When Micro-lending Turns Ugly

Stephen DeAngelis

January 18, 2008

In the past, I have praised micro-lending schemes that offer loans to the poorest of the poor so that they can start working their way up the economic ladder. Until Muhammad Yunus proved that such schemes were workable and profitable, the very poor had no access to credit, except through loan sharks who demanded up to 300 percent annual interest on their loans. As a result the poorest of the poor had no hope of breaking the chains of poverty that kept them economically depressed. Yunus and his Grameen Bank won a Nobel Peace Prize for their work. Others, however, realizing that profits could be made from the poor, have moved in and shouldered out the usurers but without Yunus’ sense of ethics and purpose [“The Ugly Side of Micro-Lending,” by Keith Epstein and Geri Smith, BusinessWeek, 24 December 2007]. Epstein and Smith report that it is not criminals that have moved in but rather large banks.

“In a gleaming office tower in Mexico City secured with retinal scanners, bulletproof glass, and armed guards, dozens of workers in white lab coats dart around a large operations center monitoring long rows of computers. Along one wall, 54 enormous screens flicker dizzyingly with numbers, graphs, and fever charts: a relentless stream of data. You’d think the urgent mission involved tracking the trajectory of a spacecraft or the workings of a national power grid, not tiny amounts of cash and credit for Mexico’s working poor. The transactions are so minuscule they hardly seem worth the bother. The average loan amounts to $257. But for Banco Azteca, a swiftly growing bank affiliated with Latin America’s largest household retailer, the small sums represent a torrent of revenue that has caught even its founders by surprise. For three decades, micro-lending was seen as a tool of nonprofit economic development. Now poor people are turning into one of the world’s least likely sources of untapped profit, primarily because they will pay interest rates most Americans would consider outrageous, if not usurious.”

When Yunus established Grameen Bank he had to work out repayment schemes and eventually settled on just a few simple rules: loans last a year, installments are paid weekly, repayment starts one week after the loan is disbursed, the interest rate is 20 percent, and repayment amounts to 2 percent of the loan payment per week for fifty weeks. You might think that 20 percent interest sounds high, but it is actually lower than most interests rates demanded of the poor — even in America.

“With no legal limits on interest levels and little government oversight, for-profit banks in Mexico impose annual interest rates on poor borrowers that typically range from 50% to 120%. That compares with a worldwide average of 31% among nonprofit micro-lending institutions, and the 22% to 29% that Americans with bad credit histories incur on credit-card debt.”

One reason I like Kiva.org is that it provides information about each of its field partners (the actual micro-lending organizations). Although some of its field partners charge interest rates approaching 40 percent, Kiva’s average field partner charges 22 percent — very much in line with Yunus’ guidelines. Compare that to the average “money lender” interest of 84 percent that the poor would have to pay if Kiva’s field partners weren’t there and you can see that they offer the poor fairly reasonable rates. The Mexican banks are much closer to the usurers’ rates than to those charged by Kiva’s field partners. Epstein and Smith report that it is not only the high interest rates that border on being criminal it is the banks’ aggressive collection methods.

“Azteca’s business model succeeds not only because it can charge credit-starved clients almost whatever it wants. Equally important is that low-income Mexicans anxious about maintaining their reputation tend to pay back what they owe, regardless of the hardship. Those who slip behind receive frequent visits from motorcycle-riding collection agents.”

Yunus started Grameen Bank because regular bankers just never “got” the concept. The only thing that Azteca “gets” is the profit. It doesn’t get the humanitarian goal that motivated Yunus.

“Access to credit opens opportunities for the poor. But it creates tempting hazards as well, which in Mexico are drawing many unsophisticated families into a maze of debts. Pawnshops and loan sharks, whose interest rates of up to 300% have plagued generations of Mexicans, now face rivals offering terms that are less harsh. But along the road to previously unavailable financing, some Mexicans are stumbling badly.”

Yunus worked the system to overcome the fact that the poor were often unsophisticated and uneducated. The institutions discussed in the article take advantage of those circumstances to bleed the poor dry. The results can be devastating. Epstein and Smith report that families that can’t repay the bank often turn once again to loan sharks and eventually end up losing everything, including their dreams of a middle class life. Yunus insists that access to credit can empower the poor; but access to bad credit can crush them deeper into grinding poverty. Yunus believes his model is workable anywhere in the world, but lenders like Azteca generally follow few if any of the principles that Yunus promotes. Micro-lending is needed. Those that take advantage of the poor are not.