Microfinance ... response to NYT on microfinance

Dear Colleagues

On April 14th, the New York Times published an article on some of the issues with microfinance. The full article is accessible at
http://www.nytimes.com/2010/04/14/world/14microfinance.html

One of the "comments" about this article was written by Brian Gately who has a wealth of experience in the microfinance field. This is his published response:

April 14th, 2010 8:30 am

I've worked in Haiti, Colombia, Bolivia and now in the US in microfinance. Here are some comments about interest rates:

--If you go to a payday lender here in the US, you might pay a $25 fee to get an advance of $250 on your paycheck for a week. This is 10% a week or 520% a year. But still not such a bad service.

--In Guatemala vendor ladies in the central vegetable/fruit market might pay 3 quetzales (their money) for a loan of 300 quetzales from the wholesaler, and then during their 16-hour day, sell the same vegetables/fruits for 400 quetzales, from which proceeds they pay back the loan. They are paying, then, 1% a day for their loan or 360% a year. But still it's a good deal for them, and convenient.

--In microfinance most loans are very short term. If you lend someone a $100 for 1 month, with two payments, and charge them 18% a year, effectively you earn about 75 cents. That doesn't cover costs.

--Interest rates on very short term loans (microfinance)are not very relevant. But, on the other hand, on long term loans--real estate--they are very relevant.

--A problem in microfinance is unfair competition. There are some charities that lend at zero percent until their funds run out--how can another institution compete with that? They can't. But zero percent is not sustainable. 40% to 60% annual percentage rate is more sustainable. Nominally this seems high. But on the other hand, if I charge $2 fee to apply to borrow $50 for a month with weekly payments, if you include the application fee as part of the annual percentage rate, I am effectively charging 2/25 x 12, or 96% a year. Still a good deal. (The formula is based on the fact that if you pay %50 over a month's time, you on the average only have use of half of it, $25 for that month.)

--Compartamos was an egregious example of greed--the end user did not benefit. They should be ashamed. It gives all of microfinance a bad name. It was a Wall-Street type IPO with incredible returns to the original investors.

Microfinance works! It is good. And credit unions are the leaders in microfinance. They are sustainable on just 18% a year maximum annual percentage rate.

Brian in Brooklyn

I am totally in agreement with Brian. My own experience supports everything that Brian is saying.

As someone who is committed to metrics ... and the idea that the metrics must be "right" ... then it very quickly becomes clear that what is important more than anything else in the microfinance field is to get a right balance between the MFI needs to have income to cover its costs and the client that needs credit to do something that has value.

I tell the story of someone who borrowed $10 with an agreement to repay $20 in two weeks time. That is a huge interest rate ... extortion if you use simple financial money metrics. But that $10 enabled the borrower to get drugs that probably saved the life of a child! A total cost of $20 to save the life of a child is a good value return ... and this, in my view, is the most important return that should be in play.

In another situation, it turned out that the MFI had "interest rates" that compute at between between 60% and 120% using simple financial money metrics. But this organization had a rule that every client must get training before they borrow. They do not charge for this training ... even though, I would say "obviously", this training had a high cost. When the trained clients borrow they have a track record of success ... and effective reimbursement of their cost of training is rolled into the repayment schedule for their loan. What is wrong with this? I would argue ... nothing, though I would argue that using interest rates to define whether or not an MFI is good or bad is nothing less than stupid.

In yet another situation, I was asked to look at a microloan portfolio that had an abysmal 65% repayment rate. It was lending to women ... but not getting the repayment of better than 95% that is widely regarded as the norm for microlending to women. A simple analysis exercise showed that there were two segments to the portfolio ... a segment where almost perfect repayment, and a segment with almost zero repayment. The high performance portfolio were young women who could work in micro-business and repay. The low performance portfolio were old women, most of whom were looking after grandchildren and struggling. With this information in hand, the funders of the program (in fact an African municipality) were able to choose what to do. The normal financial performance value of part of the portfolio was very good ... the other part of the portfolio had huge social value even though its financial performance was awful!

I argue for good data ... data that are very specific to the situation at hand ... data that helps to understand cause and effect, and to help make better decisions. This is rarely achieved by the aggregates and averages that are commonplace ... and rarely achieved when the only metrics are the money profit metrics!

Peter Burgess