Nate Mook

CEO & Founder, Localist

This conversation is closed.

Is microcredit a flawed idea that does more harm than good, with high interest rates and lack of proper regulation?

A few years ago, microcredit and microfinance were seen as world-changing endeavors that could drastically alleviate poverty by enabling those without the ability to get a traditional bank loan to receiving funding for their business or household. Muhammad Yunus won a Nobel Prize in 2006 for his work founding Grameen Bank, and services such as Kiva have brought the concept to the masses. Oprah even featured Kiva on her show, and the service couldn't find enough loans for interested lenders.

It makes sense: enable millions to make small loans, which can reach remote communities all while creating a sense of helping people without asking individuals to give their money away to charity - simply lend it. And once the money is paid back, those lenders will be more likely to continue to lend. Major countries such have Norway have even become big supporters of organizations like Grameen, because microcredit is seen as far more effective at reaching those in need than traditional foreign aid.

But perceptions are starting to change. Muhammad Yunus was asked to step down from Grameen by the Prime Minister of Bangladesh who claims the poor are being taken advantage of. There are also allegations of Grameen Bank funds being diverted illegally, but that's another issue. The biggest criticism seems to stem from the extremely high interest rates microcredit loans have. While it may seem like you give $25 via Kiva and $25 is repaid, the actual repayment number could be 40% higher, or more. That money is pocketed by the microfinance institution (MFI) that is handling the transaction and repayments. Clearly there are costs involved, and higher risks when dealing with loans to low-income individuals (which is why they couldn't get bank loans in the first place). But poor families are now being burdened by high-interest debt many can't pay off.

Is microcredit simply going through "teething problems" as Yunus says, or is the very idea flawed despite its noble intentions?

  • Mar 7 2011: I was actually a Kiva Fellow, working with microfinance institutions (MFIs) on location in Uganda for 3 months. I am still a devoted Kiva lender, but I am not an indiscriminate Kiva lender. I now do some research on the MFI before I give a loan; just as with any other institution, I have learned that some MFIs are better than others.

    As far as effectiveness goes, here's what my experience suggests. For most run-of-the-mill borrowers, loans were marginally helpful. Lots of people were able to pay for school fees, and I can see how this would have a long-range impact. A few people had a tremendous entrepreneurial spirit and it sometimes provided a real leg up for someone who wanted to start a business. But I can't say that I saw people leap from poverty into middle class. My best guess--and bear in mind that this is anecdotal and my experience was brief and limited--is that microfinance often made things less difficult for many people.

    In terms of determining where to lend your money (if you want to be a lender), one useful tool is the MIX market (http://www.mixmarket.org/) which gives performance reviews on MFIs around the world in more detail than Kiva's Field Partner profiles. They have a handy online tutorial to help you read the information.

    I would also suggest noting the average interest rate and fees borrowers pay, which you can find on Kiva's field partner profiles at the bottom of the page. I personally am very torn about the high interest rates charged by many MFI. I've heard the arguments on both sides. I myself will tend to want to lend to the MFIs that charge the lowest interest rates.

    One thing I now tend to look for is, is this a lender that offers financial training to its borrowers? You might need to go to the MFI's website, or contact them directly, to find this out.

    In sum, I don't think it's a simple either/or, good/bad. But I think it's best if we are not naive in our approach to microfinance.
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      Mar 8 2011: Laura, thanks for that first hand experiential knowledge. I would submit that raising a life from misery to viable is a great first step. Your point about informed lending is a good one as well.
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    Mar 2 2011: I used to sell loans to Americans who couldn't really afford to repay them. It was a job, working for an organisation that needed money to pay it's costs, financed by organisations with overheads of their own, with the money ultimately coming from people who probably didn't want to cause trouble for anyone.

    Looking at micro-financce, I see well-meaning investors placing money with organisations that have to maintain offices and employ people, which passes the money (plus fees) on to local sales teams, made up of people who make their living by travelling around lending money to people. Everyone at every level has bills to pay and needs to earn a living. they don't have to be evil people, but the costs involved all get passed on to the customers.

    I can't see how this model can realistically put affordable loans into the hands of those who need them. There has to be a better, more efficient, way of getting the loans to the customers.

    Ultimately, it's about establishing credit-worthiness. In countries which don't have cheap computerised credit-scoring systems, the work has to be done by expensive human agents. Find a way around that, and you'll lead a revolution in financial services.

    Currently, I'm a teacher. I believe strongly that any kind of financial services must be accompanied by improved financial literacy. This is as true in the developed world as it is in poorer countries.
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    Feb 17 2011: Like you, Nate, I'm also a supporter of Kiva and have made several loans through them, but I have to admit that, after having read Muhammad Yunus' latest book and his claim that microfinancing organizations that charge more than 15% interest should be penalized, I'm starting to wonder if it might make sense to allocate funds to other organizations i.e. charitable aid organizations that also do good work.

    After all, Yunus had a point when he said, “We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks.” And really, how are we helping the poor by burdening them with high-interest debt?

    Of course, I've heard the other side of the debate too. Kiva has defended the high interest rates by rightly pointing out the high operating costs for administering small loans to people who live in remote villages -- and that's understandable. But to chalk it up with a statement like this isn't a good excuse:
    “While these rates may seem ridiculously high to us, MFI’s are not forcing people to take out loans. MFIs are providing a service and that service is in demand even with 36% interest because these services are valuable to their clients.” (This was taken from a January 2010 blog post by a Kiva fellow)

    I cautiously floated out the question to my fellow Kiva members on a community board about whether they had any concerns about the high interest rates, but generally, I find people who support Kiva will likely defend those interest rates. (And some of those people, unfortunately, seem to have a very limited understanding of how Kiva actually works -- and this is something that CEO Matt Flannery agreed with in a response to criticism by David Roodman in April 2010.)

    Generally, I think microfinance can work -- what I think the bigger question is ISN'T about the high interest rates but, rather, why are the operating costs so high? Because, if that's the reason cited for high rates, then what can we do about the costs?
    • Mar 1 2011: I completely agree, Josephine, it is all about the costs! The moment I was left without a job I thought, alright, let's learn about microcredit and go help people in developing countries! Being a development professional is just another way of expressing the wish to help, along with charity, providing loans or development aid. Now the problem is that the professional help of person like me with my education and daily costs of living costs much more than a villager in a developing country could be in a position to pay for. The big difference between Grameen and many other microfinance institutions (which I find very positive) is that the Grameen Bank is mostly run locally in the village and by the village, by people who are not trained in world-class universities and don't expect exuberant salaries for their work. In comparison, many development workers expatriated from Europe and North America not only sustain, but actually improve their standard of living while at the job, and so cost a lot of money for the organizations they work with.
      Microfinance is not incredibly complicated. It is all about basic accounting, a little bit of understanding of local regulations, and a lot of the right attitude and knowing your market. It can be taught and it is being taught, usually also at a very high cost, and I should think that someone who has lived and grown up in the area is in a much better position to lead a microfinance business than a foreigner would be.
      I know this is a very simplistic way of putting things, but what I am trying to get at is that a way of reducing costs is to have microfinance organizations be run by locals, and that such a scenario should be possible. Kiva and other similar networks are a way to empower not only microentrepreneurs, but also local microfinance entrepreneurs.
  • Mar 7 2011: I am unsure this has been brought up, but I have seen articles like this
    http://www.ibtimes.com/articles/77043/20101029/microfinance-deaths-sks-microfinance-spandana-asmitha-share-l-t-andhra-suicides-india-microfinance-d.htm
    quite a few times before. The loan amounts may be small to us, but the relative size of the loans to these individuals seem terrifying.

    I was only bringing this article up as a talking point; I personally am unsure of how I feel on the topic either way.
  • Mar 7 2011: Charity has it's place, however, microfinance gives those who borrow opportunities beyond what just giving can do.
    Give a man a fish, feed him for a day. Teach a man to fish, feed him for a life time.
    Charity often degrades a person, where as a microloan with the promise of being paid back, can give hope to a person with an idea, lifting themselves and their families.
    Even with the best ideas and execution, businesses do fail all the time, especially in the microloan community, thus higher interest rates. I see nothing wrong with a finance company making money in the process.
    As stated before, the idea of microfinance is not charity, but giving people the opportunity to succeed with their ideas with small loans to get them started.
    To me, a loan says that someone believes in you and wants you to succeed, charity on the other hand is often one man trying to ease his guilt.
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    Mar 5 2011: The main idea behind microcredit is to tap into grassroots knowledge of local needs by identifying potenital entrepreneurs and giving them easy access to loans before migrating them out of the grey into the white economy, where they will be publishing accounts that bigger companies can use to determine their suitability for buyout or simply to clone the new business model the entrepreneur has developed and sideline him or her entirely. Multinationals simply don't have the boots-on-the-ground insight into local societies and ways of doing business; nor do they have the inclination to do themselves what others will do for free.
  • Mar 3 2011: I saw Jessica (Kiva Co-founder) speak @ a TED conference and she was no doubt inspiring. I have been a Kiva lender for a while and may have remained so, had I not listed to the speech, which is extremely unfortunate and well, ironic.

    She explained how Kiva does not make money of the loans and it is run by donations. However, the MFIs that service the loan collects interest and fees to provide their services. Until that point I had not paid attention to the field partner interest rates and fees, but when I did look, I received a massive shock. The recipients of my 0% interest loans were paying upwards of 40% on the money.

    I understand the rationale of charging interests and that for smaller loans even a small nominal fee will increase the cost of the loan significantly. But what I could not understand and am still struggling find an explanation for is how any body, let alone some one really poor pay an interest rate of 40%, 60% etc and is pulled out of poverty as a result?

    This model is sustainable only to the extent that the Kiva donors are unaware (like I was) or continue to believe that this is still the best model to pull people out of poverty. If Kiva is able to operate based on donations, extending the model to the MFIs so we dont charge any interest to the borrowers (or a modest 5 - 10%) would have been a wonderful.

    My comments are not about micro-finance in general, but only based on my experience with Kiva. I for one, am not sure if the benefits of Kiva out weigh the downside.

    I for one am willing to donate 20% of my loans for Kiva and MFIs, so the 80% can go directly to the borrowers. If that is an option. Until then, I am going back to the sidelines on micro-credit. Sadly.

    If you are poor, it is much better not to have any money, than to owe others a lot of money.
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    Mar 9 2011: i'd rather say there seems no perfect solutions.we are running microloan programms to some disadvataged people here in China and some people really changed their lives financially while some failed due to unwise decisions on what to spend the money on. looking at a bigger picture , there are some negative feedbacks about microloan.and i ithink you are right that in some cases the harm could be more than good with high interest rates and lack of proper rugulation wihich at the same cant deny the facts that many people are benefiting from it. It might be more worthwhile to ask questions "how can we minimise these harm that has been done and how can we prevent it from happening to other people" .
    just some thoughts
  • Mar 8 2011: I think its sad that instead of helping these people, these loans to only postpone & compound their current problems. Its no different than going to one of those check cashing places & getting a "Super High" interest payday loan. There has got to be another way to help these people and cover the costs. Maybe each donation includes a percentage that will cover the overhead costs. That amount would be considered the same as giving it away to charity, but the other 75% of the donation in going directly to help the person this program was designed to help. You may only get 75% paid back, but the rest is a charitable write off and there's money available to keep the whole thing operational.
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    Mar 7 2011: Then again, there are informal tools ( loan clubs, family, friends, moneylenders, etc.) that are usually more flexible, but completely undependable (and sometimes more expensive). The big advantage of formal microfinance is its reliability

    How do we know for a fact that the Poor want microfinance? Millions of clients have been using it for over thirty years. Not only do they use it, but they repay their loans, with high reliability. And it's not because of the "group pressure", but mainly because of the desire to keep access to a service you value very highly. Clients find services so valuable that they are willing to pay high loan rates and accept minimal return on savings, and return again and again for services.

    The problem is, any time you offer credit, some borrowers might over-indebt themselves. Which bring a major policy implication: we need to be more vigilant about over-indebtedness.

    To make a long story short:
    Microfinance should be regulated (subsidies, over-indebtness, etc.) in order to produce sustainable delivery year after year of highly valued services that help hundreds of millions of poor people keep their consumption stable, finance major expenses, and cope with shocks despite their low, irregular and unreliable incomes. And, MAYBE, it also gets people out of poverty.

    I'd suggest a couple must-read reference for those who are interested:
    Collins et al., Portfolios of the Poor: How the World’s Poor Live on $2 a Day, Princeton 2009
    Rosenberg, “Does Microcredit Really Help Poor People?” CGAP 2010: http://www.cgap.org/gm/document-1.9.41443/FN59.pdf
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    Mar 7 2011: So far, the story that has been told is that microcredit is an extraordinary tool that lifts poor people -esp. women- out of poverty, by increasing household income and consumption.

    Is is true? There are hundreds of anecdotes, practitioners opinions, but the fact is, before 2008, all the impact studies that have been conducted were quite not experimental (ie. not randomized). The problem was the selection bias in the attempts to create comparable control groups, which led to many controversies around the selected methodology.

    Then there was the new wave of Randomized Controlled Trials (RCTs), where a large group of participants are split into “treatment” and “control” groups at random to eliminate selection bias.
    3 microfinance RCTs have been conducted in 2009: 2 on microcredit, 1 on microsavings. The (oversimplified) results showed:
    - Some positive impact on business investment & outcome
    - No impact on household income or poverty
    - No impact on broader measures of well-being

    Now, before we jump in and claim RCTs prove that microfinance doesn't help, we need to know that even RCTs have their own limitations: They have to be planned before the start of lending, the initial loan sizes may be too small to make much difference to borrowers, it's hard to generalize their results and to test on a long term basis, as the control groups gets contaminated.

    So does microcredit lift people out of poverty? We just don’t know yet. More RCTs are on the way, but we shouldn’t expect a clear answer any time soon.

    Then why should we keep supporting microfinance? Because maybe the question is not whether microfinance helps people get out of poverty, but how microfinance helps people to cope with poverty.
    Because the problem with poverty is not that people have low incomes, but that these incomes are irregular and uncertain (cf. 'Portfolios of the Poor'). For the poor, financial instruments are critical survival tools, to cope with emergencies, smoothen their consumption, etc.
  • Mar 7 2011: If you are interested in a grass roots microcredit program check out www.eastafricametaproject.org. This is a very small organization but has had excellent results in Uganda.
  • Mar 5 2011: I believe that we need to have microfinance because it is a very useful tool. As any tool, it can be abused by some organizations or individuals but it can make a huge difference in people's lives otherwise. I think many organizations offer relatively low interest rates and we need to support them.

    Recently I made my first loan to a student through Vittana. I didn't realize that the loan has an interest collected by local MFI but given that Vittana claims that interest is 10-15% I think seems reasonable.

    I do hope that with the right technology we can lower interest rates and increase accessibility to microfinance.
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    Mar 4 2011: When it comes to money, I believe in starting with a specific goal and working backwards. I believe the right goal when it comes to money is sustainable happiness. For most people sustainable happiness includes being a (net positive) contributing member of a society, tribe, village, company, etc plus the ability to survive and provide on an hourly basis.

    Working backwards from there we can quickly realize that communities tend to self organize around shared resources that relate capitalism to taxes.

    How do we go from self organizing communities to sustained happiness knowing that a key requirement is obviously survival. The only semi-proven model for this that works is commerce via capitalism.

    SO.... How do we integrate the multitudes into commerce that ultimately leads to sustained happiness?

    In today's world this integration must include access to credit. But who decides who gets what? Who decides who is credit worthy (and how)? Who takes the risk?

    If I'm capable of weaving baskets and I know my villagers need baskets, it makes sense for me to want to make baskets. If it costs $.10 to make a basket and I need $10 plus start-up capital for equipment then I am clearly constrained by my access to that capital.

    Therein lies the simple genius of micro credit. But micro credit is a tool (like peer to peer file sharing is a tool.). As we all know, most tools can be used for good and evil. Just ask any record label owner. The evil comes in loan sharks trying to look like Yunus, not vice versa.

    If someone is willing to invest in the sustained happiness of others, I say let them. Let our courts decide who is breaking the law and let our votes decide who is manipulating the law or who is looking out for the basket weaver.

    Thanks for reading.
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    Mar 1 2011: Everything has got it's insticnt upside and downside. Micro-Credit is not any exception. My view is benefit of micro credit overwieghs it's downside. It can be improved further.

    Keeping aside politics with which unforfunately Dr. Muhammad Yunus tied up himself with his political ambition during last army rgime (disguised though) in Bangladesh for which he might be facing challenges now which I definitely don't support neither I could support political ambition of Dr.Younus himself , I see multiple benefits that Grameen Bank and Dr. Yunus offered.

    First micro-credit generated flow of money at the village level which was not there.
    Secondly in any way he saved the villagers from the traditional money lenders who are like sharks and high interest rate of Grameen bank is much lower than that of those sharks.
    It created huge emeployment opportunity for educated youths.
    It brought women empowerment at the rural level as target groups of microcredit of Grameen Bank are mostly women and many women got economic power over men due Grameen Bank & Dr. Yunus.

    But definitely thats not the ultimate answer. Not being ultimate answer it can't be either branded as a completely flawed concept as well.
  • Feb 28 2011: "Muhammad Yunus was asked to step down from Grameen by the Prime Minister of Bangladesh who claims the poor are being taken advantage of. There are also allegations of Grameen Bank funds being diverted illegally, but that's another issue."

    It is a shame that the Bangladesh PM is waging a personal and vindictive attack against Dr. Yunus. Anyone who threatens (even perceptually!) the political elites in BD have to face the music of their power - and this is what is happening. This has nothing to do with micro-financing.

    Regarding the diversion of funds illegally, this has been proved wrong by the Govt of Norway where the original allegation was floated.
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    Feb 17 2011: Full disclosure: I've been in a big supporter of Kiva and have made well over 100 loans, along with gifting accounts to friends, etc. Only a couple of those loans have defaulted, one because of a sketchy MFI that ran off with money. All the reports from the field about those loans have been very positive.

    I'm genuinely interested in the above debate, and despite trying to read about and understand the microfinance industry, don't have an opinion either way right now.