Sari Sari
A Sari Sari store run by two microfinance clients, both PWDs

Travelling to Iloilo at the beginning of the month in order to conduct an assessment of a microfinance programme that targets people with disabilities as clients, I was required to undertake a bit of a crash course in microfinance theory. Microfinance – the provision of small loans (and other financial services) to the poor to enable them to avoid using traditional moneylenders who charge high rates – is a big buzzword in the world of development at the moment, particularly since the founder of the movement, Muhammed Yunus, was awarded the Nobel Peace Prize in 2006. Yet I was surprised as I researched just how much misinformation has been popularly propagated about microfinance and how many traps that, even with quite a bit of knowledge of the issues, I had nearly fallen into. Here are some of the biggest culprits:

Microfinance exists to provide small, low-interest loans to the poor

According to his oft-told story, the first loans Yunus made were less than $1 each, and he didn’t charge any interest to the 42 borrowers who he was helping to avoid borrowing from a local loan shark. However, this is by no means a typical example of the movement he was about to create. Obviously the size of loans varies from location to location depending on local currency value and consumer prices, but one of the critical principles of the working of microcredit is not the provision of the initial loan itself, but rather the permanent availability of credit in the future. The main incentive for borrowers to pay back their loans is that if they do so they will be able to access further loans for larger amounts. So while loans may start relatively small, once a client has built up a good track record with a microbank they should be able to borrow more – eventually hundreds, and occasionally even thousands of dollars. Of course, this makes a lot of sense – if microfinance schemes wish to support the poor in setting up their own businesses, it would be detrimental to their empowerment and ability to compete in the local market not to enable them to expand their businesses as well. And even the larger loans are still relatively small as far as mainstream banks are concerned – many countries implement a cap on how large a microloan can be before a borrower should seek credit from a regulated institution.

Interest is another matter of common misunderstanding. The interest rates charged by microfinance organisations are in fact much higher than the rates charged by banks on credit cards – starting at 25% per annum and averaging 30% – 40%. This is a matter over which microfinance often comes under attack, but the high interest rates are a necessity for sustainability, and sustainability is vital for microfinance organisations to continue their work. The costs associated with providing microloans are much higher than those associated with bank loans simply because of the scale involved. It costs the same in terms of administration and staffing to make one large loan as it does to make one small loan – making many small loans is therefore a much less efficient model, which is why banks don’t do it already. Microfinance organisations also have higher costs because of the social development training they need to provide for staff, the financial training they need to provide for beneficiaries, and the intensivity of collection programmes – loan payments are usually collected weekly, in person, and in difficult to reach areas. The interest rates of microfinance organisations therefore need to reflect these higher costs if they wish to survive. They are still a lot lower than the rates charged by traditional moneylenders.

Finally, the microloans themselves are not the only important feature of microfinance services. Other financial services are also provided which are considered vital for financially empowering the poor communities served (see below).

The high microloan repayment rates make it a low risk investment

Large, well-run MFIs like Yunus’ Grameen Bank report repayment rates between 97-98%, and even smaller lenders report that they try to keep their average rates between 90 and 95%. However, there is no real consensus in the industry on precisely what “repayment rate” means and how it should be calculated – this means that these figures can be very misleading, particularly as many microlenders have differing methodologies for dealing with collections and loan write-offs. This isn’t to say that the poor aren’t necessarily good borrowers, just that there isn’t enough conclusive evidence to support the assertion that on average microfinance sees better repayment rates than bank loans; and that often microfinance providers are not able to accurately assess risk (and therefore set interest rates or take other action accordingly) because the calculations they are using are flawed.

The term “well-run” is also operative here. The microfinance organisations that exhibit the best performance and can be most confident of their repayment figures are those that stick almost religiously to a formula tailored to the local circumstances within which they work. Lending to people with no collateral is, by nature, risky, and the successful microfinance organisations are the ones that manage this risk carefully – by requiring borrowers to be accountable members of a small local community, by operating a loan cycle system that allows borrowers to gain credit and borrow more, and by ensuring frequent scheduled repayments that are collected in person by trained social development workers.

Microfinance is intended to help the poor set up small businesses

While this is certainly one intended use of a microloan, it is by no means the exclusive approach of microfinance providers, who recognise that it is the opportunity to continue loaning ever larger amounts that is the principle motivator for clients to pay their loans on time. These loans may be spent on business creation and business expansion, both of which are usually essential for the client to ensure they can pay, but later loans may also be used to cover school fees for children, doctors and hospital bills and other circumstances that require a relatively large sum of money up-front. One of the intended outcomes of microfinance schemes is to undermine local moneylenders who charge extortionate rates of interest, and people do not always borrow from money lenders just to start businesses. Loans for immediate consumables (food to eat etc.) are usually not an option (although that doesn’t mean they aren’t used that way), and there are sometimes concerns about clients using microloans for cultural practices that the loan providers don’t see as a “justified” use of the money, such as bridal dowries in India. Naturally this leads to debate about just how “locally responsive” microfinance providers need to be if they are to genuinely empower local communities within the context of their own cultural and social practices.

Fish Stall
A fish stall in the market in Iloilo City

Microfinance is also about more than just making small loans – the principle is designed to address not just credit exclusion, but exclusion from other financial products as well. Most successful microfinance organisations offer savings schemes in addition to loans, and sometimes require their clients to hold savings if they wish to take out further loans. In fact, some of the few good impact assessments that exist have shown that these savings facilities can make more of an impact on relative poverty than the loans themselves. Micro-insurance is a new and growing addition to the scene that seeks to address healthcare provision among poor communities in developing countries.

Microfinance targets the poorest of the poor

In fact, most beneficiaries of microfinance schemes are fairly close to the poverty line – the “richest of the poor” if you will. This is for good reasons – it is these clients who are in the best positions to start successful businesses, generate an income to pay their loans and benefit from the opportunities that microfinance brings to improve the financial condition of themselves and their families. The poorest families are more difficult to reach (sometimes physically as many live in the most rural areas) and are often in need of other more immediate interventions before they could be in a position to benefit from a loan – education is one of the biggest gaps, as well as healthcare. A recent report by USAID, a large provider of funds for microfinance programmes, concluded that their requirement for at least 50% of their aid money to reach the very poorest families wasn’t being met because it was unrealistic in the first place. This is not to say that the poorest are impossible to reach, but microfinance organisations need to work with them in the context of a wider suite of interventions and need to be cautious about the risks involved. Many established microfinance organisations are now looking at how to conduct the outreach work needed to target poorer sectors, but their efforts are largely experimental and they can only do so because they are confident of the security of their existing programmes. Also, it is important not to underestimate the poverty of those who are nearer the poverty line who are being reached – we’re talking people who live on $2 a day rather than $1, so even though they may be at the “richer” end of the poverty scale they are still very much in need of the vital services microfinance brings, and it is only by addressing their needs that microfinance organisations will put themselves in a position where they can target poorer clients.

Microfinance providers are strictly not-for-profit

In the early stages of its development, microfinance was the exclusive preserve of charities, non-profits and NGOs, but as the industry has grown many profit based microfinance providers have started to appear, and big players in international financial markets are beginning to take an interest – SKS is an Indian microfinance bank that is about to become the third such organisation to make shares available on public investment markets (the first was Mexican MFI Compartamos in 2007). Naturally, there are concerns that this situation will lead to exploitation of the poor for profit and Muhammed Yunus has condemned moves to seek funding by these means, stating that it “endangers the whole mission”.

There have been some reported cases of for-profit microfinance organisations engaging in exploitative practices, particularly in India where there is a large microfinance market, and this is obviously a big problem that needs to be addressed. However, in the majority of cases, for-profit microfinance providers maintain that they can still focus on social development goals while being profit-oriented, and there is a strong argument that the presence of competition from for-profit organisations is good for organisational efficiency and accountability. In particular, because of market pressures driving up efficiency, for-profits can often charge lower interest rates on loans than non-profits.

A workshop making school furniture run by the Association of Disabled Persons in Iloilo

When it comes to putting microfinance organisations on the investment market, there are distinct advantages that can be accessed – not least a strong capital base for expansion that is unavailable through more traditional funding options such as charitable grants. Microfinance is nowhere near as far reaching as people generally believe and it is estimated that 80% of demand goes uncatered for. Accessing capital markets may be the only way to make the provision of microfinance a reality for all those who need it, and yet the idea of corporate fat cats profiting off the poor gives this approach a bad image in people’s minds. A big problem here is the conflation of “profit” with “exploitation” – it is important to make a distinction between the two (if you are unwilling to do this, then it must be assumed that microfinance itself presents you with an undesirable solution to poverty, grounded as it is in capitalist principles). The fact is that if financial equality (or at least the opportunity to achieve financial equality) is the ultimate goal, then attempting to protect “the poor” from capital markets is ironically disempowering – giving people access to basic financial services for empowerment but then artifically sheltering them from the markets that provide the context to these financial services means setting up a situation by which they continue to rely on a form of charity. Obviously this is an undesirable solution – the goal of microfinance should surely be that ultimately the empowered poor can become players in these markets, rather than subject to them, although obviously this is a difficult, long-term process. That’s not to say that these transitions and transactions shouldn’t be handled with great care, nor that for-profits and big market players should be allowed to take a cavalier attitude to poverty, but if these relationships open up opportunities for microfinance to benefit more people, then it is to NGOs and charities that the task will fall of ensuring that the benefits are maximised, that corporate bodies are clear on their social responsibilities, and that beneficiaries are educated about capital markets, their role and how they can be interacted with. In addition, it is to be hoped that the extra resources that capital investment can provide could enable non-profits to focus more of their attention on the very poorest.

Microfinance is a magic cure-all solution for world poverty

Of course, if there was a magic cure-all for world poverty, you’d hope we’d be a bit further towards achieving the Millenium Development Goals than we currently are. Yet microfinance is often treated as this magic solution, particularly in the wake of the publicity received by the industry after Yunus won the Nobel Peace Prize in 2006. In reality, microfinance only addresses one possible cause of/solution to poverty, and while finance and credit exclusion are important issues, as we have explored microfinance initiatives can only help alleviate extreme poverty on a long term and wide scale when applied in a context that includes other vital services and interventions.

In addition, the jury is still out on the impact that microfinance really has on poor families – many microfinance organisations, particularly smaller ones, do not attempt to conduct qualitative impact analyses themselves, instead relying on the (faulty) assumption that if clients continue to loan then microfinance must be working for them. In fact, repeat loans can be a sign of any number of realities, including the often cited worry that clients are taking out loans from one organisation to pay off another. Also, there have so far been very few methodologically sound studies of the impact of microfinance, and those few that have been conducted using randomised control trials show mixed positive and negative results, indicating that the effect of microfinance on the poor may not be as straightforward as originally thought. And there is always the much neglected study of the social and cultural impact that microfinance programmes have, as connecting the poor to Western lending practices and empowering women entrepreneurs in societies when men are often the traditional players in money markets will inevitably have some big cultural consequences.

Again, this is not to diminish the importance of financial empowerment and ending credit exclusion when it comes to eradicating poverty, just that to truly understand the real impact of microfinance, providers need to take more responsibility for measuring their own impact where they work and a lot of research still needs to be done.

(The photos in this post show clients of the microfinance programme of the Association of Disabled Persons in Iloilo (ADPI). You can see more photos from my trip to Iloilo here.)

This Too Shall Pass

Let it go this too shall pass

At the bottom of this post is OK Go’s awesome Rube Goldberg Machine video for their single “This Too Shall Pass”. I’m able to embed it in my blog and share it with any readers because OK Go recently left their former record company EMI in order to self-produce under their own label, Paracadute. EMI don’t allow embedding of videos that feature the music of the artists they represent as it doesn’t generate any revenue for them (YouTube pays a small royalty, but only when people watch the videos on the YouTube site) – this meant that even the band themselves couldn’t post the video on their own website, and that the viral mechanisms that had made their previous videos so popular (see Here It Goes Again and A Million Ways) were unavailable to them. As lead singer Damian Kulash explains, their record company was cutting off its nose to spite its face, because the record industry in general doesn’t understand the basic mechanics of the internet.

The internet has brought a massive step change in the way that consumers interact with markets, and the music industry has been no exception. Never before has there been such diversity or immediacy for consumers, nor such a large community of people who can interact and share information. For music lovers, this has come to represent an opportunity for music to be created and distributed in different and innovative ways, while blogs and social networking sites offer the chance to feel much closer to the musicians who create the music than before. For the record companies and those with a vested interest in intellectual property however, the freedom of exchange that the internet enables has come to represent a deeply problematic forum for users to bypass profit mechanisms, to violate IPR and to establish their own, unregulated distribution networks.

This clash of interests has come to a head in the UK this week, and while the record companies seem to have triumphed, internet users are incredulous at the way these “dinosaurs” seem to refuse to recognise the potential the internet offers for marketing and distribution, preferring instead to cling to outdated ideals and modes of production and to criminalise those who are potential consumers of band merchandise and gig and festival tickets. However the music industry’s resistance to change is by no means unprecedented. Writing about the move towards a market economy in 17th century Europe, economist Robert Heilbroner notes the following example:

“The capitalists of the day face a disturbing challenge that the widening of the market mechanism has inevitably brought in its wake: change.

…the button makers guild raises a cry of outrage; the tailors are beginning to make buttons out of cloth, an unheard of thing. The government, indignant that an innovation should threaten a settled industry, imposes a fine on the cloth button makers. But the wardens of the button guild are not yet satisfied. They demand the right to search people’s homes and wardrobes and fine and even arrest them on the streets if they are seen wearing these subversive goods.”

Robert Heilbroner (2000) The Worldly Philosophers, 7th ed.

It isn’t hard to spot the parallels with the Digital Rights Bill that has been rushed through Parliament this week, and that, among other measures, threatens to cut off internet access for anyone found downloading or sharing copyrighted material. The Bill was passed despite widespread public disapproval, and, according to many MPs and commentators, without adequate time for proper debate or scrutiny. But will this really be a win for the record companies? They may be wiser to take a lesson from the ultimate end of the button makers guild – after all, despite their efforts at the time, people have been wearing cloth buttons for a great many years now without fear of prosecution.

Economists know only too well that change is part and parcel of the way markets work, and even such aggressive resistance from the record companies is likely only to delay the inevitable. Anthropologist Daniel Miller describes in Material Culture and Mass Consumption (2nd ed. 1991) how manufacturers from the 1920s to the 1960s “attempted to construct a highly predictable, homogenized and consistent market, which would allows for longer factory runs and higher profitability”, however this attempt failed in the face of consumer demand for greater diversity of goods, and industrial production was forced to adapt to the trends it had attempted to dictate. The relationship between consumers, producers and demand is by no means clear cut and there is a lot of debate in social theory on this point, but anthropologically demand can be seen as a process of negotiation between the two sides, that is played out in the arena of a fluid and responsive market. If one side tries too hard to maintain the status quo, the negotiation breaks down. The internet provides a solid ground for organising resistance, but so far the demands of the consumers have fallen on deaf ears. However, the internet has also shown itself to be a space where consumers can interact more directly with the producers – the bands and artists who create the music in the first place, and if the record companies refuse to meet them on this ground they could easily write themselves out of the picture altogether.

The UK Government maintains that the Digital Rights Bill is a necessary measure to protect the creative industries from collapse. However, stifling consumer voice is no way to ensure creativity remains possible – quite the opposite – particularly as everyone in this debate seems to agree on the point that good artists and musicians should be able to make a living from their work. Consumer demand for the products of the music industry is stronger than ever, particularly in the face of the hugely effective marketing medium the internet affords, but the demand for a change in the way these products is delivered is just as strong, and this demand will continue to change as the market, the internet and the world continue to develop. The record companies need to accept that change is integral to the way a capitalist economy works, and that like everyone else in the world they will need to adapt and keep on adapting to survive, because, at the end of the day, this too shall pass.

Postcards from Iceland

The use of anti-terrorist legislation by HM Treasury in order to freeze the UK based assets of Icelandic bank Landsbanki this week has understandably provoked a lot of anger from the Icelandic people. Whether or not the UK actually declared that the people of Iceland are terrorists is a debatable affair – the act that Alasdair Darling used to freeze Landsbanki’s assets was the Anti-terrorism, Crime and Security Act 2001, and there are some commentators who claim that Iceland’s assets were frozen under the “crime” aspect of the Act rather than the “terrorism” aspect. In fact there is no such distinction; the section of the Act that deals with the freezing of assets states that such an action may be taken against any foreign entity that is or is likely to take “action to the detriment of the United Kingdom’s economy”. Perhaps it could be argued that this was the case here. But it’s not the wording of the Act that’s important. It was created, as the Home Office website is happy to proclaim, to “in order to provide stronger powers to allow the Police to investigate and prevent terrorist activity and other serious crime”, and the specific measure that deals with the freezing of assets is intended to “cut off terrorist funding”. Of course, the Act was used by HM Treasury because it was the quickest way to act to secure British funds invested in the bank without having to go through Parliament. They believed, and many UK citizens will no doubt agree, that they were justified in taking such action to protect the UK Economy as the Icelandic bank failed.

The citizens of Iceland however are another matter. It’s not just that the actions of the UK stand to have a devastating impact on their economy and their lives. It’s that the use of legislation designed to be used in exceptional circumstances to protect national security interests against the threat of terrorism has been perceived as a symbolic act of significant hostility against a nation of friendly allies. The title of the Act is important because the absurd juxtaposition it creates brings the desperation of the measure to light. For instance, as I write Landsbanki is still listed on the HM Treasury website as a “regime” with which the UK will not have financial dealings, alongside Zimbabwe, Iraq and Al Qaeda. A very particular insult in a global culture where “terrorist” has come to stand for the most base of evils. Luckily for us their protests haven’t yet escalated to the level of violence; the Icelandic Prime Minister has called the act “quite hostile” and an online petition condemning the “abuse” of the Anti-terrorism, Crime and Security Act 2001 with regards to Iceland has been hugely successful; over 65,000 people have signed so far, both from Iceland and from elsewhere. However for me the most powerful protests against the action of the UK Government are the postcards that accompany the petition – photos and images made by ordinary Icelandic people that depict their incredulity at being branded “terrorists” by the UK Government. They serve as a powerful visual culture reminder that those who are affected by the actions of the UK are real people, and they are deeply offended.

Images from http://lisa.indefence.is/Postcards