The Cost of Doing Good

18 June 2009 at 08:53 4 comments

By Nancy Tuller, KF8, Ghana, Africa

I have a professor and mentor from my undergraduate days whose advice and thoughts I value and respect so much.  I still communicate with him regularly, and over the years, the topic of interest rates in microfinance has come up repeatedly in our conversations.  This is the man from whom I first learned about community currency, an alternative exchange system used alongside national currencies.  He is knowledgeable about micro and macroeconomics, as well as finance.  However, our conversations about interest rates for microloans always end the same way:  with me, for the most part, defending the rates charged for microloans, and with him maintaining that the rates are most often too high.  I think I finally have the words to support my position, and I offer them up to you all.

It seems I’ve always intuitively known that if you want to be in the business of giving very small loans to the poor, your expenses are going to be higher than if you are a financial institution that works with middle to high income clientele.  If you want to continue providing basic financial services to the poor you must have a sustainable operation, with an ability to cover all your expenses and generate funds to lend as well.  Many microfinance institutions (MFIs) rely on donor funds to stay sustainable, and I would even venture to say, without the statistics at my fingertips, that the majority of MFIs begin operations this way.  Many are not able to wean themselves from donor funds.  But relying on donor funds has its own cost, in terms of meeting donor needs, reporting back to donors, and the very real threat of MFIs losing sight of their own missions by putting their financial viability (and sometimes donor missions) at the top of their priority list.  The more recent trend in microfinance is to move away from donor funds and seek financial sustainability as quickly as possible.  Scaling up the business by adding more borrowers is a step in this direction, and there are certainly MFIs, who once they have reached a financial comfort level, have lowered their interest rates.  However, that comes with time and sustainability.  The first goal, before lowering interest rates, is financial self-sufficiency.

One thing that is really important to acknowledge is that different country contexts present different challenges to meeting financial sustainability for MFIs.  For example, Kiva recently launched its first loans to borrowers in the United States.  One of the MFIs offering these loans, ACCION, charges an interest rate of 12% APR.  That may seem on the reasonable end to many from the US.  However, at least here in Ghana, and I suspect it is true for the majority of developing countries, 12% is considered a steal!  The Central Bank of Ghana charges 18 % APR on loans, and commercial banks in Ghana charge (depending on what type of business loan it is) from a very rare 21% APR (for a construction loan) to a high of 83.31% APR.  The common range would be from approximately 32-38% APR.  (See these figures on The Central Bank of Ghana website: www.bog.gov.gh.)  For a country with a low GDP, in which government revenues are low, and the economy is slower, the lack of money circulating makes it a lender’s market.  I would definitely qualify 83.31% as falling into the category of greed.  But the average rates that commercial banks charge would generally give them no more profit than a bank in the US.  Most importantly, when an MFI, like Sinapi Aba Trust (the one I am currently working with in Ghana) charges 36%, it must be understood that its expenses greatly exceed those of a commercial bank, and its revenue stream is more like an extremely slow trickle.  Sinapi Aba Trust (SAT) is a financial NGO, and as such, is not legally allowed to accept deposits.  Such deposits are a major source of revenue for banks that hold the savings of middle to high income clients.  In fact, SAT pays other banks to hold its money in current accounts, from which it lends money and pays its own operational costs.  It also pays interest on the money it borrows from other banks to lend to its clients (though it does not pay interest on the money that it receives from Kiva lenders which goes to only a portion of SAT’s clients).  In addition, MFIs like SAT must meet the costs of providing the services that they render, which are generally much higher than commercial banks.  Consider that it costs the same to process a loan for $7,000 as it does for a $700 loan.  Yet the $7000 loan generates a far greater return through interest payments than the $700 loan.  And what commercial bank loan officers will come and find you at your place of business to collect your payment so that you don’t have to take time out of your working day to run down to the bank?  Which commercial banks will send a loan officer out to your place of business to get an update on how your business is doing?  How many of them offer business training or literacy programs or any number of other services that many MFIs combine with their financial services?  Most MFIs bring the banking operations to the loan clients at village meetings or even their homes or businesses, where clients apply for loans, are assessed, trainings are often given, loans are disbursed, payments are received, interviews to assess impact are conducted, and so on.  All of this takes time, and time equals money in the form of salaries for loan officers, who then return to the office and upload all data into computers or ledgers, and in the form of transportation to remote villages that can be hours or days (then hotel bills must be included) away from their headquarters.  Add to these costs the brick and mortar expenses—overhead of operations.  And in a country like Ghana, where the Ghanaian currency is depreciating on a daily basis, all these costs increase daily.  And remember that purchasing power varies greatly among countries.  Most, though not all, organizations offering microfinancial services fall into the non-profit category, wherein their positive profit margin is reinvested into their operations.  SAT constantly struggles to remain financially stable while not compromising its mission “to serve as a mustard seed through which opportunities for enterprise development and income generation are given to the economically disadvantaged in society.”

Yes, my friend and mentor, in a perfect world there would be no interest charged, a system that makes the rich richer and the poor poorer.  However, the poor need financial services now…not in the idealistic future.  What seems to you to be high interest is a Godsend to the poor in most of the developing world.  Their economies are not mini-replicas of the US economy, where despite the recent economic turmoil we have enjoyed a relatively stable and secure economy that has allowed us to enjoy comparatively low interest rates.  The evidence that the interest rates charged by MFIs are for the most part fair is reflected in the overall success of microfinance operations around the world.  The poor see these microloans with accompanying interest to be their best opportunity for rising above poverty and improving their quality of life.  Remember that with most MFIs, collateral is not required, as it is with commercial banks.  Without microloans, the poor might be paying triple the amount of interest or more to the local moneylender, with the result of sinking even deeper into debt.  Repayment rates on microloans far surpass the repayment rates at commercial banks worldwide.  And clients are motivated to repay through plans that allow them to take out successive loans in higher amounts every time they finish paying off a loan.  In order to stay in business, MFIs must charge enough to cover their expenses.  I’m not trying to make the case that microfinance is perfect.  It’s not.  It is not the answer to poverty alleviation all by itself.  It doesn’t always work for every loan client.  There are defaults and business failures and fraudulent practices by MFIs going on (including charging excessive interest rates).  What works in one context won’t necessarily work in another.  Perhaps the real evidence that proves that interest rates are reasonable for the most part, even when they seem high from a western perspective, is reflected in the countless stories of grateful loan clients whose lives have positively changed as a result of the microloans they have received.  Be it in Bangladesh, Peru, Indonesia, Tajikistan or Ghana, loan clients have come forward, many in these pages, to tell their stories of hardship to hope—of desperate need to grateful success.  Read on…

To learn more about Sinapi Aba Trust and its work, go to http://www.kiva.org/about/aboutPartner?id=88&_tpg=fb

To join the Sinapi Aba Trust lending team and loan to a deserving Ghanaian entrepreneur, go tohttp://www.kiva.org/team/sinapi_aba_trust_ama_anidaso&_tpg=fb

Entry filed under: ACCION USA, Africa, Americas, Christian Rural Aid Network (CRAN), Countries, East Asia & the Pacific (EAP), Eastern Europe & Central Asia (EECA), Ghana, KF8 (Kiva Fellows 8th Class), Kiva Field Partners, Kiva Team, Middle East & North Africa (MENA), Sinapi Aba Trust, United States. Tags: , , , , , , , , , , , , , .

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4 Comments

  • 1. rhea  |  22 June 2009 at 08:04

    There is no price one can place on doing good, whether at home or across the globe….
    you being there without compensation speaks volumes of what can and is being done to help others

  • 2. Nancy Tuller  |  19 June 2009 at 00:05

    I somehow knew you would be the first to respond, Philip! I so enjoyed your response, and as ever, you give me much to think about! And I should have made clear in my blog that I was talking about flat (simple) interest, because that is generally the type of interest charged on microloans. Thank you for bringing that up. And as usually happens, I agree with your final assessment, that we have a challenge still ahead of us to re-create credit/issuance and exchange systems in general. You are doing great work in that direction, and I’m so happy to hear of your growing success in that work!

  • 3. Unilove  |  18 June 2009 at 23:16

    Wow.

  • 4. Philip Beard  |  18 June 2009 at 16:46

    Dear Nancy,
    Thank you immensely for this detailed, spirited defense of standard MFI interest charges. You have made a convincing case (and a very welcome one — it’s always wonderful to learn of personal and institutional success stories in the realm of poverty alleviation!) for the RELATIVELY low interest charged by SAT and its sisters. And your account has led me to ponder anew, for the how-many-thousandth time, the nature of interest and the role it plays in different financial venues.
    What occurs to me to emphasize this time is the fundamental difference between simple and compound interest. As you point out, the repayment rate for MFI loans is very high compared to the performance of standard commercial loans. I take this to mean that the loans are not only repaid “someday” with greater certainty than are commercial loans, but that they are also more frequently repaid ON TIME. This means that the interest typically paid is limited to that applied to the original loan principal — i.e. that the interest-on-interest compounding mechanism is far less frequently invoked than is the case with commercial loans. This keeps the lending-earning-repaying cycle relatively transparent, simple, and from the borrower’s viewpoint affordable.
    I am also assuming that the micro-loans that MFI’s make do not have compound interest built into their repayment structure as do, say, standard mortgages and other long-term loans.
    What makes the MFI system so much more humane and sustainable than conventional banking practice, it seems to me, is precisely this non-reliance on compound interest as part and parcel of the loan process. Just look at what’s happened to American credit card debt, as a dramatically contrasting case study: People miss payments because they’ve been encouraged to overextend themselves, and via compound interest at around 25% they end up so deep in the hole that no matter how hard they work, they can’t climb out of it anymore. To say nothing of the massively failed macro-financial picture: Interest-bearing loans of hundreds of TRILLIONS of dollars have been made to finance the purchase of high-risk derivative “instruments” like debt swaps and subprime mortgage packages which ultimately fail because they’re essentially Ponzi schemes — and the composite debt for those derivatives is more than three times the GLOBAL GDP! That means they can never be repaid, even if all our resources were committed to repaying them.
    I remain as committed as ever to the designing and implementing of credit regimes based on concrete value rather than speculative value, and that do not charge interest unless they create the money to pay the interest with, separately from the principal that they lend. The functional mechanism here, as we’ve talked about many times, is SPENDING rather than lending money into existence. And I am learning from various sources that such responsible, non-scarcity-producing spend-and-lend regimes have a history — sort of a parallel banking universe that nowadays few people are aware of. Perhaps the currently most relevant example is the Bank of North Dakota, a publicly owned state bank that has been spending money into existence and making low-interest loans available to large numbers of people ever since 1919, when it was founded to save farmers from foreclosure by the railroad-owned big banks. Good heavens, if North Dakota can do it, surely other states, counties, countries can do it as well — if only we can surmount the dominant mythology that tells us that the only responsible way to issue money is via private banks charging whatever interest (and demanding whatever collateral) the market will bear.
    Thanks in large part to your direct experience of working as a micro-lender, and the insight into MFI practices that you are gaining, my cautions and suspicions regarding microlending are much allayed. What you describe is a credit system that extends services to people otherwise ineligible, and as such it is definitely a major step in the right direction. But still, to reach its goals it avails itself of a corrupted, unsustainable tool, i.e. national legal tender issued by private banks at compound interest. Our remaining challenge is to create credit systems that reclaim all aspects of the process, first and foremost the issuance mechanisms, for the “commons” sphere alongside the private sphere. Only once we have broken the private banks’ monopoly on credit issuance will we be able to look towards a genuinely sustainable financial future.
    Have you had a chance yet to read Tom Greco’s new book, “The End of Money and the Future of Civilization”? Do it as soon as you can, and keep imagining how we can take a Good Thing — Kiva-style microfinance — and keep moving it toward ever better manifestations.

    As ever, your good friend
    Philip


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