Two recent articles on microfinance and the Yunus Nobel Prize

The Nobel Peace Prize will be awarded to Muhamad Yunus for his work with Grameen Bank in microfinance this coming Sunday in Oslo. I've already said some stuff about this, in an earlier post when the award was announced, here. But here are two recent articles on Yunus and microfinance, this one from the New Republic, and this one from the New Yorker (which also covers the borader topic of venture philanthropy).

Unfortunately I don't have time now to comment on them, although I think they are each problematic in different ways. I'm in the middle of a survey of recent books on microfinance to write a review for the Times Literary Supplement in January, and then a longer, academic review essay later on - it's a lot of reading. The last time I went through the technical literature systematically was back in 2002 around the time I was writing this article on microfinance and globalization, and there has been a huge increase since. Most interesting to me has been the entrance of formal economics into the field. Maybe I'll try to make some comments on all this, but in the meantime, congratulations to Mr. Yunus.

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Why Nobel laureate Mohammed Yunus will doom microfinance.

Poor Vision

by Andrew Curry

Only at TNR Online
Post date: 12.07.06

By now, Mohammed Yunus's first loan--$27 from his pocket to a group of bamboo furniture makers in a Bangladeshi village--is a legend in the international aid community. Inspired by the results of his modest 1974 experiment, Yunus, an economist, went on to found the Grameen Bank, which today provides millions of Bangladesh's poorest with life-changing access to credit.
Yunus will be awarded a Nobel Peace Prize for his work this Sunday in Stockholm. The honor is proof that small-scale lending to "the bottom of the pyramid"--or so-called "microfinance"--has become the hottest idea for solving poverty to hit the development community in decades. But following Yunus's vision is the best way to doom a promising movement to failure.

The problem isn't Grameen's size or its borrowers, but its philosophy: Yunus is firmly anti-profit. "Maybe banks can make a profit from [loaning money to the poor]. ... But this is what loan sharks do," Yunus said after his Nobel win was announced in October. "We have enough enterprises generating money for profit. I would rather think that the rich can set up social enterprises." Yunus even objects to the term "microfinance," preferring the profit-neutral "microcredit."

This principled allergy to profiting from the poor may be part of the reason why Grameen still depends on NGO grants and its founder's incredible charisma to stay afloat. Indeed, Grameen is glorified philanthropy, not banking. If small-scale financial services are to be a long-term solution to the problem of poverty, they need to embrace profit.

The reasons lie in the realities of lending. Though Grameen and others have convincingly dispelled the notion that the poor are bad credit risks--Grameen's reported repayment rate is close to 99 percent, comparable to that of most commercial banks--microfinance still poses huge challenges. Big banks have traditionally shied away from loaning to tiny customers, because doing business on such a small scale is very expensive. Since small-scale borrowers are often illiterate, with little or no collateral and primitive or nonexistent bookkeeping, evaluating their creditworthiness is a labor-intensive process.

Take the case of Serbia's sole microfinance bank, ProCredit Bank Serbia. The bank's 330 loan officers visit two or three clients a day. Loans are evaluated based on business plans and capital, but personal behavior and family reputation can be equally significant. "These businesses don't have books--this isn't a corporation," says ProCredit Serbia executive board member and former loan officer Mirjana Zakanji. "We have to assess the potential of the owner of the business, because they're also the main employee." Eighty percent of the bank's 7,000 new loans each month are for less than $12,500. (The European Bank for Reconstruction and Development defines microcredit as any loan under $38,500.)

Given the intense--even holistic--work involved in each micro-loan, it's not hard to see why most banks would rather issue a single loan of $1,000,000 than, say, 10,000 loans of $100. Yet microfinance banks around the world have managed to turn lending to the poor into a profitable, sustainable business in the last decade, even at the very smallest loan levels. ProCredit Bank Serbia's German parent, ProCredit Holdings, has profitable branches in Haiti, Congo, Angola, and El Salvador. Indonesia's state-owned, commercial Bank Rakyat started offering micro-loans in 1984. Today, its smallest micro-loan unit has over 700,000 clients and turns a profit, despite a $33 loan average.

How can loans so small make money? Microfinance banks are forced to charge high interest rates just to cover costs--and even more to make a profit. In a study of South American microfinance banks published in April, Harvard Business School professor Michael Chu found interest rates ranging from 21.76 percent at Bolivia's Asofin to 87.5 percent at Mexico's Compartamos. In India, microfinance banks typically charge at least 30 percent a year.
Compared with Grameen's rates (between 10 and 20 percent per year, about what Americans pay for their credit cards), that's high. And that's what bothers Yunus. High interest rates have drawn increasing fire from other quarters, as well, with the spread of micro-lending. Last year, Indian officials used a spate of rural suicides as an excuse to shut down microfinance bank branches and threaten interest rate caps of 10 percent, a level that would put most of the country's microlenders out of business.

But the profit motive isn't necessarily bad for poor borrowers. Profit breeds competition, which in turn lowers interest rates, as microfinance banks compete for clients. In markets where multiple banks have gotten into the microfinance business, interest rates have dropped significantly, and the banks have grown. Chu cites Bolivia's example. When the first micro-lender opened there in 1992, it charged 35 percent interest. Intense competition in the years since has driven the average interest rate down to 21.23 percent, South America's lowest.

"There are all kinds of prejudices and value judgments when you talk about profits and the poor," says Chu. "Those are just knee-jerk reactions. The prejudice against profit is a judgment made by emotion, not efficacy." And for-profit microfinance banks are still a bargain when compared to the only other option available in many parts of the world: traditional moneylenders and loan sharks, who normally charge 10 to 30 percent interest per month, or more than 1,000 percent per year.

Moreover, if financial services to the poor are to grow, they need to be able to do more than cover costs. When microfinance banks make money, they earn the capital necessary to expand, making more credit available to more people. And, whereas Grameen's transparency leaves much to be desired, commercial banks are held to a higher standard of accountability. "To develop this type of business to a high level, it needs to be financially stable and sustainable," says ProCredit Serbia's Zakanji. "There are thousands of NGOs rushing around the world without clear goals. Commercial institutions with demanding shareholders will be more successful in the long term than most of these guys." Indeed, after three decades, the sector is finally on the verge of becoming an attractive investment. In the last year, major funds like TIAA-CREF and banks like Citigroup have announced plans to invest in microfinance operations.

That's why the worst thing that could happen at this stage is for profitable banks to be undercut by subsidized competitors like Grameen. To be sure, it may be difficult for some commercial banks to reach the "poorest of the poor," as Grameen does. Banks like ProCredit serve mainly micro-entrepreneurs, poor people with skills or businesses who need capital to grow or stand alone. But, any financial institution--even Grameen--requires that borrowers pay the money back, with interest. A strong case can be made that, instead of taking on debt, the truly destitute will always need the help of charities.

There's no doubt Yunus deserves his prize. His work has been instrumental in changing the lives of the poor in Bangladesh, and his success has given the microlending effort invaluable credibility all over the world. But, while Yunus has described his vision as a panacea for poverty, it's not a universal solution. If the idea is to succeed, the development community must set aside its distaste for profit and embrace the market.

Andrew Curry is a freelance writer in Berlin, Germany, and a former Fulbright journalism fellow.