Wednesday, April 04, 2007

Is Micro-Finance the Answer to Poverty?

By Vivek George


These days micro-finance has gained considerable popularity and is seen by many as the answer to poverty. In this, micro-finance does not differ much from fad-diets; everyone is obsessed with it, many hope it will be the panacea to the world’s ills, and perhaps micro-finance even helps a little here and there, but in the end, the root problem still exists. The practice of micro-lending is not new, however. Micro-finance as we know it dates back to the 1970s, but within the last few years it has gained a great deal of momentum, especially through the efforts of last year’s Nobel laureate Mohammed Yunus. Mr. Yunus’ Grameen Bank (founded in 1983), is one of the leading micro-finance organizations, lending millions of dollars worth of micro-loans to the “poor”. But have these loans truly been directed to the poor and more importantly have they assisted in breaking the cycle of poverty? Well, let us see if we can answer that question.

The other day a close friend sent an email to me and a few others entitled, “Interesting”. Being interested I decided to give it a look. What I found was a link to the New York Times article, You, Too, Can Be a Banker to the Poor, by Nicholas Kristof. After reading a few lines, I realized this was yet another one of those micro-finance articles, the type that has become ever-increasingly popular in the press, touting that the end of poverty was simply a few clicks away. Annoyed by a lack of informed reporting on the subject, I decided I would write to my friends to provide them a more realistic view of the subject.

From the first line it was clear that Mr. Kristof did not understand how micro-finance works in the real world. “For those readers who ask me what they can do to help fight poverty, one option is to sit down at your computer and become a microfinancier,” he wrote. The key flaw of this line is “fight poverty”. This is because, for the most part, micro-finance does not help the poor (those who live on less than $1 per day, the UN yardstick for poverty). Mr. Kristof cites a man who owns a TV repair shop as an example of a person who has benefited because of loans from organizations such as Kiva (a leading micro-finance organization). But let’s be honest--do we really think a man who owns a TV repair shop or carries a mobile phone lives on a dollar a day (I doubt there are many poor Americans who can afford a TV repair shop)?

In India, roughly speaking, the family income bracket breaks down as follows:

Families with less than $1 per day – 300 million
Less than $2 per day – 600 million
Less than $10 per day – 900 million
Over $10 per day – 200 million
(Note: A family is defined as consisting of 4 members)

The TV repairman in India is likely to be in the $2-$10 (or higher) bracket. While people in the West might consider such incomes as low and hence, "poor", those who work among the impoverished do not think of shopkeepers as poor. It is misleading to talk of assisting those living on $2-$10 or more per day as helping the poor.

And what about illiteracy and lack of education? Can we really expect a poor, illiterate person from the rural, third world to create a sustaining business from a $100 micro-loan? It is hard to find any meaningful number of entrepreneurs among the truly poor. Even in a superpower like America, most of us would not be able to start and run a successful business, so how can we expect every loan we send to India, Angola, or Haiti to initiate an entrepreneurial endeavor?

Kiva and other micro-finance institutions (MFIs), for the most part, help the lower middle class – those in the $2-$10 range in family income – who may not have easy access to credit from commercial banks. For this reason MFIs may be their best and only option to pay for emergency hospital care or dowry for their daughters' marriage. But these organizations are not real charities that focus on the poor and their needs(education, healthcare, infrastructure, etc). Nor do MFIs care to know what the borrower uses the funds for as long as there is an assurance (usually collectively guaranteed by a group) for the return of loan principal and payment of interest.

This leads to the next issue which Mr. Kristof’s article and most others on the topic miss – interest rates. Most micro-finance organizations charge interest rates between 24% - 36%. Can you imagine ever taking a loan out at that rate? MFIs trumpet a loan repayment rate of 95 percent or higher (to make a point that the poor are very credit-worthy), and yet they justify these exorbitant interest rates by claiming a high risk of default.

Fundamentally there isn’t anything seriously wrong with most micro-finance firms; the issue is the context of what they really do and who they really help. Micro-finance firms must be honest about who their borrowers are, and what they do with the loans. To determine whether these firms are truly fighting poverty or if they are just running another business for profit (Kiva is not-for-profit, but this is not the case for many MFIs) I return to the question I first asked – is their goal to truly reach the poor and more importantly break the cycle of poverty? I think it is clear that these firms are far from genuinely trying to eradicate poverty.

I apologize if this is discouraging, but fighting poverty is going to take more than just throwing money at the problem from the comfort of our homes. You may be saying now, how can I fight poverty with the little time and resources I have? There are different answers to that question, but what is important is that we seek real solutions, not comfortable myths, to this global problem.


Please visit us at www.tgfworld.org and www.indiauntouched.com

9 comments:

Craig Sickel said...

Mr. George: I applaude your work in India. I agree with you on some points and disagree on others. I agree that KIVA does not help people start businesses. KIVA loans assist those with existing businesses. I have put some money into KIVA loans with the understanding that this small transfer of money from the US to the borrowers is a help. You agree that these particular borrowers are helped. Maybe the local economies are helped too. Maybe it helps the children to get a better education and avoid your definition of poverty. The full benefits may take years or decades. My money also comes back to me, so I only loose the opportunity cost, a reasonable exchange. I have a comfortable life and am not hurt.

About the interest rates, you are mistaken. The high rates are due to fixed and processing costs of small loans, not risk.

I also donate to Gremeen. You mention Gremeen and Dr. Yunus (he is a Ph. D), and the implication is that Gremeen is the same as KIVA. You know this is not true. This lumping of the two and generalizing them diminishes your credibility and suggests you have an undisclosed agenda.

"Can we really expect a poor, illiterate person from the rural, third world to create a sustaining business from a $100 micro-loan?" Another over-generalization. Are you contending that there are zero such people who can use a micro-loan to create a sustainable business? Again your credibility suffers. No data provided. What percentage of the "poor", who do not have the opportunity, can and will create a sustainable business, if given the opportunity? Micro-finance and other efforts like yours can find these people and give them the opportunity that would otherwise not exist.

You wrote an opinion piece and provide no data.

You ask if microfinance is the answer to poverty. Your answer is that "these firms are far from genuinely trying to eradicate poverty." You only use KIVA as an example. KIVA is not representative. Are other firms trying to eradicate poverty and what has been their success? You do not address this.

I suggest better questions: Can poverty be eradicated? If so, how? If not, is working to reduce poverty usefull and possible? If so, how to proceed? If not, quite all efforts.

I suggest that putting down other's efforts in this way, that do not fit your model, is counter-productive.

Abraham M. George, The George Foundation said...
This comment has been removed by the author.
Abraham M. George, The George Foundation said...

Mr. Sickel: My credibility will be judged by our work, and I leave it to others to make that conclusion. Let me now comment on some of the points you make.



First, as the original posting says, there is nothing fundamentally wrong with micro-finance. It helps some people start small businesses. That helps the economy, just in the same way as a private for-profit company does. If we have many entrepreneurs starting businesses in poor communities, it will greatly reduce unemployment and generate income for many people, including the poor.



As the blog posting points out, micro-loans are often given not to those who are defined as "poor" by usual yardsticks (UN, World Bank, etc.). But micro-loans help the poor (if they receive) meet some of their personal emergencies. It is certainly cheaper than the 120 percent rate usually charged by local money lenders. MFIs require the entire Sangha (self-help group of women) to guarantee the payback of every loan with interest; they do not care to know the purpose of the loan taken.



Mr. Yunus started his noble venture with the right idea of offering credit to a selected few who were fairly poor, and supported them in their business ventures. Today it is a different set of activity, targeting people who are not necessarily the poor. It doesn't imply that the business activity so created is not helpful to the local economy.



KIVA and other non-profits are making funds available to those who might not be able to borrow from banks. But they seldom advance loans to the poor.



We work with some 30 self-help groups where we help poor women save, and supplement it with government grants and commercial loans (including those from MFIs). 95 percent of them use those for their personal emergency needs. The few who try to start any business -- mainly resale of vegetables and cattle -- are not any better off than working in a farm or a factory as a laborer.



By the way, the transaction cost does not justify 24-36 percent. We offer at 12-15%, and cover all our costs. Even if there is a little cost overrun, it is considered as part of our social contribution.



I have provided several ideas for dealing with poverty in my other blogs. Most of those ideas are on interventions that can be directly made (for the poor), and not necessarily rely on trickle-down effects.



Abraham

Saravanan said...

Respected Mr.George,
I am a 20 year student from Coimbatore Tamil Nadu and I am greatly moved by your works for the poor.I certainly beleive that the people who couldnt have the basic education cant make out a good business with the loans .All they can is to provide physical work and what one can do is to rise the payment given to him and making sure that his children get good education and his poverty is eleiminated in the next generation.
Really hats off to your 'Shanti Bhavan'

Vivek said...

Mr. Craig: No one disputes that universal availability of credit, even at 24-36 percent, can be helpful to those who are shut out of conventional sources. The questions, however, are on who are the recipients of micro-loans, and what do they use those loans for. The burden of proof is on the ardent supporters of MFIs to show that microfinance lives up to their claims; to date, there is little data that supports the argument that microfinance is alleviating poverty in any meaningful number. I suggest that you find answers to the following questions:

a) What percentage of the micro-loans is provided to the poor in a country like India? (The poor are defined internationally as those with daily income below $1; according to the government, based on caloric intake, the poor in India are those with daily income below $0.26).

b) What percentage of the recipients of micro-loans among the poor (as defined above) is running sustaining small businesses?

c) What percentage of all recipients of micro-loans is running sustaining businesses?

Based on a survey of our area in Tamil Nadu, the answers to all three questions above are the same: less than 10 percent. If this result is representative of the entire country (we believe so), then there is certainly an issue concerning "truth in lending." It is inappropriate for MFIs (that are run for-profit in India) to make inaccurate claims.

As for grouping Grameen and Kiva, if you read my article carefully, I did not group the two organizations, but simply referenced Grameen for historical purposes. And though Kiva and Grameen have different models, they are both institutions in the business of providing micro-loans.

Lastly, your points have been noted, but please refrain from personal attacks.

Vivek

Craig Sickel said...

Abraham and ViveK:

Thank you for your responses. I have become somewhat familiar with your work at TGF and find it remarkable. Your dedication, tenacity, determination and hard work has been used to apply your experience and skills to a difficult problem in a deserving location. Your families, friends and collegues must be proud of you and priviledged to know you, as they should be. And your recipients must appreciate your help. If only more people with your knowledge and abilities would take on similar ventures, the world would be a better place and the future would look brighter.

My intention was and is not to make a personal attack. I do not know you personally, only your writings. Abraham, are not the postings to this blog, part of your work?

You are free to disparage my writing, I will not take offense. I know I am not good writer (or speller).

As a donor to MFIs I am concerned about their affectivenes in using my money and I am not the only one. So, I was interested in your critique. I just found it weak. You state in this posting. responses to me and elsewhere, specific items of concern about MFIs. You may be correct, but you support the statements by personal observation, internal unpublished studies and references to newspaper articles or nothing at all. Sorry to sound harsh, but this would not fly for an undergraduate homework paper. I am aware of studies that partially support some of your assertions, but not definitively. I am not aware of any published studies on your work and its effects on the poorest families in your area.

Grameen has been the subject of many studies and they post links to them on their website, even the ones that show their weaknesses.

I find your idea about public companies moving into rural areas and employing locals to be very interesting, however, there are no references to books or articles. You make no predictions that the poorest will be employed, so maybe this has the same limitations as the MFIs.

Abraham M. George, The George Foundation said...

Dear Craig: I am not into proving or disproving the claims made by MFIs. We focus our work on the poor – for those below $1 a day. The burden of proof is on MFIs and their supporters to substantiate their claims. Exceptions do not prove those assertions. Further, there are no studies I am aware of that clearly provide the statistics on the income levels of the beneficiaries of micro-loans, what percentage among them are poor (below $1 in income per day), and how many among the poor are running sustainable businesses.

However, I know from my 11 years of work and interactions with several MFIs and self-help groups in Tamil Nadu and Karnataka about the way MFIs work and who the beneficiaries are. As I point out in my blog postings, the beneficiaries are small businesses/shopkeepers and others with some business or educational backgrounds. They are mostly in the lower middle-class economic status (shopkeepers, suppliers, etc.). There might be just a handful of people in the poor classification – less than $2 per day in family income – who have started some sort of business (home-made sweets, few sheep, etc.) with micro-loans. I have not found sustainable businesses run by any of them. It needs a whole different set of interventions (and not just $100 in credit) to turn uneducated and socially deprived poor people into successful entrepreneurs, if at all that is possible.

MFIs help promote small local businesses, but they are not, in my opinion, targeting those who are poor by Indian standards. I am in support of ethically run MFIs (who charge reasonable interest rates and engage in proper collection practices). What I do not agree with are the claims they make.

In my opinion, poverty will not be solved by NGOs (even though they could help reduce suffering) or through micro-finance. It will be solved only with vibrant economic activity in deprived areas – companies that employ large numbers of people and pay decent wages and give proper benefits. Those who earn sufficient income to be able to send their children to proper schools and provide healthcare for their families will not have their next generation experience poverty.

I think I have said all I want to. I am happy if you are providing assistance to MFIs who in turn help small businesses. That is fine by me.


Abraham

Concept & Context said...

Dear Mr.George,
I just got an oppourtunity to visit your Blog.Contributing to create better understanding(through your Weblog)of the subject of poverty itself is such a laudable thing.In addition to that I learnt you are not just writing but involved in the process of poverty alleviation.You are doubly blessed!
I fully agree with you that micro finance by itself can not remove poverty.Setting up micro enterprises and running them on a sustainable basis would ensure that.As of now most MFI initiatives
focus more on "linking with banks" rather than creating sustainable oppourtunities. For the past six years I have got some exposure to SHGs particularly in South Tamilnadu.I have not come across many micro enterprise initiatives.
As you have put it in your Blog the need of the hour is to put management and entrepreneurial practice into SHG concept if real and tangible result on the poverty front is to be achieved.
S.Gnanaharan.

Abhishek said...

My two cents on the questions raised in the blogpost and the comments. Rather long, but I believe I answer some questions.


I do not think micro-finance is an answer to poverty. As vivek says micro-finance does not reach out to the poorest of the lot. It is so because the poorest should not be given loans, they cannot afford to repay loans in the period of time as currently expected by most MFIs. They should not be given loans because they will not spend the loan on something constructive for their future but rather to pay for their immediate needs. There are two ways of looking at micro-credit.
1. to be used to pay for needs
2. to be used as an investment in a business.

Every MFI aims at giving loans which are used for type two. Type one doesn't solve the problem of poverty nor does it really help the MFI. Why do MFIs try to focus on type 2? the risk of default is lower and possibility of future loans is higher. Type one possibly means the clients get deeper into debt, means lesser clients for them in the future.

micro-finance does not reach out to the poor. Forget definitions or stats of the number of families in each economic strata. The question is doesn't the current level of the society addressed by MFIs require loans to better their economic status? I strongly think the TV repairer needs the loan and the fact that MFIs are currently addressing such people is not a negative point.

For the poorest lot, micro-finance is not the answer. Possibly micro-credit along with support systems which ensure the money is spent in ways constructive for better economic growth and not for immediate gratifications.

The other question of can businesses be run on 100$ loans? Enterprises can't be created, but a cow, or seeds or pesticides/fertilizers for farms can be bought. micro-finance clients could want the loan to augment their current source of income by using the money to add or diversify their business.

Vivek, I think you are trying to search for a panacea which will completely solve the problem of poverty and you feel disappointed that micro-finance is not that panacea. I agree micro-finance is not the answer to poverty, but it's certainly bettering the current situation.

And micro-finance is doing a much better job than charity ever can.

Charity is not sustainable because the selfish interests of the charitable person is not involved. SO while today you might get a lakh out of me, but tomorrow I might not do the same thing because, I'm not getting anything out of it.

This is why for-profit MFIs should be encouraged. Being for-profit immediately makes them accountable to law, to stakeholders. MFIs
have to be efficient, because now selfish interests are involved.

I mean come on, how many people do you think are so selfless that they'll work to eradicate poverty without expecting anything in return?

Non-profits to me means two things
1. They love not being answerable, not being liable to law, not having to lose anything if they screw up. They can be inefficient and detrimental to the very cause they are fighting for. Everybody in India questions non-profits because of the very common case of people swindling money under the name of non-profits.

2. it reminds me of socialism/communism. Socialism solved one problem and created two other. Capitalism creates the best opportunities for all people and solves most problems.

The question about interest rates? If you've looked at stats, they'll show a weird figure, the higher the penetration of the MFI the higher its interest rates are.

Transaction costs are high in micro-finance because recovery costs per unit of money is much much higher than in conventional loans. People have to move door-to-door to recover payments not more than a hundred rupees.

Of course the rates of MFI with a profit motive is higher by percent or two than the ones for non-profits. Thats a small price to pay for sustainability. Not to say its unfair that the borrower is paying for it.

Now how do we resolve this unfairness? By decreasing the returns of the investor in MFIs. Decreasing their returns slightly will surely solve the problem. Such a thing creates a new problem, the investors currently are Banks or VC firms or big financial houses. Basically huge bodies, who are the ones that actually call the shots in MFIs. So they would rather invest in something else than decrease their returns even slightly.

Thats where a model like Kiva would solve the problem. Get retail investors, make micro-finance another hot place for investments. Of course Kiva does not give returns to lenders, but I strongly think if Kiva could promise returns, then more people would invest(through Kiva), which would ultimately lead to MFIs existing solely on retail investors and The bigger investors are out of the picture. Which means interest rates go down.

Kiva has done a great job of getting a wider audience for micro-finance. And more number of people are debating on micro-finance and poverty. More number of people feel associated with the Africa's poor. true they are not solving poverty by just clicking, but then they are doing their tiny bit.

My mail id is nayak.abhishek@gmail.com. Please mail me about my comment. Would love to converse on micro-finance!