This week, I’d like to stray from the usual politics of my column in order to discuss an economic issue, albeit one that has significant political implications: microcredit. Microcredit refers to very small loans, usually somewhere in the hundreds of dollars, which are lent to entrepreneurial citizens in developing regions. These loans have fairly high interest rates, usually 20 to 30 percent according to The Economist, and are intended to kick-start small local businesses. Micro are often touted as superior to direct charity because they wield capitalist incentives that push people to design profitable business plans and, in doing so, build sustainable livelihoods for themselves and their community. When these loans are paid back, the interest paid can be cycled back into the microlender and thus expand the number of loans available.
There are several charities that run microcredit operations; most notable among them is Kiva. Charitable microlenders such as Kiva cycle the vast majority of their profits back into their lending pool and only skim a small portion to pay for their administrative costs. There are many for-profit microlenders out there as well. These companies still cycle their profits back into their lending pool but skim a larger portion off in order to pay employees and expand their business. This is a difficult business model but it can be incredibly profitable when done right. A good for-profit microlender will have a vast number of loans out with tens to hundreds of thousands of borrowers. Each loan brings in a small profit for the company that, when multiplied by thousands, becomes a formidable chunk of income. Furthermore, the small scale of each individual loan mitigates the company’s losses if a borrower defaults on their loan.
Microlending is an effective method for injecting wealth into developing communities. However, not all microlenders are equally efficient, at least not in terms of providing the greatest growth in the community. In essence, the amount of growth that a microlender stimulates in a given community comes down to how much of their money stays in the community. Imagine, for example, a microlender that has issued $10,000 worth of microloans at 10 percent interest in a small town in Niger. If every borrower in the community fully repays their microloans, the microlender can expect to recoup $11,000. If this lender is for profit, then we might expect that $900 will go towards paying for salaries and other administrative costs. This means that the lender has $10,100 to reissue as loans.
Now the businesses in this hypothetical town have an extra $100 that they can draw on as credit in order to grow even further. If the lender is a charity, then we might expect that they would put $400 towards their administrative costs; thus leaving local businesses with an extra $600 worth of credit to draw on. The assumption here is that, no matter how efficient a lender is, some of their profits will leave the community.
Lenders based in the community are the exception. In that case, the money that goes towards administrative costs will be spent on food, leases, and utilities within the community. Given the previous example, no matter how much is spent on administrative costs, all $11,000 will remain in the community either as loans or consumer spending. In this way, a for-profit lender that is locally based often generates greater economic growth than a charitable lender that is internationally based. It is with this logic that I feel more organizations should be pressed to outsource their lending offices. That is, their lending offices should be staffed and maintained by the communities they serve.
For a microcredit program to be effective, it must be accompanied by a microfinance program. Microfinance refers services such as savings accounts, insurance policies, and money transfer systems. These services are crucial for new businesses to thrive. Even the relatively small businesses that are created with microcredit need safe places to store and manage their money. Many of the top microlenders offer these financial services. However, many do not. Bandhan, a microlender in India, is one such lender. This organization does an effective job of approving and delivering thousands of microloans every year. Furthermore, India is dense enough that access to financial services, even in rural areas, is not as limited as in, say, rural Zambia. Still, Indians who start businesses with Bandhan microcredit must deal with the hassle and complications of storing and managing their money at a separate institution. It seems likely that Bandhan’s impact would be even greater if they offered such services directly through their own offices.
Let me end by saying that microlenders, of all kinds, almost always have a positive influence on the communities in which they operate. Even when a lender fails, either from its own incompetence or because it loses too many loans to defaults, the money that it loaned out to the community is not likely to have any less of an impact than if it had been dumped on the community by a traditional charity program. Furthermore, developing governments often demand that charity money be sent through their organization structure before it is delivered to citizens. This practice leaves charitable money vulnerable to appropriation by corrupt government organizations. The fact that microcredit is more resistant to such appropriation makes it both attractive to philanthropists and threatening to corrupt governing bodies.