On October 29, 2006, shortly after the award of the Nobel Peace Prize to Muhammad Yunus and his Grameen Bank of Bangladesh, Becker and I blogged about microfinance, which Yunus and his bank had pioneered. The term “microfinance” (or “microlending”) refers to the making of tiny loans to small farmers, shopkeepers, artisans, and other minute commercial enterprises in underdeveloped countries such as India and Bangladesh at high interest rates—sometimes as high as 20 percent a day. In my blog posting, I called microfinance a worthy experiment, superior to philanthropy because the high interest rates that the microfinanciers charge should induce self-selection by the borrowers: a borrower has to have confidence in the project for which he is seeking microcredit in order to be willing to assume the burden of servicing his debt. But I sounded a skeptical note. I said that the “success [of microfinance] has yet to be demonstrated despite glowing appraisals by Kofi Annan and others. It may simply be the latest development fad…The evidence for the efficacy of microfinance in stimulating production and alleviating poverty is so far anecdotal rather than systematic. The idea of borrowing one's way out of poverty is passing strange. And I am unaware of any historical examples of nations that climbed out of poverty on the backs of small entrepreneurs financed by credit.” I noted that the Grameen Bank had a surprisingly low default rate and pointed out that it “does not have written loan agreements and does not sue defaulters or invoke other legal remedies against them. The natural inference to draw is that the bank is extremely selective in its choice of persons to whom it is willing to lend, and such selectivity, if imitated by other microfinanciers, must greatly limit the scope and impact of microfinance.” I concluded by “suggest[ing], albeit tentatively, that there may be a good deal less to microfinance than its boosters claim.”
Microfinance has continued to expand since 2006. The number of microloans made in India rose from 10 million in March 2007 to 26.7 million in March 2010. By the end of 2009 total microloans stood at $70 billion, half of them in India and Bangladesh. But a series of suicides by microborrowers in the fall of 2010 in the Indian state of Andhra Pradesh, the site of more than 25 percent of Indian microlending, led to charges that the microlenders, which are commercial rather than eleemosynary enterprises (though, as we’ll see, the Grameen Bank seems to straddle the two types of enteprise), were charging exorbitant interest rates and coercing people into taking out loans they could not afford to repay. Politicians urged borrowers not to repay their microloans; and repayment rates, previously as high as 98 percent, plummeted to 10 to 20 percent. The government of Andhra Pradesh has imposed strict limitations on microlending, and the Reserve Bank of India (India’s central bank) has proposed that similar controls be established throughout India—controls including a ceiling on interest rates and loan amounts and limiting eligibility to borrowers having an income above a specified level. In December 2010 the prime minister of Bangladesh declared that microlenders were “sucking blood from the poor in the name of poverty alleviation” and ordered an investigation of Grameen Bank. Similar reactions to microlending have taken place in Nicaragua, another country that had embraced microlending with enthusiasm.
And then just a week ago, in a short article in the New York Times entitled “Sacrificing Microcredit for Megaprofits,” www.nytimes.com/2011/01/15/opinion/15yunus.html?_r=2&scp=2&sq=microfinance&st=cse,Yunus himself wrote: “when I began working…on what would eventually be called ‘microcredit,’ one of my goals was to eliminate the presence of loan sharks who grow rich by preying on the poor. In 1983, I founded Grameen Bank to provide small loans that people, especially poor women, could use to bring themselves out of poverty. At that time, I never imagined that one day microcredit would give rise to its own breed of loan sharks. But it has.” He writes that the problem “began around 2005, when many lenders started looking for ways to make a profit on the loans by shifting from their status as nonprofit organizations to commercial enterprises. In 2007, Compartamos, a Mexican bank, became Latin America’s first microcredit bank to go public. And this past August [2010], SKS Microfinance, the largest bank of its kind in India, raised $358 million in an initial public offering.”
It seems rather an odd point for Yunus to make, because the Grameen Bank is itself a stock corporation, not a nonprofit. See www.grameen-info.org/index.php?option=com_content&task=view&id=179&Itemid=145. Yunus says in the Times article that all the bank’s profits are returned to the borrowers in the form of dividends, but if so I don’t understand how the bank attracts equity capital. He contends that his is the best model for microlending, explaining that “commercialization has been a terrible wrong turn for microfinance, and it indicates a worrying ‘mission drift’ in the motivation of those lending to the poor. Poverty should be eradicated, not seen as a money-making opportunity… Instead of creating wholesale funds dedicated to lending money to microfinance institutions, as Bangladesh has done, these commercial organizations raise larger sums in volatile international financial markets, and then transmit financial risks to the poor…Some advocates of commercialization say it’s the only way to attract the money that’s needed to expand the availability of microcredit and to ‘liberate’ the system from dependence on foundations and other charitable donors. But it is possible to harness investment in microcredit—and even make a profit—without working through either charities or global financial markets.” The phrase I’ve italicized is strange, because Yunus claims that his bank does not make a profit, but instead distributes any surplus of income over expenses to the borrowers, and urges that as the model for the microfinance industry.
The recent uproar in microlending puts one in mind of our own controversies over payday lending, title lending (borrowing at high interest rates with one’s car as security), credit-card lending, and subprime mortgage lending—all examples of loans at very high interest rates, made largely to unsophisticated consumers. There is an inconclusive literature on the net social benefits of these forms of credit (sometimes lumped together in the term “fringe banking”). The basic difference between our fringe banking and microfinance is that fringe banking is primarily consumer rather than commercial lending, but the small farmers and shopkeepers who take out microloans probably are even less sophisticated on average than the American customers for fringe banking. Moreover, although what critics of fringe banking call “predatory lending” is not highly regulated in the United States and as a result fraud and other exploitive conduct may well abound, regulatory protections are undoubtedly far weaker in countries like India and Bangladesh.
Yunus’s mysterious nonprofit-profit model of microfinance cannot attract substantial capital, but commercialized microfinance seems increasingly unlikely to have substantial social benefits—and this with or without regulatory controls designed to protect unsophisticated borrowers. Without the controls, there will undoubtedly be a good deal of fraud, and improvident borrowing without fraud. With the controls, the amount of lending will be curtailed. But with or without controls, the amount of lending will be limited by the very high default rates that can be anticipated unless there is very careful screening of would-be borrowers. Interest rates will remain very high and will strangle many of the businesses that rely on microfinance. Microfinance may turn out to be a niche service, with little overall impact.
Posner admits that he does not understand how Grameen Bank works ("I don’t understand how the bank attracts equity capital"), but dismisses it nonetheless ("Yunus's mysterious nonprofit-profit model of microfinance cannot attract substantial capital"). How does Posner *know* that something he does not understand cannot work?
In this country, credit unions return their profits to their members, just as Grameen Bank does. Credit unions attract substantial capital, just as Grameen Bank can and does. Credit unions perform better on most key banking metrics than the big publicly traded banks -- they have lower default rates, they fail less often, they are better managed, and they don't require government bailouts.
Posted by: Kevin McGilly | 01/23/2011 at 06:31 PM
Posner again treats us to meaningless drift, consisting of nothing more than his uninformed bias and prejudice.
Has Posner never read Peter Drucker?
If he had he would know that there is no such thing as "micro-finance" and in particular there is no rule of economics, or anything else, that defines, micro-finance in any meaningful way.
Micro-finance is pr, branding, advertising, not "economics."
There are only customers and a "theory of the business" (business model) (Drucker, Managing in a Time of Great Change) that delivers a product or service to a customer at a profit (if micro lending doesn't make a profit, its not a business, it is some form of charity).
What micro-finance is a Wal-Marts (only not with everyday low pricing) of loans. Loans targeted to a segment of society that heretofore no one thought could be served at a profit.
Can it work. Yes. Apple Computer was started on a micro-loan of $1,300.00 dollars in a garage. Goldman Sachs started in the 1860s making micro loans to businesses thought to be uncreditworthy in New York City.
Can a nation be built on borrowed money? Yes. Both the United States and Hong Kong were built on money borrowed from the Scots.
Does it take more than just loans? Yes, but we all already knew that.
Last, does any fact justify this statement, "commercialized microfinance seems increasingly unlikely to have substantial social benefits."
No. Before Sam Walton, using Posner's elitist mentality, there would have been no social benefit in a Wal-Marts. If you asked the heads of Famous Barr, the May Co., Marshalls, and a thousand other firms killed by Wal-Marts, when Walton started in the 1960s whether anything would have come of it, they all, like Posner, would have said no, such a firm will have no social benefit and cannot make a profit.
No one has done it yet, but that doesn't mean it can't be done or that entrepreneurs shouldn't have the freedom to try.
Posted by: John | 01/23/2011 at 08:00 PM
Surprise, surprise. Human nature and the law of unintended consequences. How can a microfinancier exist by charging 20% interest on loans to enterprises with profit margins of 6% or less. Now let us see, would I invest in the lending bank. Probably not.
Posted by: Jim | 01/24/2011 at 10:46 AM
Education is a progressive discovery of our own ignorance.
Posted by: Taobao in English | 01/24/2011 at 07:50 PM
This is just one more example of the flawed system we find ourselves in, and one more way for financial establishments to work around the system, lend money, then compound the global economic issue all over again.
Posted by: http://www.datecover.com | 01/24/2011 at 09:25 PM
"The idea of borrowing one's way out of poverty is passing strange. And I am unaware of any historical examples of nations that climbed out of poverty on the backs of small entrepreneurs financed by credit.” I noted that the Grameen Bank had a surprisingly low default rate and pointed out that it “does not have written loan agreements and does not sue defaulters or invoke other legal remedies against them."
.......... Ha! Establishment fear of banking going "internet?" Ha-ha! ....... "the carpet too is moving under you......... it's all over now baby blue......." B. Dylan
More seriously borrowing and "climbing out of poverty on the backs of small entrepreneurs is exactly how our nation, Korea after the war, China and others HAVE grown. Koreans and other have used some informal "banking" (when and where true banking hardly existed) of pooling assets in an extended family or other group with one being "up" for starting their business, after which another will get a turn.
Our system of "micro-finance" has been the one sided arrangement of millions of small savers loaning their hard-earneds to the bank or stock market where they've been aggregated and re-loaned at considerable profits to the bankers. Worked pretty good too for a long time when banking WAS selective and executed by ethical and skilled bankers who loaned within reasonable multiples of "their assets" ie deposits and investors.
Now what was that about lending with no collateral but still finding most folks paid them back? Kinda like credit cards given out freely to all but those of very poor credit history, including making sure to get them into the hands of HS graduates and college kids........ based on their "collateral?" and "payment history?" No....... just speculation on the odds.
As for the Grameen Bank it's interesting to look over their website which includes 16 guidelines for living a successful life. The seem to be starting a mutual fund, so like the credit unions, Kevin describes above, much of the profits of the operation can be plowed back for the benefit of the Grameen members. Grameen's Yunus, was recently awarded a Presidential Freedom Award warns that the micro arena is not an easy road for the profit minded.
Ahh, yes...... it may well be that paying back for the benefit of a community creates a stronger incentive than that of enriching profit seekers insisting upon, and pushing the entrepreneur under with usurious rates.
Jim: It's been my experience and observation that most micro-businesses have nothing that would qualify as a "profit". Instead, even in our wealthy nation what few businesses are left to the individual return a wage for the owner and the employees. (One of the groups most imparted by not being able to afford our current H/C delivery system.) No, these micro-loans are about surviving vs starving.
I'd urge you to look over Kiva.Org (an online micro) to see what kind of loams are requested and how they are employed. Several years ago I gave Kiva investment coupons at Christmas. The recipients loved the gift and have since re-invested the small amount several times over as the money has always been repaid. Perhaps the micro area "works" because of the good feelings of having helped a mother of three in some poor nation buy what she needed to begin a beauty salon or other enterprise. The investment allows her to "profit" by wielding the tools of her trade.
Ummmmm....... I suppose it would be a bit impertinent, at this point, to mention the amount of capital lost (and being lost) by the pro-money changers? Enough to enable a billion or so micro-pioneers?
Posted by: Jack | 01/25/2011 at 12:00 AM
Without the controls, there will undoubtedly be a good deal of fraud, and improvident borrowing without fraud. With the controls, the amount of lending will be curtailed. But with or without controls, the amount of lending will be limited by the very high default rates that can be anticipated unless there is very careful screening of would-be borrowers. Interest rates will remain very high and will strangle many of the businesses that rely on microfinance. Microfinance may turn out to be a niche service, with little overall impact.
Posted by: Forest Bush | 01/25/2011 at 11:33 PM
Microfinance seems to be the theory and rational compelling and fueling Arizona illegal immigration crackdown: http://lawblog.legalmatch.com/2011/01/24/arizonas-other-controversial-law-punishing-employers-who-hire-illegal-immigrants/
Posted by: Marle Robo | 01/26/2011 at 07:50 AM
I heard that the net profits of India's largest microfinance institute SKS Microfinance shrunk by more than a third for the quarter ended December 31 over the last period due to reasons of higher provisioning as published by the company's report.
Posted by: Krista | 01/27/2011 at 03:21 AM
I just get all worked up , and I stew around!
Posted by: agent taobao | 01/27/2011 at 07:51 PM
The number of microloans made in India rose from 10 million in March 2007 to 26.7 million in March 2010. By the end of 2009 total microloans stood at $70 billion, half of them in India and Bangladesh. But a series of suicides by microborrowers in the fall of 2010 in the Indian state. What a Incredible stat. This is hard to believe...
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It's sad, in France the law just changed to allow the micro credit between individuals, but the news only talk about the excesses and failures of micro credit. Results: People who have been tempted to build their businesses through micro financing have doubts and fear of life disaster scenarios ...
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Posted by: chloe | 02/16/2011 at 12:42 AM
Microfinance has continued to expand since 2006. The number of microloans made in India rose from 10 million in March 2007 to 26.7 million in March 2010. Without the controls, there will undoubtedly be a good deal of fraud, and improvident borrowing without fraud.
Posted by: Gaston Cantens | 03/11/2011 at 02:41 AM
Well i think that a borrower has to have confidence in the project for which he is seeking microcredit in order to be willing to assume the burden of servicing his debt...
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The government of Andhra Pradesh has imposed strict limitations on microlending, and the Reserve Bank of India has proposed that similar controls be established throughout India..
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Human nature and the law of unintended consequences. How can a microfinancier exist by charging 20% interest on loans to enterprises with profit margins of 6% or less. Now let us see, would I invest in the lending bank. Probably not.
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