Microcredit is a quiet revolution, creating tiny, flourishing businesses in some of the poorest places in the world. But the economic benefits are global.
Worth Reading: The Quick Take from Kiplinger
Phil Smith and Eric Thurman
Phil Smith and Eric Thurman are authors of A Billion Bootstraps: Microcredit, Barefoot Banking, and the Business Solution for Ending Poverty. Smith is a private investor, estate administrator and advocate for microcredit and retirement issues. He recently founded the Microcredit Clearinghouse.
Thurman is an expert in international philanthropy. He is president of Protos Fund and former CEO of Geneva Global Inc., where he supervised grant-making in more than half of the world's countries. Earlier in his career as CEO of Opportunity International and HOPE International, he managed poverty lending programs in more than 30 countries.
Kiplinger Washington Editors
Knight Kiplinger is editor in chief of The Kiplinger Letter, Kiplinger's Personal Finance magazine and Kiplinger.com. He has long had an interest in microfinance and interviewed Smith and Thurman for Kiplinger's Financial Book Summaries.
While the World Bank and the G-8 industrial countries mull yet again how to combat global poverty, tiny "microcredit" loans have emerged as one of the most effective ways to help the world’s poorest people become self-sufficient. Tiny start-ups spawned by these small investments turn into larger businesses that buy more raw goods and hire more workers -- which in turn become part of a growing consumer class. From Thailand to Brazil to Bulgaria, emerging markets have already demonstrated a huge appetite for American goods. A buoyant global economy will help boost U.S. businesses, even when the domestic economy slows.
Knight Kiplinger, editor in chief of The Kiplinger Letter, Kiplinger's Personal Finance magazine and Kiplinger.com, discusses the effectiveness of microloans and the latest innovations in microfinance with two of the leading experts in the field, Phil Smith and Eric Thurman, authors of A Billion Bootstraps: Microcredit, Barefoot Banking, and the Business Solution for Ending Poverty. Smith and Thurman say the poor entrepreneurs who are the beneficiaries of microloans are not only great credit risks -- repayment rates run over 98% -- but they are the key to turning villages rife with corruption and enchained by illiteracy into thriving communities. Thurman says the pressure in a small town to pay back loans and to survive as a business "is so strong that it has the double benefit of not only raising their economic standard of living but also creating a community of trust."
Smith and Thurman explain to a lay audience why the concept works so well and touch on:
- Why interest rates that might seem nearly usurious to an American are often a bargain overseas.
- How commercial banks are entering the market and making a profit.
- How microloan programs can bolster health care, nutrition and social justice programs.
- What's next for the microfinance movement.
Microfinance: Why It Works, Why It Matters
An edited transcript of an interview of Phil Smith and Eric Thurman, authors of A Billion Bootstraps: Microcredit, Barefoot Banking, and the Business Solution for Ending Poverty, by Knight Kiplinger, editor in chief of The Kiplinger Letter, Kiplinger's Personal Finance and Kiplinger.com. The interview was done as part of an audio CD of Kiplinger's Financial Book Summaries.
Knight Kiplinger: Phil, why, in your opinion, are microcredit programs more effective in relieving global poverty than large-scale macro-lending -- to governments and big businesses -- that's done by organizations like the World Bank, the United Nations and others?
Phil Smith: The major organizations are built to try to solve poverty from the top down, and as you are well aware, start having bloated bureaucracies and lose track of their mission often, where microcredit is set up to solve from the bottom up. We try to solve poverty one person at a time and that allows us to give very individual solutions to the problems.
Kiplinger: Eric, are poor borrowers -- who often lack traditional education and job training -- good credit risks? What's the repayment record of the leading microcredit programs?
Eric Thurman: They really are. In fact, that brings back memories because when I first got involved in microcredit, it wasn't a household word, and people were just astounded when they would ask me what I did -- and they'd say, "You give loans to poor people in slums and Third World countries? Do you ever get any of it back?" Well, the answer is that almost all microcredit programs are running repayment rates in excess of 98%. In fact, if they don't run over 90-some percent, they're probably not going to survive. And the best practices have now become well-enough known that you very rarely run into them that aren't almost complete repayments.
Kiplinger: What kind of peer support programs and training help assure that the borrowers' small business will succeed and the loans will be repaid?
Thurman: Well, one of the traditional methods ... is you go into a community that might have actually had a long tradition of corruption in government and various kinds of tensions in the community, but you sit down and ... find people that want to work together and to forge some sort of a mechanism that will raise all their standards of living.
Often you did this with women because they tend to be able to relate and get past social barriers faster with one another. You'll get a group of at least six or eight, sometimes I've seen groups as big as 30 or 40, and they guarantee each other's loans.
One of the mechanisms we would use when we went into a community for the first time is we would explain to the group, "We're going to make loans available, but we have to know it's going to work. So, will you pick out of your group who you think is most likely to succeed, and when her loan is working, and her business is improving, and her loan is being paid back, then the next person can have one." And so they have an incentive to make sure each person's business is working. By the time you get to the last person in the group, that's waited for so long, then everybody else feels like they need to help her get on her feet as well. So by the time you get done, this social force is so strong that it has the double benefit of not only raising their economic standard of living but also creating a community of trust.
Kiplinger: That's amazing. Some people have described microcredit as one of the most powerful forces in the empowerment of women worldwide. It's been estimated that four out of five recipients of microcredit for the starting of microbusinesses are women.
Thurman: That's true, and one of the reasons is, in a poor country, if there's a paying job to be had, even if it's day labor, it almost always will go to the men. And so, if you need to supplement the income, how do you do it? You tend to do it by something that's entrepreneurial that the woman can do at home where she can watch her children. Or if she's street vending selling vegetables, her kids can still run around and be within her sight. The women just do a remarkable job, and it's a happy thing to see them progress.
Kiplinger: Phil, the annual interest rates charged by microcredit programs often look high to us, by the standard of consumer credit rates in the U.S. and other Western nations. But how do these rates compare with the cost of credit in the informal local economies of these less-developed nations?
Smith: First of all, when you look at the rates in microcredit, I generally think that they run about the rate of inflation for that country plus 10 to 15 percent, though it varies from country to country what the rates really are. And when you look at that amount based on that formula, what you find out is that it's a very reasonable amount of interest, even when you compare it to the United States. ... The rates that are charged for microcredit are very reasonable, and what you find out is there really is no comparison. There is no source of capital for people in developing countries that have no collateral to give. So there really is no comparison rate.
Kiplinger: Sometimes the local businessperson has to deal with an unscrupulous loan shark who might be charging 20 or 30 percent a day, maybe 1000 percent APR by our standards, so the alternative of an honest microcredit program charging 20 or 30 percent per year is very attractive.
Smith: That's right. And it's very common that we charge 35 percent a year, which sounds high, but in some of the other microcredit programs, they're charging almost 50 percent a year, and still the people are pleased to have them.
Thurman: That's exactly right. And the thing we need to keep in mind is that it's not the cost of the money, it's the availability. ... More than that, it's the improvement in the life of the borrower. It's the net condition in the family a month later, a year later. And if they're advancing because of the loan, the cost isn't the issue; the issue is the amount of the advance.
Kiplinger: Very good point. Looking at this microcredit movement from the point of a Western philanthropist, large or small, a donor who wants to get involved in this: There are so many microcredit delivery programs out there today, how can a prospective supporter make a choice among them? How do you find out information about programs and their track record of effectiveness, Eric?
Thurman: Well, there are a couple of things I'd like to jump in with, and just to separate the ideas, how you choose is one question, and how you get information is another.
Information-wise, there is a whole appendix in the back of the book that we've written with A Billion Bootstraps that gives you great sources to go to. My friend Phil has put together something called Microcredit Clearinghouse, which is on the Web at www.microcreditclearinghouse.com and has a number of ways you can collect information about projects.
But the favorite thing that I want to talk about is how you decide on a program, and how do you assess it? Because it could be overwhelming and you might say, "I don't know how economies work on the other side of the world." But there's a very simple process, which we outline in the book, we call it cost-per-life, CPL. And it comes down to this: You can cut right through all the details by figuring out how much money you are putting in. And then asking the question, "What changes?" So if you say, "I’m going to put in $100,000 into this project," ask the microcredit provider what their baseline is today, and what will be happening differently a year from now as a consequence of your $100,000. And that will tell you how many lives you're changing and in what ways for how much. Then you can make a good decision whether that is something you want to do.
Kiplinger: That's a good approach to take. Now, somebody who wants to support microcredit can do so with either tax-deductible donations, which will go into a lending pool and be recycled over and over as loans are repaid, or they can also make loans to some of these organizations with the expectation of repayment with no interest or very low interest. What are some of the options there?
Smith: One of the organizations that's been doing this for a while is the Calvert Group, but several of the microcredit organizations are doing it specifically for their own programs now. Opportunity International is doing some, HOPE International is doing them, but almost all of the larger ones are doing it. They're finding out that they can expand their program just as fast by taking loans from people as by getting donations, and many times now they're getting loans not only from donors but going through the commercial sources.
Kiplinger: I've been reading that some of the major Western banks are beginning to recognize that this is both a positive, powerful movement in the international economy, and also a business at which they might make some money themselves by lending large amounts of their capital to microcredit delivery organizations. Tell us about what's happening in this area.
Smith: Well, there are two aspects to that. One is that they want to make money, obviously, when they make their loans, but the other side is banks usually have requirements for social purposes. So they can accomplish both sides of that if they will make loans to microcredit organizations who will then split up the capital and make much smaller loans. It keeps the larger banks from having to do all the administration, but still gives them the advantage of being able to make loans to poor people.
Kiplinger: The larger banks need the expertise and the local presence in the less-developed nations that the microcredit organizations have, but they can be a powerful conduit for capital to them.
Smith: Absolutely. This has especially become important in India right now. The banks there, the government, and the microcredit groups are working together very well, and it's turned out to be an extraordinarily powerful tool to help the poor people in India.
Kiplinger: Eric, a question for you. What is the stance of some of the major international organizations like the World Bank toward microcredit today? Do they view them as competitive with their traditional large-scale lending and charity programs, or are they getting on the bandwagon?
Thurman: I think everybody is in favor of the concept. The question is how they'll be involved. I remember seeing a study from the United Nations that goes back to the mid-'90s that estimated that about 40 percent of the people who got microloans rose above the local poverty level within three years.
Now, I see progress even if people aren't yet above the poverty level, but you know those kinds of studies have been done now for at least a decade. Take the World Bank, for instance, they have a whole branch called CGAP that is doing studies of microcredit. Where it breaks down is these large bodies like to do big infrastructure programs, and they like to fund government to government and they don't get to the grassroots kinds of projects that microcredit does.
So they're not very good at delivering programs. They are good at advocating for them. I don't think any of them are detracting from it, but I think it's this whole idea that Phil referred to earlier, between top-down solutions and bottom-up. I'm not an expert on the top-down approach, I'm a little suspicious about some of those projects, but I do know the bottom-up really works. If you put a little money into the hands of a local market woman in any poor country in the world, she'll do amazing things with it. She'll make a dollar go further than anybody else on the planet.
Kiplinger: Phil, who are some of the most prominent individual philanthropists and foundations who have embraced microcredit as a cause these days?
Smith: Probably the most well-known philanthropist is Pierre Omidyar, who was the founder of eBay. He has really embraced microcredit, in fact gave $100 million last year toward the purpose. Even celebrities such as Brad Pitt talk about it. Bill Clinton has. From a foundation standpoint, the Bill and Melinda Gates Foundation started getting involved in microcredit. They found that it is an excellent way to deliver the products that they're developing and an excellent way to affect people's groups that they cannot do any other way.
Kiplinger: Eric, in your book, you discuss a concept that you call Microcredit Plus, which is the collaboration between microcredit programs and other grassroots programs in health, education, job training, housing and such things. What's that concept all about?
Thurman: I can give you an example of one I just read about this morning. I haven't personally seen this program, but I saw there's a program in Thailand right now that is specifically targeting people who are HIV positive. That's the group they are making loans to, and the arrangement is that there has to be someone else who is a business partner who is not positive. By doing that, it's enabling a person who would normally be the underclass in an already poor community to get some respect and develop some income.
I've seen programs that were targeting people who were lepers, for example, who would be social outcasts, but because they had a way to make a living, they had respect and were reintegrated into the community. I've seen programs for widows in East Africa where their property rights were not normally respected. You'd have relatives coming in trying to seize the property after her husband died, and they provided legal support for people in that situation. Because you are in a trust relationship, you are integrated into the community and you have these groups that are doing borrowing together, that's a very powerful social force and you can often do extra things in addition to the lending. That's what we call Microcredit Plus, and I'm hugely enthusiastic about the way that health matters and legal matters and all kinds of other positive change can come about through these lending groups.
Smith: What we found out is that the cost of doing business is covered by the microcredit, but the borrowers are easily accessible so you can provide virtually any other service you want. In fact, there are even organizations such as Freedom From Hunger that align themselves with microcredit organizations, so that they provide information about nutrition at very low cost to the borrowers. And from my standpoint -- a donor's standpoint -- I think the extra services that are provided are just as valuable as the microloans themselves. So I orient my giving toward programs based on the other services that they do just as much as I do on how many microloans that they give.
Kiplinger: Phil, you have some interesting examples of groups in the United States, for example, local church congregations that have shifted away from direct charity that had traditionally been the province of international giving in the United States, towards microcredit. A Unitarian church you mention decided that instead of simply making handouts to poor people in the Third World, they would get behind microcredit. And I think this is probably going to be a growing trend.
Smith: Well, we hope so. We have found that charity almost always breeds dependence, and that's not good for either side. And the nice thing about microcredit is it breeds independence and also gives the borrowers pride in what they do.
Kiplinger: It's been a little over 30 years since a Bangladeshi economist named Muhammad Yunus started making tiny cash loans at moderate rates of interest to impoverished local artisans, so they could buy materials to make crafts to sell. And he demonstrated to skeptical financiers that small loans made to people with no collateral except their integrity and a will to succeed would be repaid and could lift them out of poverty. Muhammad Yunus wrote a wonderful foreword to your new book, A Billion Bootstraps, and just last year he won the 2006 Nobel Peace Prize. Tell us a little bit about Dr. Yunus.
Thurman: Well, he's a wonderful human being. He's as generous as you would hope he is in person. You've got the story about what he was doing in his own community. He was actually educated here in the United States, but he went back and tried to figure out how he could use what he had learned in a pragmatic way to let the power of the marketplace lift people out of poverty. And he still exhibits all the same qualities. It's a wonderful thing that he hasn't become detached and the rest, he's actually very involved and cares about people. So he's a wonderful person to symbolize the progress of this movement.
What he is now talking about is trying to move the industry from the handful of small loans to people to make it a more sophisticated movement whereby it's in the wholesale financial markets and you can use investment-grade money to increase loan portfolios. So he is a very progressive sort of person that just isn't trying to promote one flavor of microcredit, but he sees a whole spectrum of things that are possible. We're really pleased that he got the Nobel Peace Prize because it's giving worldwide attention to this important movement.
Kiplinger: ... He said that you have done us a favor by breaking down the challenges of growth for microfinance into bite-size elements that any reader can benefit from. From my experience as a journalist following this movement, he's right on target there.
Thurman: The thing that we want to get across as well is, as good as microcredit is, there's only one flaw. The flaw is it isn't being used as widely as it could. There are only about 100 million families currently using microcredit, and the truth is that somewhere between 10 and 20 times that many people could improve their lives if microcredit were available. So that's why Phil and I are so enthusiastic about promoting this, as is Dr. Yunus, in order to get people involved in expanding this proven solution.