HOPE president Peter Greer responds to a recent article in the Wall Street Journal. The original article can be viewed here (subscription required).
The latest article on microfinance in the Wall Street Journal, “A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum,” makes it sound as if the microfinance sector has reached its saturation point. That may be the case in Ramanagaram and select communities in India—but these communities are the exceptions to the global situation.
Worldwide, 500 million individuals are served by microfinance and yet the estimated demand is over 3 billion according to estimates by the Consultative Group to Assist the Poor (CGAP); less than 20% of the need is currently being served. And most of these borrowers are located in the “safest” locations. In more challenging places, like the Republic of Congo where civil war has left the economy in turmoil, less than 1% of the population of over 4 million is served. Although select neighborhoods in India are “carpet-bombed with loans,” the poor in the Republic of Congo and many other “bottom billion” countries are still waiting for their opportunity to begin working their way out of poverty.
The article also raises the question of whether access to small loans is really helping. Given the examples of consumption and over-indebtedness, multiple small loans from various organizations had a negative impact on Zahreen Taj. What is unfortunate is that her over-indebtedness and challenges could have been avoided by following some basic principles that spurred the microfinance movement:
1. Don’t Push Irresponsible Credit. Microfinance practices in select neighborhoods in India resemble elements of the subprime mortgage crisis, where time-tested safeguards were discarded. This helped inflate loan portfolios, but eroded the portfolio quality. The mutual guarantee, the bedrock that allows loans to be made to individuals without a credit history and collateral, only works when communities spend time understanding each other’s businesses. In the microfinance credit bubble, staff members were rewarded for the volume and efficiency with which they provided loans. The “best practices” that include investing time working with individuals and groups to ensure that the loans were used for productive purposes, not consumption, were ignored.
2. Look at Success Through the Entrepreneurs’ Eyes, Not Just Investors. The rapid growth in India was fueled by microfinance investment that was sold with the promise of beating Wall Street’s returns by a healthy margin – and many did. But we all know that too much of a good thing can be too much. These investment funds were chasing a very small pool of top-tier microfinance institutions – all of which were measured exclusively by their financial returns. The microfinance movement needs to maintain a double bottom-line where success is defined not just by financial performance but also upon the impact on the families utilizing its services.
3. Invest in Credit With Education. When responsible microfinance is coupled with education, we see empowerment of the poor. According to a study conducted by Innovations for Poverty Action, a research nonprofit based in New Haven, Conn., borrowers who received a microfinance loan alongside business training were overwhelmingly more successful than those who received only microfinance loans. Short-term profit maximization eliminates training – but this erodes the foundation for long-term client and institutional success.
4. Focus on Savings, Not Just Credit. Even in India, where it appears that the need for microfinance is being served, there still are millions of individuals in poverty looking for a safe way to save and accumulate capital. Not everyone is ready for a loan. The “Self-Help Group” model in India and the Savings and Credit Association model throughout the world have overlooked potential, but do not have the return promised by investment funds. For a family that wants a television, it is far better to save and accumulate this amount in a savings account rather than using a loan that will have to be repaid with interest.
As the president of HOPE International, I have personally seen that responsible microfinance is an incredibly effective tool for poverty alleviation. Not perfect, but powerful. A safe place to save and accumulate capital as well as an opportunity to access small loans for productive investments are critical for communities to overcome poverty. To fuel this movement, it will require microfinance institutions that limit their promised rate of return, measure their success by more than just their financial return, and follow time-tested procedures that help ensure loans and savings are used for their intended purposes.
Globally, microfinance is not even close to reaching its saturation point, but it will take patient investors to join the movement and choose to help the poor and not just maximize short-term profits.