Source: Business Week.
BALI, July 28 - In an effort to head off a potential crisis in the
fast-expanding microfinance industry, its leaders are adopting global
truth-in-lending standards and creating a system for comparing loan
terms offered by competing lenders. To manage the effort, a new
self-monitoring organization, MicroFinance Transparency, is being set
up as the industry's policeman. The goal is to prevent companies from
taking advantage of poor people with high interest rates and misleading
credit offers.
The initiative was announced on July 28 at a microcredit conference
in Bali by Chuck Waterfield, a professor at Columbia University who
spearheaded the initiative, and Nobel Peace Prize winner Muhammad
Yunus, who launched the microcredit revolution in Bangladesh 30 years
ago with his Grameen Bank.
"Microfinance emerged as a struggle against loan sharks, so we don't
want to see new loan sharks created in the name of microcredit," Yunus
tells BusinessWeek.
If the industry doesn't curtail abuses and confusion, it faces the
prospect of government crackdowns and donor funds drying up. Since
Yunus pioneered the idea of lending small amounts of money to poor
people without demanding collateral, the phenomenon has spread
worldwide. These days, thousands of organizations are making loans to
tens of millions of borrowers—usually to help them set up or expand
small businesses.
Today, there are basically two kinds of microlenders: nonprofit outfits
like Grameen and for-profit lenders, including traditional banks that
are making forays into this market.
Starting last year with an exposé of lending practices in Mexico by
BusinessWeek (12/13/07), a steady drumbeat of articles critical of high
interest rates charged to poor people have appeared in various
publications. Yunus said he was alarmed by the direction the industry
was taking (BusinessWeek, 12/13/07). "I felt so bad," he says. "I made
this thing and they came in and abused it. What a way to discredit a
whole idea!"
Waterfield, who has been researching and writing about microcredit for
decades, said he became concerned about the industry after Mexico's Banco Compartamos (BMOSF),
which had once been a nonprofit organization, switched to a
profit-seeking enterprise, and then went public early last year. The
IPO netted a windfall for its backers and attracted Wall Street money.
There are several sticky issues here. Organizations that seek profits
and rich returns for investors have to charge interest rates high
enough to produce those yields. Compartamos, for instance, charges more
than 100% annually on its typical loans, according to Waterfield's
analysis. In addition, Waterfield says, much of the microcredit
industry markets loans to poorly educated borrowers in ways that are
hard to understand and tend to underplay the impact on their family
finances. "Organizations that want to make a lot of money can set a
very high price that doesn't look like a high price," says Waterfield.
Compartamos defends its practices. The bank published a 14-page "Letter
to our Peers" in early July explaining why it charges what it does. The
letter argues that Compartamos must set high interest rates because its
operational costs are high, $152 per client per year on loans that
average just $450. "A plea for lower interest rates is in fact a plea
to increase the size of our loans significantly. Doing that can only
have two outcomes: the overindebtedness in our clients or moving to a
different segment of the market, which amounts to mission drift," the
letter says. The bank argues that it's better for poor people to have
access to credit than not—even if the interest rates are high.
MicroFinance Transparency will collect information from all microcredit lenders and store it in a database on its Web site, mftransparency.org,
that's searchable via the Web by anybody who is interested. (The group
hasn't said when that information will be posted on its site.) All of
the loans will be converted into annual percentage rates based on the
true cost of the loans. In addition, all of the costs associated with
the loan, including any additional fees charged by the lenders, will be
rolled into the total. Waterfield says most microcredit organizations
will submit their data, and, for those that don't, the information will
be collected by gathering contracts from their borrowers and crunching
the numbers.
These days, most microcredit organizations market their loans using a
monthly interest rate, say 2% to 4%. That may sound reasonable to
people used to paying even higher rates to village loan sharks, but the
lenders don't spell out to borrowers that these are flat rates—meaning
they're paid on the total loan amount, even as the borrower pays down
the principal during the year. Yunus' Grameen Bank operates
differently. It charges a 20% annual rate on a declining basis. Each
week, when Grameen borrowers make their payments, the principal of
their loan and the basis of future interest payments gradually
declines. The APR of a Grameen loan is actually about 10% per year.
One of the dangers to the microcredit industry is that countries may
put limits on the amount of interest the organizations can charge
borrowers. Already, Nicaragua, Ecuador, and South Africa have set
ceilings. While that may sound like a reasonable move, if rates are set
at unsustainable levels it could smother some legitimate microlending
activity. There's truth in what Compartamos says: It's costly to make
and service small loans to poor people. And industry leaders say they
need to charge more than what a typical bank in a developed nation
would charge for a small-business loan. If they can't charge enough to
cover their costs—much less generate profits, for those that seek
them—they won't be able to stay in business.
By the time the new initiative was announced, more than 15 sizable
microcredit organizations had signed statements endorsing it. The
roster included Grameen and BRAC, big Bangladeshi organizations, and SKS Microfinance,
a fast-growing, for-profit outfit in India. "We're very supportive of
transparent pricing. It's part of treating your customers fairly," says
Vikram Akula, SKS' chief executive. SKS already complies with the
standards laid out by MicroFinance Transparency. Its rates vary from
24% to 28% on a declining basis, and the APR terms are spelled out on
each borrower's record book. Akula predicts that most microfinance
institutions will comply.
Some industry watchers are calling for even more extensive checks and
balances. "Transparent pricing should apply to all financial services,
not just loans," says Elizabeth Littlefield, chief executive of the Consulting Group to Assist the Poor.
"Many poor people are aggressively sold multiple, expensive insurance
policies, or are paying excessive fees for remittances." Still, she
says of microcredit transparency: "We applaud the effort."
