CONSIDER INVESTING $100
for a return of 1% to 3%. That's not an especially good rate, I admit. Some bank savings accounts pay more than 3%. But for the dollar or two in interest you'll forego, you'll nurture a clever new market that seeks to pair individual investors with the world's poorest entrepreneurs.
The world's poor are defined, not just by meager net worth, but also by lack of access to capital. The American college student with no money for courses can borrow all he needs. The poor but profitable soap maker in Nigeria might wish to borrow to expand, but until recently, her only choices were local usurers with their yearly interest charges of 120% to 300%. Her needs were thought by banks to be too small to bother with, and her repayment risk, too great.
The rise of microfinance over the past 30 years has proven otherwise. Simply put, the working poor can be lent to profitably at annualized rates of 18% to 60%. Those are high by American standards, but cheap compared with other options, and they cover the considerable cost of administering tiny loans. A typical first loan of $50 or $100 is enough to buy wood to make stools, to stock a fruit stand or to fund some other business. Borrowers can turn a profit in six months. By repaying loans on time, they qualify for larger ones.
Repayment rates are excellent when loans are made to small groups of borrowers who are responsible for each other's success, a tactic pioneered by the Grameen Bank in Bangladesh. Women make the best clients; they form most of the world's unemployed and tend to spend profits to create opportunity for their children. Grameen Bank, Bengali for "bank of villages," is a bit more intrusive than a typical U.S. bank. It requires borrowers to agree to "16 Decisions" meant to break patterns of poverty and disease. Among them: "We shall plan to keep our families small," "We shall educate our children" and "We shall build and use pit-latrines." Also, no dowries.
Today Grameen has more than 2,500 branches with 7.5 million borrowers, almost all women. Repayment rates are as good as those for rich-country loans. One World Bank study found that about 3% of clients rise above the poverty line each year. Around the world, more than 3,000 other microfinance institutions now use Grameen's methods or local variations of them. About 100 million people have received small loans. An estimated billion more are candidates for them.
In rich countries, voracious loan demand is met by investors through a process called securitization. Banks make loans and sell them to investment firms to replenish their cash. Firms sort and bundle loans into bonds to sell to investors. Investors earn the interest paid by the original borrowers. Some investment firms have already begun scooping up piles of microloans. The bonds they build from them have mostly been sold in bulk to rich investors.
Tracey Pettengill Turner, an entrepreneur who has held positions with Grameen and the World Bank, founded MicroPlace to make securitized microloans available online to ordinary investors. MicroPlace, now owned by eBay, has 3,000 members and 47 investment listings serving the poor of 28 countries, including the U.S.
Turner says lenders are carefully screened by the securitizing firms, that she has had no defaults so far and that underlying repayment rates average more than 97%, vs. around 85% for typical American consumer loans. Why so high? "People value the opportunity tremendously," she says. "I think it's really about human dignity. When you talk to an individual borrower, they feel so proud to take out this loan because they feel like they're being treated like a business person."
Turner has a new awareness push called Small Change, Big Change. The average American has $100 in spare change around the house, according to Coinstar. You see where this is going.
The rise of microfinance has brought other products besides business loans, including insurance, mortgages and savings accounts. It has also brought challenges. A flood of new cash from investors has pushed average loan size higher. High-interest lenders operating under the guise of microfinance defeat the purpose and mar credibility. Lenders focus overwhelmingly on the most mature and lucrative markets, including Latin America and Southeast Asia, and ignore needy but less lucrative Africa. Competition among microlenders has brought marketing, which begs the question of whether the poor in some areas are merely provided loans or are talked into them. Some borrowers use loans to buy televisions rather than fund businesses.
The overwhelming majority of loan programs, though, help pull borrowers out of poverty. MicroPlace's screening process ensures that money goes to the best programs. Turner isn't nearly worried about providing too much investor cash for loans, noting that less than 10% of the world's need for microfinance has been satisfied. Growth in microloan investments would surely reduce borrowing costs, and might result in competitive yields for investors, rather than ones that attract mostly do-gooders. That would create a long-term flow of funds between investors and the poor that isn't bound by the aid budgets of rich nations or skimmed by the finance ministers of poor ones.