I have written several posts focused on microfinance and small loans (see, for example, Financing the Poor and Small Loans Attract Big Players). Microloans have dramatically improved the lot of many of the world’s poorest of the poor. The champion of microfiance, Muhammad Yunus, even won a Nobel Peace Prize for his efforts. Something is happening in Mexico, however, that threatens the reputation of microfinance institutions [“Microfinance’s Success Sets Off a Debate in Mexico,” by Elisabeth Malkin, New York Times, 5 April 2008].
“Carlos Danel and Carlos Labarthe turned a nonprofit that lent money to Mexico’s poor into one of the country’s most profitable banks. But not all of their colleagues in the world of microlending — so named for the tiny loans it grants — are heaping praise on the co-executives of Compartamos. Some are vilifying them as ‘pawnbrokers’ and ‘money lenders.’ They are the center of a fractious debate: how far should microfinance go toward becoming big business?”
In the latter of the two posts mentioned above, I noted that “hedge funds, venture capital firms, and other big investors are angling to get into the business” of providing microloans. What drew the attention of those groups were the relatively high interest rates of microloans. High interest rates are normally associated with high risk loans. Microloans, especially those provided to women, have proven to be anything but high risk (with many microlenders reporting that over 90% of the loans made to women are repaid in full). The repayment rate for Kiva.org — the focus of the earlier blog — is 99.78%. Not all people desiring microloans, however, are good credit risks — and there is a growing demand for such loans. Malkin points out that Yunus is at one of the microlending spectrum and profiteers, like Danel and Labarthe, are at the other.
“Microlenders, the original and still the most common type of microfinance organization, help the poor start or expand businesses in places most banks shun, like the slums of Calcutta or these impoverished hills in Mexico’s sugar cane country, three hours south of Mexico City. Their efforts are widely considered successful in transforming the lives of developing-world entrepreneurs, particularly women, and their families. Many microlending advocates, including Mr. Yunus, say that success is threatened by Mr. Danel and Mr. Labarthe’s market-oriented model, with its emphasis on investor returns. ‘Microfinance started in the 1970s with a focus on using this breakthrough to help end poverty,’ said Sam Daley-Harris, director of the Microcredit Summit Campaign, a nonprofit endeavor that promotes microfinance for families earning less than $1 a day. ‘Now it is in great danger of being how well the investors and the microfinance institutions are doing and not about ending poverty.’ He said the situation posed the danger of ‘mission drift.’ Mr. Danel and Mr. Labarthe say microfinance will help more poor people by tapping the boundless pool of investor capital rather than the limited pool of donor money.”
While both Yunus and the two Carloses claim to be interested in helping the poor, it is difficult to split allegiance between clients and investors. At least donors (the traditional source of funds for microlenders) are looking at the end result (the elimination of poverty) and not the bottom line. Whereas traditional non-profit groups reinvest profits back into helping the poor, the for-profit groups have to give profits to investors. No matter how idealistic you may be, that’s a big difference in how the two groups operate.
“Alex Counts, president of the Washington-based Grameen Foundation, said Compartamos’s poor clients ‘were generating the profits but they were excluded from them.’ Lynne Patterson, a founder of Pro Mujer, a nonprofit microfinance group with branches in several Latin American countries, agrees. ‘We use the profit to reinvest in the service of the clients,’ she said, referring to loan repayment profits. Since lack of access to credit is just one of the problems the poor face, Pro Mujer also offers services like breast cancer screenings, advice on dealing with domestic violence and financial education.”
Earlier I indicated that large financial institutions were interested in microloans because of the high interest rates that small lenders charge. Compartamos charges about twice the normal interest rate.
“After Compartamos became a for-profit company in 2000, costs fell as efficiencies increased, but the bank kept interest rates high. On average, customers pay an annual interest rate of almost 90 percent, which includes 15 percent in government tax. In much of the world, microfinance interest rates range from 25 to 45 percent. But in Mexico, high costs, inefficiency and limited competition keep interest rates much higher. Compartamos’s rates are only a few percentage points higher than Pro Mujer’s, for example. Like microfinance businesses around the world, Compartamos makes loans without collateral. Its borrowers, who are nearly all women, are organized in groups, which guarantee the loans. Stop paying and your friends must pay for you: the system keeps default rates down. Historically, microlenders point out, such borrowers are excellent risks. For instance, Compartamos’s nonperforming loans were just 1.36 percent of its portfolio at the end of last year. Servicing those loans takes labor and that pushes up rates on such small amounts. A Compartamos collection agent visits each group every week, riding public buses out to villages. Compartamos is more efficient than other Mexican microfinance institutions and its own borrowing costs are lower, thanks to its strong credit rating. Critics charge that it has not passed those savings on to its customers. The numbers seem to bear that out. A study last year by the Consultative Group to Assist the Poor, known as CGAP, a microfinance industry group based at the WorldBank, estimated that 23.6 percent of Compartamos’s interest income went to profits. Its return on average equity is more than triple the 15 percent average for Mexican commercial banks.”
Malkin points out that businesses need to earn enough operating funds to keep going (even non-profits); but making substantial profits on the meager earnings of the poor sticks in the craw of those trying to help improve the quality of life of those mired in poverty.
“Profit is not a dirty word in the microfinance world. The question is how much is appropriate. CGAP estimates the average return on assets for self-sufficient organizations to be 5.5 percent. The figure for Compartamos was 19.6 percent in the fourth quarter. Mr. Danel said Compartamos’s interest rates have fallen 30 percentage points over the last five years. ‘They go down based on efficiencies, and we pass this benefit on to the customer,’ he said. Compartamos grew to 840,000 customers last year, from 60,000 in 2000. Last April, Compartamos’ owners sold 30 percent of their stock on the Mexican stock market in an initial public offering. The public offering brought in $458 million. Private Mexican investors, including the bank’s top executives, pocketed $150 million from the sale. More than half of the public offering proceeds went back to development institutions that had invested in Compartamos when it moved from being a nonprofit to a commercial venture in 2000. One of them was Acción International, a Boston-based nongovernmental organization that helps build microcredit institutions and provides them with technical assistance. Acción invested $1 million in Compartamos in 2000. It sold half its 18 percent stake at the time of the public offering for $135 million. ‘This is one strategy to address poverty that doesn’t remain small and beautiful,’ said María Otero, president of Acción. Charles Waterfield, a microfinance consultant who has been among the most vocal critics of Compartamos’s model, disagrees. ‘Not only are they making obscene profits off poor people, they are in danger of tarnishing the rest of the industry,’ he said. ‘Compartamos is the first but they won’t be the last.’ … Mr. Danel and Mr. Labarthe argue that successful microlenders in a middle-income country like Mexico should use the capital markets, instead of crowding out donations.”
Malkin concedes that some clients are happy with Compartamos. She concludes her story with an account of some of Compartamos’ borrowers.
“At the recent weekly meeting of a group of Compartamos borrowers in the village of Valle de Vázquez, the interest rate was not a great concern. Indeed, several women said they had left another microfinance institution because it charged more. The group was well established, 35 strong and well into its third year of borrowing. The meeting, which took place in the living room of one borrower’s home, was the start of a new four-month borrowing cycle. A Compartamos manager, Claudia Ayala, began with a pep talk, pointing to a house plant set on a chair beside her. ‘This plant grows and this group can grow,’ she said to the women, who were listless in the afternoon heat. ‘How? By inviting more compañeras,’ or friends. ‘By fertilizing it with responsibility,’ she said. Though the village depends largely on remittances sent by relatives in the United States, the Compartamos loans have helped some women become self-sufficient. Silvina Martínez started a little restaurant in her house a year ago to sell her homemade snacks to students at a nearby high school. It has grown steadily since then. With this cycle, she was going to borrow about $1,100 to paint the restaurant and expand her menu. ‘It’s my own business,’ she said. ‘You are a slave to it, but at least it’s mine.’ Other women were successful entrepreneurs to start with, but the Compartamos credit gives them a push, allowing them to hire an employee or help ease their cash flow. Alejandra Abúndez, 57, keeps pigs and cattle, and produces 330 pounds of cheese a day, which she sells in the local market. She and her daughter, Micaela Rivera, were borrowing $3,550 from Compartamos to buy animal feed and to stock the tiny store in her front entryway.”
Credit is a double-edged sword. Muhammad Yunus began Grameen Bank because he understood that credit means financial power — a source of power normally denied to the poor. On the other hand, as the credit crisis in America has demonstrated, extending too much credit can cause an entire economy to falter. Neither situation (too little or too much credit) is good for either the poor or the country in which they live. I think the jury is still out on whether Compartamos is a good model to follow. One can’t deny that its approach provides it with greater access to funds. Neither can one deny that at some point the purpose of the loans that it provides is lost in the search for profits.