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.
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