The Big Promise of Small Loans

A new crop of grant makers -- and investors -- is embracing microfinance to alleviate world poverty

Veena Mankar, a banker in Mumbai (formerly Bombay), India, looked at the slums in her city and wondered why needy people in urban areas could not benefit from the same access to loans and other financial services that many of the rural poor enjoy.

So Ms. Mankar raised $50,000 from friends and family to explore microfinance — the offering of financial services to the poor in developing countries, a practice that has flourished in the villages in southern India thanks to government incentives. But she nearly abandoned her efforts when she could not find grants to subsidize her operation until it became self-sufficient.

"I was despairing," Ms. Mankar says.

Then she heard that the Michael and Susan Dell Foundation — the Austin, Tex., fund started by the founder of one of the world's largest computer manufacturers — was interested in such work. During a trip to New York, she met with Caitlin Baron, director of the foundation's microfinance program.

It was a perfect match. Ms. Baron wanted to support organizations committed to rapid growth in urban areas, and Ms. Mankar's organization, Swadhaar FinAccess ("self-support through access to financial services"), planned to start with one branch in the spring of 2006 and open two more within a year.

This month, Dell gave Swadhaar a grant of $600,000 over three years — one of two microfinance investments it has made thus far. The $1.2-billion foundation hopes to strike deals with as many as 20 groups over the next five years in India, a country of 1.2 billion where most people still have no access to financial services of any kind.

Self-Sustaining Approach

Microfinance, pioneered in the early 1970s by nonprofit groups like Grameen Bank, in Bangladesh, and Acción International, in Latin America, is one of the hottest ideas in philanthropy — and it may become the next big thing in the investment world, too.

Foundations, individuals, and even private investors are funneling millions of dollars into providing loans to the very poor so that they can start businesses. The work holds out the promise of alleviating poverty in a self-sustaining way, because more and more microfinance organizations are breaking even or earning a profit.

Yet for foundations, finding ways to make such loans on a large scale, without discouraging for-profit banks and others from moving into underserved areas, remains a challenge.

Some foundations, such as the Ford Foundation, have supported microfinance since Grameen was just getting started, but a slew of newer foundations, especially those started by technology executives, are now embracing the approach.

The Bill & Melinda Gates Foundation may spend several hundred million dollars in the coming years on microfinance, which is a key element of its new "global development program."

The foundation has vowed to allocate to the program a quarter of its total spending — the foundation spent a total of $1.35-billion last year, but that number will more than double with the recent pledge to the foundation of more than $30-billion by Warren Buffett.

Last fall, Pierre Omidyar, the founder of eBay, and his wife, Pam, gave $100-million to Tufts University, Mr. Omidyar's alma mater, and required that the university's endowment invest the money in microfinance. Nearly a third of the investments and grants made by the Omidyar Network, an umbrella organization with $400-million in assets that makes both grants and for-profit investments, are focused on microfinance.

These grant makers — who have seen early for-profit investments in their companies generate phenomenal returns — are hoping for a similar payoff from the money they invest in microfinance. Microfinance organizations serve only about 50 million people, a tiny slice of the world's poor. But Dell's grant to Swadhaar, for example, could yield decades of financial services to India's urban poor, if Ms. Mankar is able to find a model that allows her start-up organization to become profitable.

"Growth is important for microfinance organizations because you have millions of people who are unserved," says Dell's Ms. Baron, who is now based in India. "Small, good organizations are great. But big, good organizations are even better."

Focus on Women

Today thousands of organizations use the same basic approach that Grameen and others created. They provide small loans — often a few hundred dollars or less — to people who meet in groups to borrow the money and to make payments on their debt.

The organizations tend to focus on women because of gender inequalities in some developing countries, and because women often take primary responsibility in caring for children, which gives a multiplying effect to the loan. The group meetings allow the organizations to provide education to the women, but also serve as something of a guarantee for borrowers who have no collateral or credit history. The whole group of borrowers is usually responsible if any of the women fail to repay.

The organizations lend at rates that would be considered high in the United States — ranging from 20 percent per year to more than 85 percent — but those rates are far more reasonable than rates offered by informal moneylenders to people with no access to loans from traditional banks. In countries like the Philippines, such lenders charge as much as 20 percent per week, according to experts in microfinance.

The high interest charges — at least by U.S. standards — aren't related to the borrowers' record of repaying the loans. In fact, microfinance organizations report repayment rates of 95 percent to 98 percent — better than the record of the U.S. credit-card industry, where repayment rates range from 91 percent to 96 percent. The interest rates are high in microfinance because it is inefficient and costly to manage tiny loans, especially in rural areas.

A small number of microfinance organizations — estimates range from a few dozen to a few hundred — have managed to become self-sustaining or even profitable. Part of the push for growth is based on the idea that microfinance institutions can become sustainable, and ultimately lower costs to borrowers, by spreading their costs of operation over hundreds of thousands or even millions of loans.

"Unless you achieve scale, you can't become sustainable," Ms. Mankar says. "And if you're not sustainable, you can't reach out to more of the poor."

Appealing to Donors

Donors to microfinance organizations like the idea of their gift being lent to the poor over and over again.

William K. Hall, an investment adviser and management consultant in San Clemente, Calif., gives about $40,000 per year to Opportunity International, a Christian, nonprofit organization that makes loans to 810,000 people per year in 27 countries. The organization operates in the black — its revenue from borrowers exceeds its expenses — and that record, along with new donations, has allowed Opportunity International to increase its lending at an average rate of 27 percent over the past five years.

Christopher A. Crane, president of Opportunity International, in Oak Brook, Ill., says that more than half his donors are entrepreneurs like Mr. Hall. "They get it right away," he says. "They see that this is a way of helping the poor work their way out of poverty."

Four years ago, Marilyn Obdaniela, who owns a basket-weaving business in Tayabas, Philippines, used a $93 loan from Opportunity International to help expand her profitable company. She now employs 80 people, up from five in 2002, and pays enough that her employees can afford school fees for their children.

With loans being paid off and redistributed every six months, Opportunity International tells donors that for every $100,000 donation it receives, 10,000 people will be able to work their way out of poverty over the next decade.

"I'm always interested in leverage," Mr. Hall says. "I want whatever dollar I give to work as hard as it can."

Interest From Big Banks

Most for-profit investments in microfinance have come from those motivated as much by social conscience as by the potential financial return, but a broader swath of investors is now showing interest in small loans.

At least three private-equity funds have been created to invest in microfinance, and big banks like Citigroup and HSBC are now making modest commitments to microfinance.

Mr. Omidyar's requirement that his gift to Tufts be invested in microfinance hardly fazed Tufts officials, who think they can earn returns that are competitive with those earned by the rest of the endowment.

"Somebody has told us we have to put $100-million into the fastest-growing part of the world, and into a service that everybody needs," says Sally M. Dungan, Tufts' chief investment officer. "I'm pretty thrilled. This is a great way to increase your emerging-markets exposure."

Even so, such deals are more complicated to arrange and oversee than investments in stocks and bonds. Tufts has up to three years to fully invest the money. Its Board of Trustees approved two investments in April, but terms of the deals are still being worked out, and the university is not releasing details.

Although some foundation officials are wary that the social mission of microfinance could be threatened by the profit motive, most experts agree that growing interest among investors is a good thing.

"It's fantastic," says Geoffrey K. Davis, president of Unitus, a nonprofit group in Redmond, Wash., that helps microfinance organizations accelerate their growth and eventually convert to for-profit status. "It's what is needed to truly take the industry to scale."

Foundation officials also realize that too much grant money flowing to microfinance groups could distort the market, and keep banks and other investors away.

"There's a risk of giving too little money and there's a risk of giving too much," says the Dell Foundation's Ms. Baron. "Too much donor money available at cheap rates would inhibit banks from entering the market. On the other hand, you need to get microfinance institutions stable and creditworthy before banks will lend to them at all."

Some microfinance backers, including the Dell Foundation and Omidyar, as well as Unitus, are taking a two-pronged approach — supporting microfinance through regular grant making, and also taking equity stakes in for-profit microfinance groups.

In May, Dell, through a program-related investment (investments in ventures with a charitable purpose, usually at below- market rates of return), and Unitus, through its own private-equity fund, announced that they had purchased stakes in Ujjivan Financial Services Private Limited, which, like Swadhaar, is a microfinance organization focused on cities in India.

Roger E. Frank, a managing director of Developing World Markets, a Darien, Conn., company that creates investments that pay market-rate returns and are used to support microfinance organizations, says that because only a few hundred groups are profitable, foundations and nongovernmental organizations still play an extremely important role in microfinance.

"There's a huge playing field for NGO's and foundations to help these organizations that are not self-sustainable graduate so that they can tap into the broader capital markets," Mr. Frank says.

In Mexico, Unitus is helping Pro Mujer Mexico, a microfinance organization with 13,500 clients in four states, become more efficient so that the group can eventually become self-supporting and convert to for-profit status.

Unitus has given Pro Mujer, which is part of a larger Latin American network that started in Bolivia, a $375,000 grant and has guaranteed borrowing by the four-year-old organization so that Mexican banks will lend to it. Pro Mujer charges clients 6 percent per month, which on an annualized basis, including fees, works out to 84 percent per year.

Joséphine Gonzalez, the financial officer of Pro Mujer Mexico, says the organization is easily covering its costs this year, but that is thanks in part to subsidies from Unitus and others. Pro Mujer spends 40 cents on operations for every dollar it lends, which is high compared with microfinance institutions overall, but puts it among the most-efficient organizations in Mexico.

On top of that, the organization pays about 14 percent to borrow money from banks (in order to lend it to clients), even with the Unitus guarantee. Without subsidies, Ms. Gonzalez says that Pro Mujer would barely be self-sufficient — even though clients are paying high rates of interest and the proportion of past-due accounts is only about 1 percent.

"Mexico is a huge market, we're just starting, and there's no competition," Ms. Gonzalez says. "For a lot of institutions, there is no pressure to become more efficient because there's no pressure to lower the interest rate." Ms. Gonzalez says she expects competitive pressures to force interest rates down over time.

Hannah Siedek, an analyst at the Consultative Group to Assist the Poor, a consortium of 33 government and private development organizations working to expand microfinance, says bringing banks into the mix is crucial, because greater competition will force microfinance institutions to rein in their costs.

"For the longest time, the industry said we have to charge high interest rates because the operating costs are very high," Ms. Siedek says. "Our stance is yes, true — but the institution has to be sure it isn't transferring its own inefficiencies to the end client. It's a very difficult call."

Beyond Loans

Foundations also play an important role by nurturing microfinance organizations that do more than just lend. In the mid-1990s, the Ford Foundation made a planning grant to Vijay Mahajan, a social entrepreneur in India, to create a microfinance institution that would serve the rural poor.

Many of the poor women who were clients of Basix, Mr. Mahajan's organization, used the loans to buy dairy cows, selling the milk to earn a living. But the price they receive for their milk is based on its quality, and for many women the milk had deteriorated by the time it arrived at the processing plant. Basix worked with the plant to provide portable milk coolers in the villages, enabling women to deliver a fresher product and get a higher price for their milk.

"It's not just financial services, it's intervening in the marketplace," says Frank F. DeGiovanni, director of the foundation's Economic Development Unit, which includes microfinance. "It's indicative of what we call a 'capital plus' approach."

Ford also made two low-interest loans to Basix to help it get started. Basix is now a for-profit company, and works with 190,000 low-income households in India.

The Gates Foundation is supporting efforts to develop new microfinance products, and new ways to deliver loans.

In January it awarded a $5.5-million grant to the Aga Khan Foundation, a private organization focused on Asia and East Africa, to create a model for providing health, disability, and business- catastrophe insurance to entrepreneurs in Pakistan and Tanzania.

Insurance is critical for small entrepreneurs, who can easily be wiped out by medical bills or natural disasters, but to date, very few microfinance institutions have offered insurance products.

The Gates Foundation also has supported efforts by Opportunity International in Malawi to develop a technology that uses "smart cards" and fingerprints to allow low-income people to use ATM's.

Many African people lack any identification, and thus aren't offered services by commercial banks. But if their fingerprint matches the print on the smart card, they can make financial transactions at ATM's.

"New technologies will make the business models more efficient, and therefore less expensive," says Priya Jaisinghani, a Gates program officer.

Collecting Data

Foundations are also supporting efforts to clarify the data in microfinance, so that financial investors and those seeking a so-called social return on investment will have better measures. Last year, the Omidyar Network gave $900,000 to the MIX (Microfinance Information eXchange) Market, a Web site that provides self-reported financial data on nearly 700 microfinance institutions.

The Ford Foundation is supporting efforts by M-Cril, a credit- ratings agency in India, to develop a system that measures how well microfinance institutions are doing in meeting their missions.

"Any donor or foundation that is providing a grant or loan at below-market rates of interest has a right to know what benefits that subsidy is providing," Mr. DeGiovanni says. "We ought to be able to say to organizations, 'What is our money allowing you to do? What difference are your loans making in the lives of those families?'"

Indeed, critics of microfinance say the research shows that very few of the truly poor are able to use the loans to work their way out of poverty.

"If microcredit results only in making the lives of the poor a bit less terrible, or helping just a few real entrepreneurs, is that sufficient reason to laud it?" asks Thomas W. Dichter in "Hype and Hope: The Worrisome State of the Microcredit Movement," a paper published by the Consultative Group to Assist the Poor. Mr. Dichter, who has worked in international development for more than 35 years, argues that microfinance is a diversion for developing countries, which should be focused on improving governance and reducing corruption.

Historically, microfinance institutions have provided a significant amount of education to borrowers along with the loans they make. But some groups say that if they ever hope to become self sustaining on the lending end, foundations may have to step in to underwrite some of the education.

Pro Mujer Mexico sets aside 15 percent of its profits from its lending operation to support educational programs on topics such as domestic violence, women's rights, and birth control.

But when that money runs out, Pro Mujer cuts short its training. Ms. Gonzalez, the financial officer, says she would like to see foundations pick up some of the cost of the educational programming.

"We really want to keep doing it — we have 13,000 women meeting for an hour every week or two," Ms. Gonzalez says. "But we have to be competitive with our interest rates if we want to stay in the game."

Nancy C. Jurik, a professor at Arizona State University who has studied microfinance, says that is the downside of the push for self-sufficiency. "When you pressure programs in developing countries for sustainability," she says, "any kind of extra work becomes marginalized because it is expensive."