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Why giving small amounts of money to people is a good idea

PHOTO: From PBS

I’m sure most of you by now have heard something about the notorious institution we call microfinance. The once holy grail of development assistance has fallen on hard times as of late, and it’s reputation is at an all-time low. Some economists and policy-makers have gone as far as to condemn microfinance as loan sharking.

Yeah, that’s right, basically like borrowing from these guys. | Wikia: RDS77

Some PR firm really needs to take on this client. Because microfinance can’t be that bad, can it? People LOVE microfinance, they give AWARDS for microfinance, they give PhD’s in microfinance! In 2006, microcredit because the only economic development idea to win a Nobel Peace Prize, and the recipient, Muhammad Yunus practically became a household name (I said practically!). His founding of Grameen Bank in Bangladesh was praised from both conservatives and liberals. Conservatives were seduced by the idea of poor people working their own way up the socioeconomic ladder by way of entrepreneurship, and liberals saw a range of social benefits including a way to empower women in highly sexist societies.

Flickr: World Economic Forum

Oh, if things had only been that simple...

What IS microfinance?

Just so we’re clear on what exactly microfinance is, here is a brief description: Microfinance includes all financial products and services offered to people who are traditionally excluded from banking access. Primarily, poor people in poor countries. When people hear “microfinance” they typically think of micro-credit or micro-loans (which is what it sounds like, a really small loan for like $100-300 USD), but microfinance also includes things such as savings accounts, insurance, and financial education and training.

Seems pretty legit…

When you think about it logically, there really should be no downside to providing the poor with access to basic financial services. Something as simple as a bank account can be powerful. It’s a much better option than burying one’s life savings in the backyard (because we all know that floods are super rare and really not that big a deal).

chillhour.com

Also, can you imagine the financial jeopardy your life would be thrown into if you didn’t have insurance to cover that one night of too many margaritas that sent you to the hospital with a broken wrist? Or that time when you were 16 years old and took the long way home in your parent’s car to listen to your favorite song on the radio, only to completely total it (...was that just me?)? You would be screwed. Completely screwed. No insurance to cover your back. No credit facilities to help you pay off those massive debts over time at a low interest rate. You would have to fork over your 5, 10, 20, 50k dollars that you owe RIGHT. NOW.

That’s an enormous amount for me living in NYC, now imagine having an enormous debt load of even a few thousand dollars in places where the income is a US dollar a day. When you think about it like this, it almost doesn’t matter what the counter-argument is. Almost…

Committing to Sustainability, not Profitability

The founding principle behind microcredit was that these tiny loans, sometimes of only $100, would serve two purposes, one- allow people to start their own businesses and lift themselves out of poverty, and two- be a way for philanthropists to earn a small return on their investment in the form of interest payments.

Sounds simple enough. So what the heck happened?

1. Too much money!

Who would have thought this would ever be a problem? In the early days, when the reputation of microfinance was still soaring high, money from investors flooded into this new market. Mostly from people who wanted to invest responsibly and do some good in the world. But there is such a thing as too much money. Money that was dumped into these microfinance Institutions had to be put to work. Which meant making more loans to people less likely to pay them back. Sound familiar? That’s because this is exactly what happened to kick-off the subprime lending crisis in the US back in 2008!! And people say this stuff isn’t relevant, that these are fluke occurrences… Am I the only one getting riled up here? Thought so, I’ll move on.

2. Dodgy, exploitative lenders

This is definitely the worse of the two negative outcomes, and an unfortunately predictable outcome of any industry that is literally flooded with money. There will always be people who will try to take advantage of the less fortunate, especially when they are able to do so under the guise of doing good.

Aggressive and exploitative lending practices have, in cases, driven poor households into inescapable debt traps, which have even led to “suicide epidemics” in some countries. And where there’s exploitation, you know there are going to be some politicians. Allegations abound of developing country officials trying to get their own slice of the microfinance pie in very shady ways.

In my opinion, the worst offender might just be SKS Microfinance, who in 2010 was the first Indian Microfinance Institution to go public (meaning, SKS sold ownership shares of its company on the Bombay Stock Exchange to investors in order to raise massive amounts of money). Why is this such a problem? In my view, the point of a microfinance institution is to help people pull themselves out of poverty. And the point of a public company is to maximize value for shareholders-also known as make as much money as possible. Nope, nothing contradictory going on here at all…

With great power comes great responsibility

While some of the reasons behind microfinance’s fall from grace are very well-founded, a lot of negative hype around the issue is just that - a villainization of an institution/practice that has immense potential for good but must be used properly. Problems occur when lending institutions stop viewing microfinance as a way to reduce poverty first and foremost, and instead view it as merely another investment opportunity. The success of microfinance lies in the fact that it can be both, but when the social good aspect is merely an afterthought (or worse not a thought at all), that’s when the people who the practice is claiming to serve, the most vulnerable populations, become exploited and trapped.

What do you think of microfinance? Let me know in the discussion or on Facebook. 

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Alison Shea