Microfinancing: the Virtuous Cycle?

We are pleased to present another entry from a member of our team and legal intern, EZ.

BY: EZ

Microfinancing is MACRO- everyone is talking about it- and seems to be benefiting from it - but how can you get in on it? An increasingly large group of private organizations provide entrepreneurs, who are often ignored by financial institutions, with microloans and other basic financial services such as savings accounts, insurance policies, and monetary remittances. More importantly, microfinance offers hope to entrepreneurs in less fortunate areas who might otherwise consider illegal means of finance, like predatory moneylenders, who oftentimes charge an annualized interest rate of 1000% for a monthly loan.

Microfinance is not a new concept. Modern microfinance has been around since the 1970s, but, as Marguerite Robinson explains in “The Microfinance Revolution,” has only recently developed into an industry. The attraction of socially responsible investments (SRIs) and the ability to make an enduring economic and social impact is a primary motivator for this growth. The Internet has also shed light on the difficulties of starting new businesses in less fortunate areas, such as third world countries. It has also allowed would-be philanthropists the opportunity to join peer-to-peer (P2P) sites, such as KIVA and Microplace, and place soft loans of $25 or less with a credit-worthy but struggling entrepreneur. Lastly, technological advances have increased the efficiencies of delivery while simultaneously reducing the costs of funding giving the philanthropists more bang for their buck.

Alas, not all is well in Camelot. Shockingly, most small scale philanthropists willingly give microloans not knowing that the P2P’s local field partners (LFP), were charging exorbitant interest rates of up to 70% as well! This is due to the high administrative costs of delivering funds to remote clients in distant regions. Yet some microlenders have learned to reduce their costs significantly and develop more efficient models (which are less susceptible to waste), like Bangladesh’s Association for Social Advancement or ASA (Hope in Bengali), which has become self sufficient and is no longer accepting funds. Some have even received ratings from the American Institute of Philanthropy, such as Grameen America and FINCA (see http://www.charitywatch.org/toprated.html#peace).

So what can you do to help and, more importantly, avoid doing more harm than good?

1) Perform your due diligence and check the LFP profiles on your P2P site

2) Compare the LFP’s average interest rate against both the P2P’s benchmark and the local money lender rates. For example, KIVA offers LFP info at http://www.kiva.org/about/partners/

3) Be selective in where you allocate your microfund investment. This will encourage positive competition that should support the more efficient partners, which, in turn, should induce the laggards to improve their business models and pass on the benefits to those who truly need it. Deutsche Bank recently reported that the industry has 1 billion micro-borrowers who need $250 billion whereas the industry currently has an estimated loan volume of about $25 billion. Hence, demand far outstrips supply by 10x.

Remember, for many out there, you are the instrument of HOPE! So try to make the most of your social investment by simultaneously improving on the efficiencies of a most virtuous cycle.

To learn more check out these links:

MFG
Wikipedia
Microcredit
Muhammad Yunus
JAK
JAK
Association for Social Advancement
ASA.org
Bank Rakyat Indonesia
FINCA
Needs and Services
Microplace
KIVA
DB Research
Microscholarship
(An innovative offshoot of the micro-industry)

Happy lending!

E.Z. the Lender