Can Microfinance Make a Macro Difference?

If you have taken a couple Finance classes, you might have learned how a syndicate of investment banks works together to raise billions of dollars of capital for a corporation by issuing debt. You may have taken an Entrepreneurship class on how to write a business plan in order to apply for a bank loan or seed money from a Venture Capital firm. But have you ever considered how a loan of less than one hundred dollars, to someone with no assets or collateral, no business experience, no written business plan, and little education, could spur economic and social change?
It might not sound as glamorous as investment banking or venture capital, but microfinance is gaining attention in developing countries. Some people believe this emerging industry has the potential to fight poverty, empower women, and even reduce the spread of HIV/AIDS. In October, microfinance gained attracted worldwide attention when the Noble Peace Prize was awarded to a Bangladeshi bank specializing in microloans, and to its founder, Muhammad Yunus.

Dr. Yunus grew up in Bangladesh, and earned a Ph.D. in Economics at Vanderbilt University in the United States. In 1974, he developed the idea of microfinance while visiting an impoverished village in Bangladesh. He met a group of women who struggled to support themselves by making and selling bamboo furniture. They had to take out loans from a local moneylender in order to buy the bamboo, and they were charged such exorbitant rates of interest that they could barely make enough profit to support their families. He lent the women $27 of his own money. Traditional banks could not be bothered to make a loan so small, but that amount of money was enough to help the women escape the cycle of debt and build a sustainable business making furniture.

Yunus began to travel to villages and make more loans of his own money, and he found that most of the borrowers paid him back. In 1983 he founded Grameen Bank, an organization that made loans to poor Bangladeshis. Most of Grameen’s loans are for less than $100, to help people start businesses that have the potential to be self-sustaining. While $100 seems like a pittance in the Western world, in a developing country like Bangladesh it can be enough to buy a sewing machine, a fishing boat, materials to build furniture, fruit to sell at a roadside stand, or a cow from which to sell milk. About 97% of Grameen’s loans are to women, because it is believed that women are more likely than men to devote their earnings to taking care of their families. To date, it is estimated that Grameen Bank has made more than $5 billion worth of loans to more than 6.5 million borrowers.

Today, there are an estimated 7,000-10,000 microlending institutions. Microfinance is spreading in developing economies – in Africa, Latin America, and India. Most of the institutions receive some money from charities or governments, but an estimated 50 institutions cover their costs unaided. Some public health experts have suggested that the spread of microfinance can combat the spread of HIV/AIDS. A recent study in South Africa showed how access to microfinance cut women’s risk of domestic violence by half. Women in abusive relationships are at a greater risk of HIV transmission, but with economic empowerment, women are less likely to remain in abusive relationships because they are financially dependent on their husbands.

Right now, people are split on whether to view microfinance as charity or as capitalism, and this will be one of the industry’s challenges in the future. For-profit financial institutions like Citigroup and Deutsche Bank are beginning to take notice of this emerging industry, and to investigate the profit potential of providing financing to microfinance institutions, or packaging and reselling their loan portfolios as securities.

Microfinance has also attracted some critics. Some critics argue that the interest rates microfinance institutions charge, though smaller than the rates of local moneylenders, are still high enough to constitute predatory lending by Western standards. Other critics have suggested that many microfinance institutions employ questionable accounting practices to hide the fact that they are dependent on contributions from charity, that their repayment rates are not as high as claimed, and that they are not self-sustaining businesses.

Will these criticisms keep the microfinance industry from growing and providing more of the world’s poor with access to credit? On the contrary, it is likely that criticism will help the industry. No institution or economics pioneer should be above scrutiny, not even a Nobel Prize-winner, and this scrutiny should help make sure microfinance institutions stay honest and operate according to the highest standards. As more companies enter this market and compete, the result should be lower interest rates and higher standards, which will benefit everyone. Microfinance as an industry is still in its infancy, but I believe this small industry is heading for big things.