Micro Finance, Macro Impact

You may have heard of microfinancing, but not a lot of people know exactly what it is, or how it could involve the average college student. Broadly defined, microfinance is the provision of financial services to people whose income and collateral are too small to secure a loan from a traditional bank. The idea started gaining momentum in 2006, when Muhammad Yunus, founder of the Grameen Bank in Bangladesh, won the Nobel Peace Prize for the concept’s development. According to a 2008 article by Forbes, as many as half of the three billion people currently living in poverty may be eligible for microloans. Recently, this burgeoning nationwide trend has made its way to Tufts, thanks to sophomore Brooke Evans, who recently decided to bring Kiva, an online microfinance initiative, to campus.

“I was having one of those moments where I was like, ‘What should I be doing with my life,’” said Evans. “I thought, what would be the number one thing that I thought that Tufts didn’t have but needed.”

With this in mind, Evans created the Tufts University Kiva Initiative, or TUKI. Founded as a non-profit in 2005, allows anyone with $25 to make a loan to any of thousands of financially struggling entrepreneurs in 52 countries worldwide. With over 600,000 users, Kiva has lent out almost $130 million to around 182,000 causes. The organization boasts a 98.48% loan repayment rate as of April 9, 2010.

Evans decided to introduce Kiva to campus partly because student lenders are likely to have their money repaid. They can then circle the money through other loans. “It’s about doing good with what you have,” Evans said. “It’s like, here’s $25 dollars and you can lend it, and then it comes back to you.”

So, considering its ease, why isn’t microlending the de facto standard for funding to third-world entrepreneurs? Though microfinance boasts many success stories, some are more skeptical of its effectiveness in every situation. This includes Tufts Economics Professor Edward Kutsoati, who has been involved in projects on microfinance for a rural farming community in Ghana. He and his colleagues noted that for a large farming community, farmers were virtually excluded from the bank’s loan portfolio. “The bank claims farmers have a high default rate; the farmers say the bank’s loan terms are not flexible enough for their needs,” said Kutsoati. The researchers suspected that these factors “may be keeping ‘good’ borrowers away from the bank”― those who would fully repay if they could.

Kutsoati sees both the value and the risks of microloans. “Everywhere you go, there are success stories, but there are also examples of families whose lives have been ruined by debt,” wrote Kutsoati. “Credit, or access to credit, helps if the individual has a good business plan and works hard. Small loans are not for all.”

The cost of microloans is one of the main obstacles to their success. Due to high demand, which often outstrips their supply, many microloans are attached with high interest rates. Kutsoati also notes structural difficulties for entrepreneurs. “Recall that these loans are made to folks who live in poor communities, which means they often lack the basic infrastructures (good roads and communication networks, energy supply, etc) to enhance productivity of their small businesses,” he said.

Another factor hindering its success is the tendency of microloans to peter out over time. “The first rounds of infusion of loans into a community will more likely unleash ‘entrepreneurial spirits,’ leading to high returns and profits,” said Kutsoati. “But as more and more loans are injected in this community, returns fall, profits shrink, and default rates begin to rise.” Consequently, when lending institutions follow “the herd” into a community, each often fails to realize the amount of total credit burdening their clients. To compound matters, defaults often create “tremendous social tensions within the community, since loans are usually guaranteed by peers in joint-liability scheme.”

Sociology Professor Ryan Centner, who has worked with Ananya Roy, a prominent critic of microloans at Berklee, has concerns about microfinance that surpass economics. Centner is especially leery of lending programs that target specific groups, such as the poor women from rural areas that dominate the focus of programs like the Grameen Bank . The organization says that it concentrates resources on women because the opportunity of self-employment and access to money helps empower them. They claim that the overall output of development is greater, since women are more likely to use their earnings to improve their living situations and educate their children. But Centner is more skeptical. “I’m worried about anything that’s billed as a panacea, that’s going to just fix everything everywhere,” he said.

Centner also said that the community-style lending of programs like the Grameen Bank could provoke unforeseen consequences. “There can be lots of very serious peer pressure, sometimes deadly peer pressure, applied to people in this group,” said Centner. “So that if one person is delinquent in repaying her loan, then she faces the wrath of her peers.”

But merely handing out loans to those in need cannot solve the long-standing problems of an already disadvantaged community. Many of the women targeted by microlending live in societies where they lack social power and the opportunity for upward social mobility. It’s dangerous to try to change the fundamental parts of a social dynamic in places where financially independent women could clash with underserved men, who feel they deserve loans as well.

Kiva and other microlending initiatives are also problematic in that lenders are given very little information about whom they are loaning to. According to Kiva’s statistics, the lender’s “partner star rating,” a measure of the lender’s past loan repayment―or the risk rating of getting the loan back―appear to have little sway in lenders’ decisions. Instead, factors such as geography, gender, and the lender’s picture are used more frequently to determine whether or not a lender will give out a loan.

“Africa, East Asia, and Central America are more common in the fast-funding loans,” writes Kiva, with Africa making up 30 percent of all loans. “Central Asia, South America, and Eastern Europe are more common in slow-funding loans.” 75% of all loans are made to women, and they are funded 1.5 times faster than men. But what determines the rate of a loan isn’t so concrete. Lenders with fast funding times tend to have “happier” descriptions and seem like more “spirited” people. Likewise, loans that have interesting anecdotes such as “Unrefined palm oil is a deep orange in color,” or feature the borrower in a colorful photo or wearing traditional clothing tend to attract more sponsors. Adds Kiva, “African loans that have not been funded tend to have ‘boring’ names.”

“That’s not Kiva’s fault, except that Kiva is opening this up to anyone,” said Centner. “It also lets the process of deciding who is deserving and who’s not to people who don’t really have any idea.”

Though perhaps a perfect model may yet to be found, microfinance has already changed many lives for the better. And, having made its way into student hands on campus, it has the potential to impact many more. While microloans aren’t necessarily a fix-all, they certainly merit a closer look.

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