Poor still benefit when microcredit reaps megaprofits

Written by Patrick Fisher April 5, 2011 0 comment

Michael Green

IS it right to profit from the poor? This question has sparked a civil war in the business of microcredit – making small loans to the poor in developing countries – and badly tarnished the image of what had been seen as a rare success story in the fight against global poverty. Who wins this battle about how best to deliver aid could determine whether hundreds of millions of people get the chance to escape abject poverty.

The controversy began last year when reports emerged that farmers in the Indian state of Andra Pradesh committed suicide because of the usurious rates of interest being charged by microfinance providers. In October, the state government issued an ordinance that imposed severe restrictions on microlenders in order to, it claimed, protect borrowers from “being exploited by private microfinance institutions through usurious interest rates and coercive means”.

Much of the blame fell on SKS, a microlending business that had expanded rapidly by raising money from the global capital markets. The need to make profits to satisfy these commercial investors, it was alleged, had driven up the loan rate charged to the poor, with fatal consequences.

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SKS’s share price slumped 50 per cent when Andra Pradesh introduced the legislation. Things got worse this year when the man who started the microfinance revolution, Nobel Peace Prize-winner Muhammad Yunus, wrote in The New York Times not to defend but to denounce. “In the 1970s, when I began working [in Bangladesh] on what would eventually be called ‘microcredit’, one of my goals was to eliminate the presence of loan sharks who grow rich by preying on the poor”, he lamented, “I never imagined that one day microcredit would give rise to its own breed of loan sharks.” Ouch.

On the surface, the charges of robbing from the poor to give to the rich look pretty damning. SKS charges interest rates of about 25 per cent, , enough to make your average Australian’s eyes water. One of its commercial backers, California-based venture capitalist Vinod Khosla, made a handsome $117 million profit when the company’s shares went on sale in the middle of last year.

Yet microcredit is an expensive business. With many thousands of borrowers, microfinance institutions need a lot of staff to administer the loans. And since each loan is small, the margins to cover these costs are wafer thin. Even Yunus’s Grameen Bank lends at 20 per cent.

In an ideal world, there might be philanthropic dollars aplenty to help microfinance providers. In the real world, where it is estimated that there are now about 150 million poor people using microfinance but up to one billion reliant on real loan sharks, there’s simply not enough aid money to get the industry to scale. Better, say firms such as SKS, to charge borrowers a bit more and grow the business with commercial capital.

But what about those suicides? The stories are hard to substantiate and SKS vigorously denies that this is a problem among their clients. Its defenders say SKS had started to ruffle feathers in Andra Pradesh by eating into the business of official and unofficial lenders tied to local politicians. In 2003, SKS had 11,000 clients: by last year it had nearly 6 million. It is these vested interests that are alleged to have orchestrated the campaign to blacken SKS’s reputation to teach the upstart a lesson. (Yunus was the victim of the toxic politics of his own country when Bangladesh’s Prime Minister, Sheikh Hasina, had him removed from the board of the Grameen Bank he had founded on the ludicrous charge that his appointment had been unlawful.)

The microfinance business has so far weathered this storm reasonably well. Indeed, it may prove a useful warning to the industry that it needs to be cleaner than clean, given its altruistic goals. But there are bigger battles to come in the debate about the role of profit in serving the poor.

A new wave of business-minded philanthropists, who we call “philanthrocapitalists”, are getting excited about a host of other business opportunities to serve the poor. One of them is Khosla, who has said he will plough most of his fortune back into philanthropy through traditional charity and investments such as the one he made in SKS that paid off so handsomely.

Citing the great Indian economist C.K. Prahalad, author of The Fortune at the Bottom of the Pyramid, philanthrocapitalists believe that it is profit that will drive a massive wave of investment in basic services for the poor such as water and sanitation, healthcare and education. The American bank JPMorgan predicts that these new business opportunities, which it calls “impact investments”, could be worth $1 trillion over the next decade.

We in the developed world might feel uncomfortable with businesses providing services that we expect government to deliver. The critics will quickly leap in with the charge that investors are profiting from the poor. But in a world of limited and dwindling aid money, profit may be our greatest ally in the fight against poverty.

Michael Green is the co-author, with Matthew Bishop, of Philanthrocapitalism: how giving can save the world