Archive for October 19th, 2008
A Problem of Success
We went to interview 3 of the 5 Kiva clients at this brand-new office. They’ve been in business for 2 months and have gathered 11 clients total. The loan officer, Vitalik, took us through a marketplace that looks just the same as cloth-covered market kiosks around the world. You could see it at a farmer’s market in Seattle or the Chatachung Market in Bangkok. (The knock-off Prada handbags were, I admit, more reminiscent of Thailand than of Washington. None of the Kiva clients were selling such things.) All three clients had opened two locations and had at least one employee, two were widows who had raised children by themselves, and all of them originally went into business because they lost their jobs during perestroika and had no way to feed their families. All had been in business for more than 9 years.
The interviews were quick, painless, and eye-opening. It really did give me a good sense of what kind of entrepreneurs microfinance works with, and what kind it doesn’t.
Yet her loan, for purchasing several months’ inventory in bulk, was for only $1200. That’s a substantial amount of money in her town but is too small for most banks, and thus she qualifies as a microfinance client and has been able to really benefit from loans. She started out from scratch, twice, being an unemployed widow with kids and grandkids. At one point her store was robbed of everything, and she had no insurance. Through microfinance loans she rebuilt her business and now has ambitions of opening a while network of stores. That’s absolutely a success story of microfinance substantially improving someone’s life.
I also saw little old ladies that lay out bedsheets on the sidewalk and pile fruit on them, and sell it with the help of a small, old scale. They are too poor to be microfinance clients, because they live so close to the edge of poverty that they’re not generally able to repay loans. Which is a smart decision on HOPE Ukraine’s part; the bank has to be self-sustaining in order to be able to continue their work, and so must select their clients carefully. Because the loans are not collateralized, the loan officer must spend a good deal of time assessing the business. He checks through the entrepreneur’s inventory to ensure that the business is stable and active, visits her home to verify that her standard of living supports business expansion, speaks to her neighbors to gauge her credibility. One loan officer might serve up to 150 clients this way. It’s an enormous workload. And it keeps the microfinance bank – indeed, the entire microfinance industry – afloat.
This system still leaves a whole class of poverty totally unaddressed. I knew in advance of coming here that microfinance is applicable to only a particular subset of the poor. At risk of belaboring the obvious, microfinance only works with business owners. Even more precisely, it works with business owners who are successful enough to want to expand their business. Just subsisting is not enough, any more than it would be enough for a small business owner in the States. A homeless, destitute, starving person is not a microfinance client. A wealthy business owner in a developing country is not a microfinance client. Rather, a lower-middle class to middle-class entrepreneur in a developing or former communist country is a microfinance client.
The answer is that she was poor in the way we think of abject poverty, and is now a member of the middle class. The exchange rate means that she’s still qualifying for loans that are very small by Western standards, but her lifestyle takes her out of the standard mission of “eliminating poverty.” We have already eliminated her poverty. She’s the “after” picture.
But she is still working and expanding her business. She is still too small to interest an international bank, or even a national bank headquartered in an expensive capital city. A little bit of money still goes a long way, and her alternative is still local moneylenders who vastly inflate interest rates.
A business owner in her position, a success story such as Galena, is now living in a gap in the system. Too wealthy to qualify for international aid, too poor to qualify for traditional bank loans, too successful to utilize the social safety net (even if it existed in her country), too struggling to enter the global business class – she is the perfect microfinance client. And yet as philanthropic Westerners, our first instinct is to look at Galena and think, “She isn’t poor enough to need my help.” I had this thought upon meeting her, and I’m sure I’m not alone, so I’ll reiterate the thought:
We want to help eliminate poverty. That’s what I’ve dedicated a year of my life to doing, and what many people have dedicated vast sums of their own money to doing. But once we’ve done that, the very people we’ve helped become, somehow, less deserving than they were when we started. Because microfinance works, because we have succeeded in our task, Galena is now less deserving than the little babushka who sells fruit off a bedsheet. So what is she to do? If we turn away from her when she has entered this gap in the system, we risk letting her slide back into poverty.
Where do the boundaries of poverty begin and end? And within those boundaries, where does our reponsibility lie? Once you have helped someone overcome one obstacle, do you abandon them before they encounter the next? At what point does Kiva, as midwife to small businesses, step back and let them succeed or fail on their own? When do we tell Galena that we’ll no longer be a partner for her?
I have no answers to this, only more questions. But if the questions serve to spark debate, perhaps the community can find answers. When you speak to friends about poverty and microfinance, please remember Galena. She is real. Your answers affect her life.
7 comments 19 October 2008
Trust As A Foundation
If ever there was a time that underscored the importance of trust in economics, now is it. Readers of this blog from the United States can attest to the financial ruin that awaits us when banks suffer not only from a deficit of wealth but also a deficit of trust; it turns into a vicious circle with declining returns for all. Likewise, theoretical people stuck in a theoretical game like the Prisoner’s Dilemma favored by political scientists, real people in real marriages, parents sending children to summer camps, etc. can all point to the necessary foundation of Trust for successful relationships and beneficial outcomes. Bereft of trust, vicious circles of unwanted yet nonetheless bad outcomes await everyone involved in that particular relationship.
It has long been noted that poverty exists as a vicious circle. Forced to work as children to support their families, children cannot get an education; forced to rent cars/wheelbarrows/storefronts they cannot afford to buy outright, entrepreneurs are stuck in a rut of paying rent but gaining no equity; forced to live in abject living conditions because they cannot afford to move, people get sick more easily and miss work and are condemned to low wages; the circle gets more and more vicious. One of the goals of microfinance is to help those entrepreneurs escape their particular vicious circle of poverty by offering loans to those people when no traditional banks would do so.
So while the great Indian, Mahatma Gandhi, had his satygrahas or experiments in truth, then we may say the great Bangladeshi, Muhammed Yunus, conducted his experiment in trust when he started microfinance. At its core, microfinance is simply a manipulation of common financial practices to suit the needs of the poor. Each of the adjustments to traditional financial practice is meant to overcome some market failure or to adapt banking to the realities of poverty. The most basic of these adjustments is the substitution of reputation for physical collateral. To cover themselves in case of a borrower’s default on a loan, banks disperse loans only if the borrower provides a substitute item that the bank can claim as ‘payment’ for the loan – collateral. The poor do not have many items available as collateral; hence, banks balked at loaning to them. Due to their exclusion from the financial world and their continued lack of physical collateral, Dr. Yunus decided that a ‘banker to the poor’ could use a borrower’s reputation and continued access to credit as a substitute for collateral. Microfinance builds trust as the cornerstone of its loaning structure as a result. The poor borrowers meet the trust MFIs initially displayed by lending without requiring collateral, and thus a virtuous circle of continuing trust begins.
Like Dr. Yunus’ Grameen Bank, my host MFI (microfinance institution, aka banker to the poor) relies mainly on group lending to distribute their loans. The basic framework is this:
A group of women in a neighborhood come together and form a group of eight to ten entrepreneurs; the MFI then offers the group a loan. Each person receives a pre-agreed portion of the total loan. The loan cycle lasts either four or six months. Once a month, the women gather at the MFI branch office in their neighborhood. People who do not come are fined a small amount. At these monthly meetings, the women have elected a treasurer, secretary, and president. They collect all their repayments and pay the MFI a lump sum (the aforementioned absentees can send their repayment with another group member if they wish…if they miss and don’t send their money, they have five days to pay or they are fined 5% of the loan). The individual portions of the total loan can vary significantly; for example, one group I sat in on had one member with a loan ten times the size of another member.
The actual loan has a fixed interest rate and each monthly repayment is equal repayments of principal, interest, and voluntary savings. Members have the option at the beginning of the loan to add a fixed percentage to their loan as voluntary savings. If they select this option, they will pay a little extra each month for the term of the loan and receive it all back at the end. One interesting manipulation to this model is that at my host MFI, they teach the women how to loan these savings to each other on top of their formal group loan. Thus, if one woman makes Christmas figurines and she wants even more money in November to prepare for Christmas, she can ask the group members to loan her the group’s savings which she would pay interest on. Thus, the women not only learn how to pay back loans, they learn how to distribute and manage loans themselves. Plus, the accumulated interest from these loans from their savings goes back into their group savings, helping all involved.
So how does this explanation fit with the opening salvo on trust? The group loan mechanism has a powerful effect on creating trust within neighborhoods. Last week I spoke with three groups in three different stages of their loans (receiving the loan disbursement, paying back month two of four, and finishing their loan and getting their savings) and they all had the same refrain: We have more trust in each other now than before. Imagine cross-guaranteeing other people in your neighborhood. Every month that passes with successful repayments (and in microfinance, this figure is at 96-98%!) is a month of trust built. Also, as mentioned earlier, this is the first time that a financial institution has placed their trust in these women entrepreneurs. To be able to match that trust with on-time repayments is an honor for these groups (one group in their ninth loan cycle received a cake and a congratulatory speech from the branch manager) and one every woman told me: I am a punctual payer. This virtuous circle of trust is repeated with larger and larger loan amounts until one day the women can go directly to the traditional banks with equity in their businesses, savings, knowledge of the loan process, and a long (almost always perfect) credit history.
In the classic Prisoner’s Dilemma (two people being questioned: if one rats out the other he gets 5 years while the other gets 15 years; if they both rat each other out, the both get 10 years; if they both hold out, they get out free), an absence of trust in the other person leads to selfish behavior and a less than ideal outcome (10 years each instead of both out free). This vicious circle can be overcome if somehow, through many iterations of the game trust begins to form between the two prisoners. Poverty is a veritable maelstrom of vicious circles. Microfinance offers a mechanism of injecting trust into this Charybdis. MFIs step into the gap and offer trust in poor entrepreneurs. Poor entrepreneurs have overwhelming matched this trust to the tune of 96-98% repayment rates. However, the group mechanism created by Dr Yunus and mimicked in my host MFI stands to build trust outside of mere financial services. Women from the same neighborhood brought together for loans grow to trust each other in their endeavors. Now we see poor neighborhoods with trust growing as a firm foundation for their economy. And if the last month in the United States has shown us anything, it is that Trust is the foundation for economic growth. Poverty exists in many vicious circles and microfinance is not a cure-all. I do believe, however, that if a vicious circle infects other areas of life and drags them down with it, then virtuous circles like trust can infect other areas in a similar manner and drag them up with it. I am a fan of microfinance yes because it is a vehicle for the creation of wealth but more so because it is a vehicle for the creation of trust.
To view fundraising clients of EDAPROSPO on Kiva’s website, please click here
Here are some pictures I took of the three groups I met with last week:
4 comments 19 October 2008
RSS - Posts