More to microfinance than moneylending

Issue 18 - Sep 2008
Aadisht Khanna

Two years ago, Bangladesh’s Grameen Bank and its founder Muhammad Yunus received the Nobel Peace Prize for their pioneering use of extending small loans to the poor as a poverty-reduction strategy. The Nobel Prize sparked mainstream public interest in micro-lending as a concept. Since then, the micro-lending website Kiva has attracted hundreds of individual micro-lenders, and hedge funds and universal banks have set up microfinance funds to finance microfinance institutions (MFIs). The discussion of microfinance has moved from economics and policy journals to business newspapers to general-interest newspapers and magazines. As interest in microfinance has risen, so have the number of sceptics, who have raised questions on the morality as well as the effectiveness of microfinance.

The moral challenge to microfinance comes from those who see the high interest rates being charged by micro-lenders, and see it as usury with a more acceptable name. Interest rates charged by microfinance lenders run as high as 30 percent in India and Africa. In Mexico, Compartamos Banco charges rates as high as 100 percent.

Compartamos is a special case. It has a virtual monopoly on micro-lending within Mexico, which is severely under-banked. It also treats microfinance as a business enterprise, raises capital from market investors rather than from philanthropic institutions, and functions as a full-fledged bank. It also lends to individuals instead of only to groups of women, and does not conduct vocational training or hold social meetings.

Dr Yunus has criticised Compartamos for being a commercial moneylender and not a development institution, but his own Grameen Bank and other MFIs set up on the Grameen model have been criticised for charging interest rates above 25 percent. A major cause of this is structural: the operational overheads associated with underwriting and collecting a huge number of small loans is significant. Defenders of microfinance use the excellent repayment track record of microfinance borrowers to claim that even these high rates are not usurious, and also point out that even a high interest rate is beneficial if it is lower than the usurious rates being charged by traditional moneylenders.

The other common criticism of microfinance is that even as charity, it is ineffective. Despite Grameen Bank’s many years of operation in Bangladesh and its large-scale coverage of the poor, Bangladesh remains desperately poor. Sceptics have questioned if microfinance can function as a poverty reduction strategy in the absence of the basic requirements for wealth creation: property rights, social capital, a well-functioning financial system and free markets in goods and labour. A sceptical examination of microfinance starting at its very basics is called for.