Microfinance Was Different before Capitalists Discovered It
In 2007, when my better half and I first met, she was working in microfinance law. I had heard of microfinance, but was only superficially familiar with it.
I knew how microloans work, and that Muhammad Yunus had won the Nobel Prize for it the year before (the Peace prize, not for Economics), bringing the field attention and legitimacy. I also understood that microlending runs contrary to most banking: usually, you must have collateral in order to give a loan. There has to be something lenders can take and sell if the borrower fails to repay. Because of this, microloans seem much riskier.
Yunus didn't invent lending circles. Savings circles predate him, and have been known as tandas in Latin America and by many other names around the world. Yunus brought them attention, and for a while, that was terrific. Many of the world's poor got access to funds that helped them start a very small business and create some level cash flows.
Counterintuitively, microloan default rates are lower than traditional loans. That may be because they were usually lending circles, not individuals. The members of each circle are highly motivated to help one another repay; that's how they get to use the funds, and how they improve their own credit record. Sometimes, the social dynamics were more coercive.
Then the major financial centers including Silicon Valley got wind of microfinance's successes, and eventually got enthusiastic. Money poured in. And as the money mounted, problems multiplied:
- The circles broke, and increasingly microloans went to individuals.
- Countries couldn't track who had a loan, so some individuals applied for many.
- Some markets got saturated, with some borrowers taking multiple microloans, one to pay off the other, unable to close the loop.
- Some borrowers got in deep trouble. Some committed suicide.
The first sign of trouble in microfinance was the controversial IPO of a Mexican microfinance institution, Compartamos, in 2007. The company had been charging interest as high as 100%, and its IPO enriched the founding investors instead of building the business. A couple years later, the Indian company SKS Microfinance went public, revealing cruel strategies that contributed to the suicides in Andhra Pradesh.
Microfinance was never a panacea, but it was helping many people live better lives. Over time, the microfinance sector shifted back toward savings-led microfinance, which is stabler and less coercive.
This article is cross-posted on Substack here, Medium here and LinkedIn here. It's also here in my Brain.