Pains and pleasures of Kiva’s P2P principles
20 February 2010 at 06:18 Claude Mansell 32 comments
By Claude Mansell, KF10, Rwanda
Kiva is pushing the limits of P2P microfinance lending. It already is the most transparent peer-to-peer platform connecting lenders and borrowers around the globe. Yet until February 1 lenders were receiving all of their money back, whether a borrower fully repaid his loan or went into default. Kiva’s local microfinance partners tended to guarantee full repayment. This “cushion” shielding the lender from the harsh economic reality has now been removed by Kiva, in an audacious move to bring lenders closer to the borrowers’ real life. Will lenders be confronted with massive losses? How will the partner Microfinance Institutions react to this policy change? Does the policy change actually bring lenders closer to borrowers, in an emotional and economic sense?
My gut feel says that Kiva’s Microfinance Partners will do their utmost best to minimize default rates on the Kiva loans. Have they not, in the previous years, voluntarily guaranteed full repayment and carried the credit risk, only to be an attractive partner for Kiva and its lenders? Also, now that the MFI’s do not need to write off on Kiva loans, the benefits of having loans funded by Kiva only get larger. Would they want to jeopardize the interest- and risk-free funding by Kiva by a bad repayment performance? Surely not!
I tested this assumption on my visits to branch offices of Vision Finance Company (VFC) in Rwanda. The statement of Semahoro Evariste, branch manager in Kanazi, 30 km from Rwanda’s capital Kigali, reflects their position well:
“If there is a risk, it is not more than 5%“, “We will do everything possible to get full reimbursement”, and he concluded by saying: “I want to thank those who provide credits for our clients, it is really very interesting, we will do everything to be Kiva’s extension in the field”.
What could be the worst case scenario for Kiva and its lenders? At VFC, the Portfolio at Risk (PAR 30) is 7,3%. PAR 30 is a conservative measure for payments at risk. Using this measure, lenders run a risk of 7,3% when lending to customers of VFC. Of course, this is an average. In the worst case one lends to this one person who happens not to repay at all. So, as in all other investments, it makes sense to spread the risk through a well balanced portfolio of Kiva loans!
Then what about the emotional and social side of this new policy. Would you, as lender, rather be living under the rosy yet unreal assumption that all Kiva borrowers fully and unconditionally repay their loans (contrary to what we see happening in all other credit markets), or do you want to feel the dust, sweat, draughts, heat or bitter cold that comes along with your borrower’s effort to pay you back?
1. Why do we need Microfinance Institutions (MFIs) and Interest rates? « Living, Loving, Laughing | 10 March 2010 at 07:22
[...] If you are worried about microfinance reaching the poorest of the poor then you know that “exact”person to person money transfer is impossible. I urge you to suck it up and realise that you are possibly contributing to that person’s next loan. Or read about Kiva’s new philosophy on lenders taking on loan risk in Claude’s Fellows Blog. [...]
2. Who really cares about Kiva loans? The difference between Kiva and MFI loans « Kiva Stories from the Field | 27 February 2010 at 10:01
[...] protection policy where partners will no longer be able to guarantee Kiva loans (see posts by Claude Mansell and Nicky Goh), many of you Kiva Lenders are worried this move will greatly affect your portfolio [...]
3. Why do we need Microfinance Institutes (MFI) and Interest rates? « Kiva Stories from the Field | 24 February 2010 at 06:25
[...] If you are worried about microfinance reaching the poorest of the poor then you know that “exact”person to person money transfer is impossible. I urge you to suck it up and realise that you are possibly contributing to that person’s next loan. Or read about Kiva’s new philosophy on lenders taking on loan risk in Claude’s Fellows Blog. [...]
4. Morgan | 23 February 2010 at 14:24
To those who say this is a “marketplace”, it is not. We are giving our money out at a loss equal to inflation. These are one sided transactions that we make. It is a gift, not a loan. We are giving away the time value of money.
I understand the feel-goodness of giving money away, but the economic reality is that for Kiva to be sustainable, it needs a model that provides a return to it’s lenders in exchange for risk. This will greatly increase the amount of funds available for disbursement and improve the quality of the projects.
5. Salah Boukadoum | 25 February 2010 at 07:41
There are other ways that economic returns can be generated when providing loan capital to an MFI, separate from interest income. For example, our company Soap Hope invests 100% of profits into MFIs at zero percent interest – we only require repayment of the initial capital. Why do we do this? Because it creates a powerful competitive differentiator. Our customers are more loyal, we receive attention locally and nationally because of our social mission, and our employees are incredibly committed. The “lost” time value of money is insignificant compared to the benefits we receive. That’s why we call our model Good Returns. You can learn more about this concept on my blog http://salahsblog.com and the company at http://soaphope.com. My personal goal is to recruit 1,000 businesses into this model and thereby generate one billion dollars for non-profit MFIs.
6. James | 22 February 2010 at 23:05
Actually, if you want to be a realist, ALL kiva lenders are lending to MFI’s and NOT to those borrowers who borrow from MFI’s. As kiva lenders, we “backfill” loans that have already been made by the MFI’s without our participation in the selection process. Horse sense mandates that if an institution makes a loan to an individual and charges that individual a robust interest… then other lenders lend interst free money to that institution (AFTER THE FACT) then, they are indeed lending to THAT institution and that institution only.
It seems sensible that those organiziations, to which we lend interest free money, should pay us back the money that we lent them!
7. Amy | 24 February 2010 at 23:02
I agree with what James said on 22 Feb 2010, above, and I add that we are not provided with enough information to make an intelligent lending decision to any individual borrower. For example, the “profiles” of individual loans do not tell us anything about the competition the entrepreneur faces, or other market conditions facing the entrepreneur. We have no way of evaluating whether the entrepreneur’s business plan is realistic. Some MFIs do not even tell us the borrower’s full name, or the city/town in which they do business (citing “privacy” concerns)! In light of this situation it makes no sense to tell me that if borrower X does not pay back his loan, I lose my money. The MFI who made the decision to lend should be held accountable for it. And, Kiva decision-makers, forbidding the MFIs from bearing the risk of default does NOTHING to make me feel “closer” to the borrowers. I cannot imagine why anyone would feel that.
8. Changes to the Repayment Policy – who wins? « Kiva Stories from the Field | 22 February 2010 at 08:52
[...] have seen Kiva’s recent announcement of the policy change with regards to repayments, or indeed Claude’s excellent post from last week about the impact of Kiva policies in the field. As someone who has spent more than her fair share [...]
9. Dan | 21 February 2010 at 16:54
While any single action by Kiva is not going to fully address the issue of risk, I applaud this move as a step in the direction of transparency and for strengthening the peer to peer aspect of Kiva. Without it, it was too easy for the MFI Field Partners to simply send along the monies that the repayment schedules required without any credibility that the borrower was in fact making this repayment. I personally am looking for credibility more than a guarantee. To me it is all about the borrowers/entrepreneurs.
In more sophisticated markets there are provisions for risk sharing, e.g. the originator retains 10% of the risk of default. There are also “insurance” programs which underwrite against default loss. Either of these would be acceptable additions as Kiva matures — so long as the actual repayments (or non-payments) of the borrowers are what is reported to Kiva lenders. Let’s face it, the vast majority of defaults on Kiva are from the failure of an MFI Field Partner itself. Let’s work on cutting that rate down.
10. Daniel Mayhugh | 22 February 2010 at 04:38
Dan,
I think you’re right. It should bring more transparency and hopefully give more warning to when an MFI is struggling. The Kiva 1-5 rating will have more meaning now, if it takes into consideration the late payments, etc.
11. Kati Mayfield | 21 February 2010 at 15:02
Thanks to Claude for his thought-provoking post! As Adam mentioned above, the incentives Kiva’s MFI partners have to keep delinquency and default rates low are many. I am a Kiva Fellow working with Prisma Honduras, S.A., and was interested in finding out what Prisma is doing to combat delinquency/default. Here are my thoughts: http://prismahonduras.wordpress.com/2010/02/21/in-defense-of-the-mfi/
12. In defense of the MFI « Prisma Honduras | 21 February 2010 at 14:52
[...] Leave a Comment For some of those reading and commenting on KF Claude Mansell’s blog “Pains and pleasures of Kiva’s P2P principles“, Kiva’s new policy of not allowing MFI partners to cover borrower default came as a [...]
13. Kogie | 21 February 2010 at 03:27
Kiva lenders worried about a significant increase in the default rate should be comforted knowing that most MFIs have much stronger motivations to keep default rates low than simply appeasing Kiva and Kiva lenders. Profit margins on microloans are often miniscule, despite the perception that interest rates are “high”, and as you probably know, administrative costs are quite high. A default rate of even 5% is sufficient enough to cripple or completely undermine many MFIs. Kiva lenders enjoy high repayment rates because MFIs are looking out for their own interests by keeping default rates low, and it just so happens that our interests are mutual.
Adam Kogeman, Kiva Fellow, 10th class, Phnom Penh, Cambodia
14. Daniel Mayhugh | 20 February 2010 at 15:55
I would also suggest that Kiva sends an email to notify all the lenders of this change. We will be affected the most and have to mentally adjust our thinking, since previously we always got our money back unless the whole MFI went under.
All the newcomers to Kiva would assume their loan wouldn’t be guaranteed, I would think. Because their loaning money out.
Change is rarely easy to deal with.
15. markaz18 | 20 February 2010 at 13:25
Lots of comments here
I think MFIs will welcome this change and pull up their sleeves further because they know Kiva can always introduce the ‘cushion’ again.
As for the reaction of lenders, I doubt they’ll complain a lot. I would imagine most individuals donate very small amounts and even then, their money is lent to several micro-entrepreneurs to lessen the default risk.
16. Kevin | 20 February 2010 at 12:59
With this new change, it is clear that the peer-to-peer connection is stronger than ever before with Kiva. In the past, with MFI’s guaranteeing loans, that was NOT exactly peer-to-peer. If an individual ran into a problem and was delinquent or defaulted, the lender still got their money according to the predetermined schedule. That is not reality in the financial world. There will be always be late payments, or client’s who have no choice but to default if faced with a crop failure or death of an income-producing asset such as a dairy cow or poultry stock. The change with Kiva now is that these losses will not just be felt with the MFI but with the group of lenders that chose to fund a specific client.
I really can not see how dedicated lenders will change their thinking with this new shift in policy. I feel that most Kiva lenders with more than five loans are here for a reason and that they are smart enough to understand reality. The 98% repayment rate right now is clearly inflated, and with this new change it is clear that the repayment rate will drop by at least a few percentage points, but so what? Are you, as lenders, then just going to donate money to some other charity group? You get no return, financial or social, in that capacity and you have no idea where your money goes. With Kiva you have a clear understanding of where your $25 or $50 loan goes, and if a person has no choice but to default, you get a story of why that is the case. Can you really be so upset at that situation that you decide to never again loan on Kiva and withdraw all of your funds?
17. Daniel Mayhugh | 20 February 2010 at 15:49
Of course some people will feel like that and of course some will withdraw their funds. Will it be a large share of lenders? Probably not. It will just slow Kiva’s growth, which may be a good thing.
18. Jan & John, KivaFriends | 20 February 2010 at 11:17
I am taking a ‘wait and see’ attitude, just as we have with the currency loss scenario. We have been adding less credits as time goes by and Kiva grows larger and more complicated. So far our losses are a small percentage and mainly due to large MFI failures. We can accept small losses, but would not be able to continue for any length of time if individual defaults increase. I would hope that if Kiva takes the pressure off the MFI in this way, that they would then increase the surveilance to make sure the partners are still doing all they can to lend to responsible borrowers. I strongly feel the person to person connection in lending but also want to feel that MFI’s can be trusted to pass on to us the correct information to assist us in choosing our borrowers.
-jan-
19. Leigh Madeira | 20 February 2010 at 11:10
David – I don’t really follow your point as you seem to contradict yourself. You say Kiva should provide transparency and that lenders should be able to choose the loans they want to support, yet if the borrower who YOU picked does not repay, you still want your money back? To me that is neither p2p nor transparent. This is a marketplace, and with any marketplace there are different products (borrowers) with different risks (field partner risk rating, your own judgement, etc) and the choice is yours…yet you can’t have it both ways!
20. David | 24 February 2010 at 19:57
I am not contradicting myself. If lenders who feel strongly about default protection no longer have that option then I guess they can take their money elsewhere. Obviously Kiva is not interested in offering loans with a variety of features and letting the lenders choose… Kiva is a marketplace at their convenience, and not when it does not suit them.
21. David | 20 February 2010 at 10:40
Kiva lenders have no returns, therefore our risk should be very low. If our money is not repaid to us we cannot lend it to help others. Kiva is supposed to provide transparency, meaning that the terms of the loan are clearly explained, and to be a marketplace, meaning that lenders can choose loans with the features they want. Now Kiva has taken away an option that reassures lenders. I do not see this as a good thing. I don’t think Kiva respects lenders and our money. I think Kiva is overreacting to some undeserved bad press by making bad decisions…
22. Stefan | 20 February 2010 at 10:23
I think it is a mistake to take the Microfinance partners off the hook to this degree. When they are required to cover loans, that is a strong incentive to keep them sharp. It also has a “trickle-down” effect to the borrowers, who are required to be that much more careful. And it has a psychological impact on us, the lenders. I feel good lending, knowing that my losses are very small. I don’t think I will feel quite the same as I watch my capital diminishing more rapidly.
23. Daniel Mayhugh | 20 February 2010 at 07:48
This is what I wrote on a similar topic on Kiva’s blog, http://kivanews.blogspot.com/2010/02/update-on-recent-change-in-default.html
———–
The repayment rate will obviously go down some, but I still think this is a good move (even though I don’t want to loose my money), because it brings a new level of transparency and clarity of the specific loan along with the larger MFI’s statistics. This could still be skewed if the MFI only posted their top clients on Kiva, but Kiva can’t control that.
I don’t think Kiva was wrong to allow this option in the past, because we need to remember that MFI’s charge interest to cover defaults on their loans.
I believe 1 of the great secret successes of Kiva is and will continue to be their ability/role to bring transparency, accountability and a rating system to MFI’s. I think in 5-10 years, Kiva’s rating of a MFI’s will greatly affect a MFi’s ability to successfully gather finances/grants.
Anyways, those are my thoughts.
———-
I’ll just add. I think some Kiva lenders will fall away as their portfolio gets smaller and smaller (it’s inevitable because they receive no interest). I will probably be one of those. I love Kiva and what it’s doing, but I don’t really want to loose my capital. A partial repayment here and there would be ok, but since I don’t add any additional funds I might pull out when my credit gets too low. I’d probably rather loan to an MFI through Microplace and get a small rate of return. I’m still a big fan of Kiva and will promote it, but for my personal situation I may back out at some point. If it was my call, Kiva could allow the MFI to choose whether or not the guarantee repayments. If the loanee didn’t pay back the full amount, the MFI post a journal update or something like that saying what happened and that since they account for defaults they will send Kiva the rest of the payment. Transparency and everything else should be above board, right? I just thought of this idea, but I think it could really work.
24. Adam | 20 February 2010 at 12:14
Actually, Kiva was allowing the Field Partner choose to guarantee repayments. Problem was, most of them decided to do it.
25. James | 23 February 2010 at 22:15
Bless you Daniel!!!!! …for mentioning Microplace. I had never heard of it before and have constantly been looking for an alternative lending conduit to fall back on in the event that Kiva takes a path that is in conflict of interest. I really appreciate you sharing that information! Thanks.
26. Antoine Stépane Terjanian | 20 February 2010 at 07:37
Wait a minute Mr. Mansell:
I am not convinced that it is a good thing to let the partner MFI off the hook.
After all, they are the ones who know the borrower (or should) and they should examine the ins and outs of the proposed investment to ensure it is sustainable. Yes we have some KF’s, who bravely go to spend some time with partner MFIs, and give us a true picture. But some of these KFs are talking of embellishing their stories so they attract more lenders. Some MFI’s have even taken photos of 50 farmers with the same good-looking cow ;(
If Kiva lenders wanted to give away their money, they could do so by donating (with a tax-deductible receipt) to a large number of charitable organisations working internationally, some of them with low overhead.
I am not convinced that local MFI partners should get Kiva lenders’ money, “interest free”, then charge an interest on it (in one case I am aware of, a KF was trying to justify 3% interest per month) and then pay themselves comfortable salaries and HQ overheads.
I agree with you that the partner MFIs would not want to jeopardise their relationship with Kiva by selecting too many borrowers who would default, but to what extent are lenders going to tolerate these losses.
I would be agreeable to what you are trying to sell us, if, and only if, the partner MFI is run by “volunteers” with no salaries, commissions or bonus payments. Otherwise, this new practice that you are trying to sell us, would be equivalent to the MFIs having their cake and eating it too!
Thank you again for volunteering as a KF and for informing us, candidly, as you did.
AST
27. kurt | 20 February 2010 at 08:59
I agree with AST. There is on this website a text about the difference between microcredit and subprime. If the intermediary bears no risk, I see no difference with securitised loans
28. Adam | 20 February 2010 at 11:45
AST, I think you definitely have some valid concerns, but just to point one thing out EVERY single Kiva Field Partner charges interest with the interest free money they get from Kiva, and in many cases its much much higher than 3%. You’re right, this margin is used to “keep the lights on” and pay their staff.
29. Antoine Stépane Terjanian | 20 February 2010 at 12:41
Adam:
Thanks for your input.
Please be precise: are you saying that Kiva-partner MFIs are charging borrowers “much much higher” rates than 3% per month? I repeat “per month”?
30. Claude Mansell | 20 February 2010 at 23:30
Thank you, Mr Terjanian, for sharing your perspective. I just want to react to your concerns about comfortable salaries and bonusses. I agree with you that one would not like to see that, as a result of Kiva’s goal to augment transparency, you would suddenly contribute to excess profits and high bonusses. The reality, though, is that many of the MFI’s struggle to be operationally sustainable. Low salaries, such as for the Credit Officers who do the field work with the clients, lead to quite some turn-over. The locations and buildings (“overhead”) of the so called HQ’s and branches are not exactly comparable with Wall Street. This week I was in Gisenyi, up North in Rwanda, in a street with lots of small banks. I ironically called the street “Hole Street” because of the massive potholes that made it hard to even get there by car. Having said that, I agree with you that we should all make sure that MFI’s do not take (personal) advantage of the new policy, and that in that respect the pressure should stay on.
31. Adam | 27 February 2010 at 21:41
Antoine:
My bad. 3% a month is probably in the ballpark.
32. Jeff | 20 February 2010 at 06:55
Well, Claude, that’s a difficult one. As a lender I prefer to see my money come back so that I can then lend it to someone else. I use Kiva knowing that the repayment rate is 98%.
The field partner is the one that chooses who to lend to. They are the one that decides a borrower satisfies their criteria. I have no part in that and rely on their judgment. If they bear the losses then that keeps them honest (no, honest is not the right word but perhaps you know what I mean).
Many loans are to groups where the group members guarantee the loans of fellow members so the idea of a guarantee is very common in micro-financing. Any method that increases the likelihood of repayment helps to keep the money coming.
In the end result, if a field partner has a greater percentage of defaulted loans than competitors, it will likely see its loans funded less successfully.