The idea of making high-interest loans to people who earn a dollar a day has been controversial from the beginning. But it proved to be a very profitable industry, so people stopped asking questions.
Suddenly they’ve started asking questions again. One person they asked was the young daughter of Dhake Lakshmi Rajyam, a woman in a dirt-poor corner of Andhra Pradesh, India, who had borrowed $2,400 from a group of microloan companies, notably SKS Microfinance Limited, the country’s oldest and largest microlender.
“We have lost my mother,” the daughter told an interviewer, gasping as she talked. “Nobody will support us.” The woman had become overwhelmed with debt – something that shouldn’t happen in microcredit, where the money is borrowed by a pool of people who help one another with the repayments.
But something appears to have gone terribly wrong when SKS had decided to become more profitable in advance of taking the company public and selling its loans as packages of securities.
At the company’s urging, its loan agents, according to an investigation by the Associated Press, had “urged other borrowers to seize the family’s chairs, utensils and wardrobe and pawn them to make loan payments … Unable to bear the insults and pressure of the crowd of borrowers who sat outside of her home for hours to shame her, Rajyam drank pesticide and died.” It was one of many such cases. SKS continues to deny all responsibility for the deaths.
Is this the end of the microcredit dream? Should we stop putting the very poor into debt, and use charity instead?
To understand, I asked the man who invented microcredit, Muhammad Yunus. His Grameen Bank, founded in Bangladesh in the 1970s, was the mother of all microloan outfits. It invented the key principles: Lend to the very poorest, lend to groups, and make loans only to women (because men would spend them on non-productive uses such as dowry).
“When we created microfinance, we had no intention of making money,” he told me. “It is a business, because it has to be – meaning that it covers its costs, it makes a profit. But profit for the company, not for yourself. I don’t want to take money from it.”
Microloans work when very poor people are trying to get out of their situation – usually, studies show, in order to enter a proper labour market. The loan provides the means to improve one’s life, and its repayment the incentive. “If you want to encourage people to earn, encourage people to change their culture,” Mr. Yunus says, “you have to make the roadway for them to do that – remove the barrier.”
But tiny loans must necessarily have very high interest rates (Grameen’s, among the lowest, are 20 per cent a year), just to cover their basic cost. And microloans have to be a profit-making business: If they aren’t, the pool of capital will disappear fast, and there won’t be any more loans.
“The reason this works better than charity is because charity is dependent on an external infusion of money, and the moment that infusion stops, the whole thing stops,” he says. “So that’s not sustainable. If you design it as a business, it continues, it never stops, because it has its own steam.”
A high-interest, profit-making loan to the poor sounds a lot like Money Mart. The difference is all in how you organize the payments, the collateral and the penalties. (The latter two are basically non-existent in traditional microloans.)
“Once we became respected, some people started using the same methodology to make money for themselves – departing from a social business to a profit-making business, and that’s where all the problems were created,” Mr. Yunus says. “That’s not microcredit, that’s an aberration of microcredit, it’s a distortion of microcredit. If you accept that as microcredit, you have to accept all the loan sharks calling themselves microcredit as well.”
At the very moment when our banks were falling victim to dreadful lending practices, some of the banks of the very poor were adopting those very practices, including the securitization of loans. This was not a discredit to their system, but rather to ours.
It should have gone the other way around. Western banks ought to have been required to adopt the practices of Mr. Yunus’s Grameen Bank: ownership by borrower-depositors, profits used to capitalize the business, lending strictly limited by ability to repay.
As it happens, he has recently set up Grameen lending institutions for poor people in Glasgow and, appropriately enough, in New York. As the big lenders stagger in shame, we can look forward to a day when all loans are microloans.