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Finance Development

What’s Behind the Microfinance Backlash?

Enter the loansharks, photo: _Teb/flickr

The prime minister of Bangladesh, Sheikh Hasina’s request for an investigation into the activities of the Grameen Bank (the Nobel Prize winning microfinance initiative), has revealed that something has been going wrong with the promising  development approach of microfinance. For years, the collection of critical voices was been increasing and growing louder.

What were once considered isolated issues seem to point to chronic (and perhaps systemic)  problems. Politicians now seem to feel compelled to draw attention to them, with some even going so far as to encourage people not to repay their loans.  It is unclear, however, if the tide is truly turning against microfinance and existing problems are becoming systemic, or if these problems are mostly isolated.

A closer look at some of the complaints and allegations reveals the following major flaws:

Poverty and indebtedness

The original intention underlying the strategy of providing micro loans to the poor, was to support the small business efforts and low-scale entrepreneurial efforts of people living at or below the poverty line. In this area, microfinance still remains very successful and is highly regarded. This approach was envisioned as a way to bring development aid directly to to those activities that could become productive and expand economic activity. The benefit was to cut out the “middle man” (government and other agencies) where aid money could be redirected from those who most needed it.

However, where the results of microfinance become less positive (and the intentions blurred) is where microfinance services provide loans to individuals for non-productive activities. Critics have noted that microfinance providers provide loans to those who qualify, even when these individuals want to buy consumable commercial goods or other necessities. In broad terms, this is a simple banking transaction. But, one of the consequences is that for those who cannot afford repayment and will not generate additional income from their activities which the transaction supports, microfinance can add the additional burden of indebtedness.

Getting rich off the poor?

Until recently, the microfinance activities of NGOs were completely unregulated, although this is beginning to change. Over a decade ago, efforts to monitor activities on an international level  centered around protecting microlenders from failing and offering them other support. But, increasingly, national regulatory bodies are being created to take a much more active role in the industry.

As microfinance organizations began generating high returns and moving beyond merely sustaining their activities but also successfully generating profits,  microfinance began to appeal to the commercial sector. According to the New York Times, the microfinance sector is one of the fastest growing areas of banking. Major global financial institutions have begun to create packages of securities that include (and in some cases are based on) microfinance loans. (Which frankly begs the question: Could a micro lending boom be followed by a micro lending crunch?) Even the American retail chain Walmark reportedly quickly moved to gain a share of the microfinance business by acquiring a banking license to offer micro loans at its retail stores in Mexico in 2007.

From lenders to loan sharks?

An additional important complaint is that interest rates for micro loans tend to be very high. Much higher than the interest rates any typical consumer would expect to pay on a credit card in a developed country (currently in the range of 15-25 percent).  According to the Financial Times, annual percentage rates can range from 20-50 percent and reportedly can reach rates of 85 percent and as extreme as 110 percent in some instances. (This seems to depend on whether the lender charges interest on the full amount borrowed throughout the life of the load (until it is fully paid off and regardless of whether the principal declines during payment) or, if the lender charges interest only on the principal due.) Clearly, for an organization looking to maximize its profits, the former would seem to be the most profitable approach.

There are even news reports alleging that some microfinance institutions send their staff to the creditor’s home to take notice of what goods can be claimed, should the “client” fail to make his or her payments, or default on the loan. Sure, there is the simple argument that “business is business”, but business activities devoid of ethics are more likely to degenerate into  problematic or even parasitic activities for the communities in which they operate. I think we are far beyond the point of blindly believing that the ends (profits) always justify the means.

If these allegations are true, then the lack of reliable oversight and regulatory controls on institutional activities, combined with a blurring of the original mission and vision of microfinance (providing sustainable aid to the poor) may lie at the heart of the problem. And as such, the issues deserves much, much more scrutiny.

In all fairness to the the NGOs that continue to operate with a mission to aid the poor, over the past forty years, microfinance has proven itself to be a very successful sustainable development approach, so it should not be vilified. However, because organizations offering microfinance seem to be acting as either pro-poor and pro-profit institutions, it may be time for local communities (and perhaps the international community) to encourage a systematic differentiation between the two (especially in those cases where the division is not so clear.) To better flush out the abuses of commercial opportunism, microfinance organizations should make their intentions apparent, especially to the communities within which they operate.

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