limited scale of the operations involved; Kiva’s website provides an explanation for why microloans charge much higher interest than typical banks

The nature of microcredit – small loans – is such that interest rates need to be high to return the cost of the loan.

…To break even on the $100 loan, the MFI would need to collect interest of $10 + 1 + $25 = $36, which is an interest rate of 36%. At first glance, a rate this high looks abusive to many people, especially when the clients are poor. But in fact, this interest rate simply reflects the basic reality that when loan sizes get very small, transaction costs loom larger because these costs can’t be cut below certain minimums.

Compartamos’ rates are obviously much higher than even this example from Kiva. However, Capitalism 101 provides much of justification for Compartamos — profits are necessary for a firm to scale up successful operations and, from an economy-wide perspective, they invite competition & bring in new entrants to the market

…Compartamos concedes that its rates may seem high–though it reckons they are closer to 70%–but says they are set to allow the bank to grow quickly to meet vast untapped demand in Mexico. Its borrowers have risen in number from 60,000 to around 900,000 in the past eight years. This is hardly an indication of exploited customers.

…A “big win” like the Compartamos IPO was needed to attract lots more capital into the microfinance industry, says Álvaro Rodríguez Arregui, the chairman of ACCION International, a charity that has been helping to spread microfinance since the 1970s.

…For-profit microfinance has been growing fast, including in India where SKS, a lender created by Vikram Akula, a former McKinsey partner, is backed by Sequoia, a leading Silicon Valley venture-capital firm.

Or, as the co-CEOs of Compartamos put it -

Mr. Danel and Mr. Labarthe say microfinance will help more poor people by tapping the boundless pool of investor capital rather than the limited pool of donor money.

“It’s marvelous to have one creditor but it’s marvelous to have one million creditors,” Mr. Labarthe said, “and that’s where we really start to change the face of opportunity.”

…Mr. Danel and Mr. Labarthe argue that successful microlenders in a middle-income country like Mexico should use the capital markets, instead of crowding out donations.

As part of their defense, they argue that Compartamos’s success has prompted a number of institutions, including traditional banks and retailers, to start offering financial products to the poor.

However the real rift, I’d argue, isn’t over the operational details of how much interest should be charged (an impossibly difficult question to really answer outside of the market) but rather, around microfinance’s relationship with & the virtues of capitalism. Should microfinance be an escape from it or the on ramp to it?

11 thoughts on “A Rift in Microloan-World

  1. Seems silly to, in the abstract, favor nonprofit or for-profit microfinance. Let both forms try, and see which one wins (or, more likely, each will ultimately dominate different niches of the microloan sector). Nonprofits certainly beat the pants off of for-profits in, say the US higher education system (also museums, disaster relief, etc.), so I’m a bit surprised that Yunus is so bent out of shape by Compartamos–if the nonprofit form “fits” better it will be fine, Compartamos or no Compartamos.

  2. Vinod, there are three VERY distinct characteristics of Compartamos (as opposed to other microlenders) that are relevant to this discussion, only one of which you mentioned:

    1. They are one of the only PO microfinance organizations.
    2. Even for microcredit, their interest rates are substantially higher than the market demands.
    3. In beginning as an NPO, Compartamos also had first-mover advantage and state support in crowding out “competitor” microlenders.

    I don’t think it’s correct to abstract from a unique case to the whole industry. When Compartamos first chose to go public after its first 10 years operating as an NPO, it received a number of rebukes and more benign criticisms from its peer organizations, including CGAP. Further, its sphere of impact decreased as overhead costs increased and as the priority shifted from providing as many cost-recovering loans as possible to increasing shareholder profits. There’s a strong argument here, not for the failure of microlending, but for the impact of business organization, or entity type, on bottom-lines. I am all for double (or triple) bottom-line companies, but in the case of Compartamos, the current board has often opted for profit over the more socially beneficial aims of microlending, in part because the original nonprofit does not maintain the same level of governance or input (although it still holds a substiantial share of the decision-making power). A major principle of microlending is that it should not be usurious; it is trying to provide capital outside of the traditional markets that moneylenders occupy. What good then, is a state-supported, market distorting PO group using the rhetoric of microlending while adhering to different principles? There is a strong argument for why the “bottom-line” is easier to maintain in a non-profit or private organization, where shareholders and boards have different goals.

    However, Compartamos does NOT fit the profile of many other microlenders, and so it would be unhelpful to take their unique development and apply it to all other agents in the same field. It is an interesting cautionary tale — one that will continue to play out — for new entrants into such a system, but it is otherwise not indicative of trends within the microlending/microcredit world.

  3. Camille, If I’m reading you correctly, Compartamos converted from nonprofit to for-profit (I’m assuming that that’s what you mean by NPO and PO)? That’s realy interesting! Do you have links to more info. about that? I looked through Vinod’s links, but didn’t see it (I may have overlooked it).

    There is a strong argument for why the “bottom-line” is easier to maintain in a non-profit or private organization, where shareholders and boards have different goals.

    Just trying to keep the definitions clear here–who are the “shareholders” on a non-profit? Do you have donors in mind? Also, what do you have in mind by (seemingly) calling non-profits “private”? Aren’t for-profits “private” too (i.e., as compared to gov’t agencies)? Just trying to keep us all on the same page here–this is a very interesting topic, but I think people (me included, no doubt!) tend to use confusingly different terms which can inhibit analysis.

  4. I read (admittedly quickly) through this document and didn’t see that Compartamos began as a nonprofit–maybe it’s a complicated ownership structure that I’m overlooking? Clarification most welcome!!

  5. Yes, that’s what I mean — they switched from a nonprofit organization (or NGO, more specifically) structure to a publicly offered (PO) structure last year. I think their rationale for doing so (they wanted to raise more money to offer more loans) was totally legit. The jury is still out, and many microlending groups are wary, of what the impact of becoming PO will be since their interest rates scaled way up after that shift took place. [Accion (Compartamos' original NGO "owner"), CGAP Analysis (pdf)]

    Just trying to keep the definitions clear here–who are the “shareholders” on a non-profit? Do you have donors in mind? Also, what do you have in mind by (seemingly) calling non-profits “private”? Aren’t for-profits “private” too (i.e., as compared to gov’t agencies)? Just trying to keep us all on the same page here–this is a very interesting topic, but I think people (me included, no doubt!) tend to use confusingly different terms which can inhibit analysis.

    I apologize — I was unclear with my definitions and definitely blurred concepts. I would argue that donors are NOT the formal shareholders of a nonprofit, although the politics of nonprofit financing certainly tend to inform major programmatic decisions. In that specific sentence, I meant to differentiate between when shareholders and the board split on decisions in the PO context, versus when the board and staff split on decisions in nonprofits. In using the term “private,” I meant to distinguish between nonprofits and for-profit non-public (i.e., not PO) entities. You’re correct, though, both are privately held.

    It is not my intent to advocate a policy prescription regarding the proper organizational model for microlending institutions; while we often think of Grameen, and other NGOs (or nonprofits) as the standard model, it’s also the case that more traditional, for-profit banks are extending their services into these same areas. I simply meant to highlight that Compartamos is HIGHLY unique, that it does not exist in a “less distorted” market than other microlenders, that it has run into pretty significant, and in many ways justified, criticism, and that there may be a better equilibrium out there between organizational goals and entity type.

  6. Camille, You know a lot more about the specifics of Compartamos than I do, but I think we are about 100% on the same page if you’re agreeing that it’s still up in air in terms of how much microlending would ideally be done by for-profit concerns (whether “publicly offered” (PO) or “privately held” (haha, “pre-IPO”)) and how much by nonprofits/NGO’s. Maybe it’ll wind up like hospitals in the US–where there’s a blend of for-profit, nonprofit, and gov’t hospitals (I’m not saying that the blend there is ideal, just that there are probably good reasons that none are at zero %).

  7. microfinance’s relationship with & the virtues of capitalism. Should microfinance be an escape from it or the on ramp to it

    microfinance is tool to engineer an (a) alternative model that can either suceed or fail in its mission to open the chinks in the armor of capitalism being “one size fits all” for the world (b) remixing technique to suit the local realities and agendas instead of listening to western agenda set by lending institutions like world bank and imf.

  8. western agenda set by lending institutions like world bank and imf

    I mean this in a nice way, but (almost) nobody of any significance in the “West” (in which I would include myself as a charter member, being an ABD) thinks that the World Bank or the IMF are anything but cr@p.

  9. Many years ago, if you walked into the Mattancherry Market on a typical morning, you’d find lots of money lenders doing their thing. The rates were cut-throat; if you asked for Rs.100, they’d give you Rs.95 and you’d have to return Rs.100 to them in the evening. Their clients were always the poorest of people and everyone paid them back on the dot; because, poor people are honest. Erm, the small fact that the lenders had names like Steel-rod Stephen, Thorappan Bastian, Hammer Hamsa, sported massive moustaches, and were rumoured to have thick Police Files must have played a part too. They were the real pioneers of Micro-loans.

  10. 8 · rob said

    western agenda set by lending institutions like world bank and imf
    I mean this in a nice way, but (almost) nobody of any significance in the “West” (in which I would include myself as a charter member, being an ABD) thinks that the World Bank or the IMF are anything but cr@p.

    Even if we think that they are crap, lending institutions directly or indirectly do control a lot through their aid packages to poor countries in Africa and Asia. Probably this microloans phenomena, whether it it is good or bad, is an outcome of that resentment ?

  11. Hmm.. the post talks about 36% interest rate.
    “Suppose that the transaction cost is $25 per loan and that the loans are for one year. To break even on the $500 loan, the MFI would need to collect interest of $50 + 5 + $25 = $80, which represents an annual interest rate of 16%. To break even on the $100 loan, the MFI would need to collect interest of $10 + 1 + $25 = $36, which is an interest rate of 36%. “

    I guess what Kiva was trying to say is that the lower the loan amount is then the cost of the transaction (the Fixed cost) becomes a greater % of the total leading to higher interest rates.

    I have been lending on Kiva and I see the average loan size being >$500 and now they are doing group loans which average $1k or more — this means that the transaction cost is a rather small % of the overall loan and wont impact the interest rate in a huge way.

    MFI is not the magic bullet for poverty alleviation but it does go a long way. Wish the Indian government stopped its obsolete license raj hangover and let Kiva in. Wouldn’t we love to contribute towards Sulabh toilets, clean water projects, solar panels, CNG autorickshaws…the list is endless.