The blog entry dated December 7, 2009 provided a summary of microfinance and the entry posted on December 20, 2009 outlined microfinance's benefits and provided a few success stories. The focus of this post is to discuss microfinance's shortcomings and begin a discussion on how the service that offers poor people access to basic financial services may be improved. (Photo of an outdoor market was taken during my visit to Pisac, Peru in June 2009)
I appreciate the way microfinance provides an opportunity to individuals whom seek to improve their lives and become better providers for their family through entrepreneurship; however, I am concerned that microfinance fails to achieve its primary objective of eradicating poverty for millions, perhaps billions, of people worldwide. Additional problems I have observed of microfinance operations in the developing world include little or no access for goods or services produced by entrepreneurs to reach global markets, debt rather than equity financing, exorbitant interest rates for loans, and lack of scalability and sustainability.
Microfinance institutions (MFIs) should take a more proactive role in assisting borrowers (entrepreneurs) gain access to lucrative markets for their services or products. During my extensive travels to developing nations, I observed recipients of microloans manufacturing small crafts or clothing items. The consumer market for these entrepreneurs is limited to nearby villages or passing tourists and MFIs should help rural entrepreneurs gain access to large population centers. Furthermore, I recommend that MFIs take a more proactive role in assisting borrowers to gain access for their goods in lucrative industrialized markets in North America or Europe. To facilitate liberal access to the United States market, the U.S. government enacted legislation such as the African Growth and Opportunity Act (AGOA), Haiti Hemispheric Opportunity through Partnership Encouragement (HOPE) Act or the Central America-Dominican Republic-United States Free Trade Agreement (CAFTA-DR).
Microloans create a revolving door of debt by requiring entrepreneurs to take subsequent loans in order to grow their business operations. In the preceding blog entry, I use Bayamma Neerudi's experience to highlight the benefits of microfinance. Not to diminish the impact microcredit has made on Ms. Neerudi or individuals like her worldwide, but Ms. Neerudi has obtained three loans in order to grow her business. Where is the savings or reinvestment mechanism? While I recognize this information may be missing from Ms. Neerudi’s story, too many MFIs are not working with borrowers in implementing savings strategies. Technically, microfinance includes microsavings, but the latter is often missing when it comes to the operations of MFIs. I encourage MFIs to make a stronger effort to incorporate savings as a means to promote business scalability.
I propose a different type of microfinance model. As stated above, traditional microfinance models support debt rather than equity financing. I recommend that MFIs reevaluate their lending model by providing private equity financing to entrepreneurs. An equity "fund" should operate similarly to a traditional microlending operation with one of the objectives to provide initial or early development funding to a variety of private enterprises to stimulate social and economic development. The differences between my recommendation and traditional microcredit vehicles are: (1) Rather than immediately repay the principal and interest, entrepreneurs are required to save a portion or reinvest initial revenue to maximize sustainable growth opportunities, (2) entrepreneurs are required to implement a revenue-sharing plan for all employees, (3) entrepreneurs are required to operate with complete transparency including providing every employee a copy of the business plan and the opportunity to provide input regarding the business strategy and operations, (4) all recipients of the fund will receive support and technical expertise from MFIs and their contributors, and (5) the size of the loans should range from $5,000 to $500,000. $100 loans will not eradicate poverty.
When I taught my first seminar on entrepreneurship at the CFDE University in Port-au-Prince, Haiti in 2007, my students’ greatest need to become successful entrepreneurs was access to capital. I was astonished to learn that lending rates from the black market, MFIs, and government-owned banks were 15, 18, and 20 percent respectively. I have met with MFIs in Africa that charge borrowers up to 30 percent interest for loans. I understand that MFIs incur vast costs in administering small loans to several borrowers, but charging high interest rates is wrong. While I am not an expert in finance, I know from my experience as an entrepreneur in developing markets that through a different lending model, borrowers will no longer need to be punished with excessive interest rates.
With the current model, entrepreneurs find it difficult to scale or sustain their business operations. I see an immediate need to change to microfinance model. In principle, I support microfinance and the positive benefits realized by people striving to break the bonds of poverty. However, how does a MFI define success? Increased gross domestic product? Increased per capita income? Increased personal spending? Can we say that the results of microfinance are reflective of the hundreds of millions of dollars invested? Microfinance is mostly a good thing as it often helps keep borrowers from even greater catastrophes. However, microfinance fails if judged by the number of borrowers whom overcome the barriers of poverty.
As always, your comments are appreciated.