Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor

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A microfinance Industry insider offers a shocking account of corruption and betrayal of the poor by an industry supposedly dedicated to doing good. Hugh SInclair is one of the rare field workers who has seen microloans at ground level; he concludes that predatory lending and profit pressure are causing most microloans to do far more harm than good. This is the sad tale of a good idea gone horribly bad.

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1 Thou Shalt Not Criticize Microfinance

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Im a dodgy moneylender, exploiting the poor with useless, overpriced loans, ideally obliging their children into forced labor in the process.

This did not go down well. I had been introduced to yet another gathering of bright-eyed microfinance experts at yet another microfinance conference, and I had incorrectly assumed that irony and sarcasm were within their grasp. They were not. I attempted to redeem myself.

Guys, Im joking . . . it was a joke. Im a microfinance consultant, were all cool . . . sorry.

I had broken the golden rule of microfinance, the unwritten code that bonds its practitioners together. I had criticized microfinance and, perhaps worse, I had implicitly challenged the developmental claims the sector proclaims so vehemently. This is unacceptable from an insider. But none of the experts offered a defense or rebuked my confession. Such comments cut a little too close to the nerve to warrant further conversation. It is usually better to discuss the weather or the palatial dcor of the conference rooms instead.

 

2 Baptism in Mexico

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I stumbled into microfinance, partly out of curiosity, partly out of intrigue, partly for lack of anything else that excited me at the time. Some brief background is required to explain how this historical glitch occurred.

I was an investment banker for years, initially in Toronto, then in London. Im an economist, and I worked for Barclays, which sponsored me to do a masters degree in finance. I had drifted into technical trading of derivatives, something now criticized with some justification for being destabilizing. I subsequently moved to the corporate finance department of ING Barings. I found the work dreary, but I needed to pay off some student loans and this job served that purpose for two years. At a loss at what to do next, I thought an MBA might be worthwhile, so I went to Barcelona for a couple of years for more studies.

During this period Nick, a friend from ING Barings, and I hatched an ambitious travel plan. We were determined to see more of the world beyond our air-conditioned offices, but backpacking no longer appealed. It had to be something original, and we decided that the journey would have to be a Guinness World Record to qualify as sufficiently original. We searched for a feasible journey and eventually settled on riding motorbikes from the north coast of Alaska to the southern tip of Argentina in record time.

 

3 Bob Dylan and I in Mozambique

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To suggest that our decision to move to Mozambique was an informed one would fall short of factual accuracy.

I had met World Relief staffers in New York some months before while attending a conference. They were particularly interested in my experiences with struggling MFIs. A few months later they contacted me to ask if I would be interested in assisting them in Rwanda, Burundi, Mongolia, or Mozambique. Neither Jessica nor I had ever been to Africa or knew much about the place: it had animals, wars, and poverty. I remember reading something about two of the countries being particularly brutal and ruled them out immediately.

This was a major decision, and I needed to consult Jessica. I shouted upstairs: Those American guys have offered us work in Rwanda, Burundi, Mongolia, or Mozambique. Fancy any of those? I think Rwanda and Burundi have wars or something, might skip those.

Jessica shouted downstairs, What language do they speak in Mozambique?

I searched online. Portuguese. But dont you reckon Mongolia would be awesome? We could go on that famous train.

 

4 Another Mozambican Civil War

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I had suggested to Petr that he hold little back in his presentation, as long as he could support what he said. He thus delivered a devastatingly critical report, with full supporting evidence. It largely revolved around a lack of leadership, poor decision-making, inappropriate capturing and use of savings, unsophisticated window dressing of the accounts, and incompetence at head office. It complemented my previous meetings with management, which had spelled out some simple truths:

1. Using client savings to cover operating expenses was not only illegal, but pointless, since it merely postponed the inevitable meltdown.

2. The branches were actually covering their operating costs. The drain emerged from one source—the Maputo office. Solving the Maputo problem was relatively straightforward, but this would mean slashing headcount and the salaries of those involved in decision-making. Client savings were not being raided to support the field operations but just the head office.

3. World Relief Mozambique was urging FCC to apportion certain unnecessary expenses at head office to the branches in a purely accounting sense. This simply shifted expenses from head office to the branches, but World Relief Mozambique was keen to push ahead with this accounting game regardless.

 

5 The “Developed” World

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We first flew to London and packed up our apartment, then moved to the Netherlands. I hadnt lived in England for years, many of my friends had left, and I felt oddly like a tourist in my city of birth.

Holland has an immigration bureaucracy thats complex even for EU residents—moving to Mozambique is a doddle in comparison. Most problems catch you in a circuitous, disorienting paradox: You need X to get Y, and Y to get Z, but you cant get Z without X. In Mozambique you just paid $50 and X, Y, and Z mysteriously ceased to matter.

While this exercise in repetitive head-banging was in full swing, I began work at Triple Jump on September 1, 2006. It had a pleasant startup feel about it—no furniture in the office and only a few staff. My first projects involved buying sofas, plants, and office supplies. There were few other occupants in our building, and one of them had kindly installed a table-tennis table in one of the empty offices on our floor.

We rented an apartment just across from the offices of DOEN, one of the original founders of Triple Jump and a leading light in Dutch development finance. The group would eventually distance themselves from Triple Jump, but over the years we got to know them quite well. The Triple Jump office involved a fifteen-minute bicycle ride mostly through a park, and initially I had few international travel obligations. It was a pleasing start to a new chapter.

 

6 Something Not Quite Right in Nigeria

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It was another dark, wet evening in Amsterdam. My boss had asked me to visit a prospective client in the center of town who was passing through Amsterdam. Fortunately I had the required waterproof rain trousers to hand and cycled for twenty minutes to a hotel on a canal somewhere downtown. It was a large Nigerian MFI and Mark wanted to do something with them. I didnt know much more. I was to listen to their problems and offer some free technical assistance in the hope that on the back of this we could win a deal to lend the MFI some money. Our business model was fairly simple.

I met the CEO, a gentleman named Godwin Ehigiamusoe.* He moaned for a few minutes about his IT systems, which barely functioned. Its the standard moan of many MFIs, a catchall excuse for the entire worlds problems—blame it on the computers. It sounded like quite a straightforward case, and I had the team required to fix such problems, so I agreed to put together a proposal. Given that the proposal would be entirely free, in an effort for Triple Jump to secure the opportunity to invest in an MFI its staff clearly knew very little about, the deal was low risk for him.

 

7 Something Not Quite Right in Holland

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Onyeka and his trusted sidekick slogged around Nigeria fixing branches. It was tedious, repetitive work, but this was their job and they were reasonably paid for doing it. I received the occasional email from Onyeka asking specific questions, and it was reassuring to see that our work was being successfully replicated. It made little difference to the poor, who continued to pay through the nose. I rather hoped that LAPO was a closed chapter. The prospect of a return visit had minimal appeal, and as long as they could limp through another year or two and continue repaying Triple Jump, I assumed that my work with LAPO was over.

Six months after our second trip to Nigeria, on January 22, 2008, I received a final email from Nigeria. Onyeka had finished.

Onyeka and his team completed a project that many in the microfinance sector would have feared impossible, particularly one performed without armies of overpriced consultants. They had taken sixty-three branches, plus a few new ones, installed updated software in each, cleaned up the databases, trained the staff, organized the process of consolidating all this data into a centralized database, and completed this largely on their own in a mere six months. This was one of the most impressive IT implementations in microfinance, given the low starting point.

 

8 In Front of the Judge

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Going to court in a foreign country accused of professional misconduct, in a language you dont understand, while counterclaiming deliberate deception on the part of the former employer, is not a relaxing exercise. Your fate is debated in front of you by people in suits and strange outfits, and you dont understand a word of what is going on.

I awoke the following week with trepidation.

To my delight, Edith was extremely cool. She was mysteriously attractive in a manner almost unbefitting a lawyer. The offices were sufficiently formal and intimidating. She appeared too sweet to be a lawyer—somehow I couldnt picture her fighting my case in court. She had reviewed the core documents and believed the case was comparatively simple: In Holland you cannot simply ask someone to leave your office, accuse them of misconduct, offer them a new contract, oblige them to sign it without stating any genuine reason, and threaten them with a court case. This is a fairly open-and-closed case of a breach of Dutch employment law—we will have to go into detail about the reasons and context, but essentially your case is very good. In terms of obeying protocol, they messed this up, and that is your trump card.

 

9 Rustling Dutch Feathers

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With my newfound freedom I began working on a number of exciting projects, including a large assignment for the peer-to-peer microfinance investment platform MyC4, based in Denmark. The U.S. equivalent, Kiva, was growing at phenomenal rates, and learning the model in detail through my work with MyC4 provided experience useful for revealing some unusual activities at Kiva a couple of years later (Kiva had coincidentally recently teamed up with LAPO).

Still, something had shifted within me. At this point began what may best be described as my whistle-blowing stage. I was detested by Triple Jump and its partners. By the end of this period I would be detested by much of the community of microfinance investment funds. I focused initially with getting information on microfinance failures into the public domain. My office spat with Triple Jump over LAPO would eventually culminate in my providing key details about LAPO for a story in the New York Times, which shed disturbing light on how the microfinance sector actually works from the highest levels down. My attention—and that of the New York Times—would begin to turn to more familiar names in microfinance like Calvert Foundation, Deutsche Bank, and Kiva.

 

10 Blowing the Whistle from Mongolia

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We took the Trans-Siberian train to Mongolia. What a delightful way to travel to work.

Much of the actual whistle-blowing concerning the more nefarious activities of the microfinance sector, LAPO, and its investors took place from Mongolia, of all places. This was ironic, since the country demonstrates one of the best examples of effective microfinance I have seen. Anyone feeling disillusioned with microfinance ought to visit Mongolia.

Mongolia is a vast country with one of the lowest population densities on earth, beaten only by Greenland and the Falkland Islands. Travel ranges from hard to impossible most of the year. Many Mongolians are nomadic, so even the notion of a fixed address can be nebulous. Temperatures are way below minus 30 Celsius for a number of months of the year, and we routinely enjoyed minus 45. The microfinance sector is well regulated and competitive. Annual interest rates do not exceed 30 percent thanks to effective regulatory oversight. Operating costs in Mongolia are genuinely high, and yet the MFIs make reasonable profits. They are obliged to be efficient because their revenue is ultimately limited by the maximum interest rates they are allowed to charge. If an MFI cannot reach a scale to cover at least operating costs, it will rely on investors to provide a subsidy or it will collapse. That the sector works at all sheds some doubt on the claims of, for example, the endless Mexican MFIs that claim they have to charge rates of over 100 percent per year to cover costs. Is it really so much more expensive to operate in Mexico than Mongolia? I saw no evidence of this, and I have lived and worked in both countries for extended periods.

 

11 Enter the New York Times

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Terry and I had discussed the LAPO case with a number of journalists who were beginning to take a hard look at the microfinance sector. On April 14, 2010, Neil MacFarquhar of the New York Times published a front-page article entitled Banks Making Big Profits from Tiny Loans, which criticized the microfinance sector in general, mentioned LAPO in particular, and named three investors explicitly: Kiva, Deutsche Bank, and Calvert Foundation, which was raising money for LAPO on the MicroPlace platform.

Until recently, MicroPlace, which is part of eBay, was promoting LAPO to individual investors, even though the website says the lenders it features have interest rates between 18 and 60 percent, considerably less than what LAPO customers typically pay. As recently as February, MicroPlace also said that LAPO had a strong rating from MicroRate, yet the rating agency had suspended LAPO the previous August, six months earlier. MicroPlace then removed [LAPO] after The New York Times called to inquire why it was still being used and has since taken LAPO investments off the Web site.1

 

12 Collapse, Suicide, and Muhammad Yunus

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Picture the scene. A kite-maker in Nicaragua had managed to obtain loans from all nineteen MFIs that formed the Nicaraguan Microfinance Association.1 With weekly repayments this would involve an average of four daily repayments. There could, conceivably, be queues of loan officers outside her kite shop. As she paid off one loan officer with the proceeds from another, the actual loan officers probably got to know one another in the process. Maybe she had to visit the MFIs rather than the loan officers visiting her premises? How much time does it take to visit four MFIs a day, queuing up, making the payment, and then shuffling off to the next? How many kites could she possibly make in the meantime? Sound like a farce? Welcome to Nicaraguan microfinance.

Nicaraguan microfinance should have served as a wakeup call for the entire sector, since its lending reached such absurd levels. Of course, it did not. The biggest single private investor by the end of 2008, that bastion of due diligence and conservative lending in the interests of investors and the poor alike, BlueOrchard, had managed to pump in a whopping $46 million alone.2 It is quite possible that the capital provided to our highly leveraged kite-maker actually originated in Geneva.

 

13 The Good, the Bad, and the Poor

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Favelas, or slums, litter Latin America, not just Brazil, where the word originated. They are parking lots for people. No one intends to live in a favela forever; they intend to use the slums as a springboard into a new life. Many migrate from the countryside to the big city in search of work, a better life, the chances that rural society no longer offers them. Half the planet now lives in cities, and favelas house a decent proportion of them. Quickly erected, lawless, often without the basic amenities many take for granted, favelas are sufficiently large to develop their own characters. Many inhabitants are never able to leave, because the new life never emerges. For me, the favela is a place of hope. The inhabitants are there as a stepping-stone to fulfill a dream. They look forward to something, aware that they may never achieve it; but at least they have a dream. The very existence of the ever-expanding favela is testimony to how many never realize their dreams in the great parking lot of life. But some do, and they keep the dream alive for the rest.

 

Appendix: Microfinance Economics 101

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Economic theories supporting microfinance abound. The broadest principle is that of the efficient allocation of resources. The argument suggests that some people have excess cash, but do not face particularly interesting investment opportunities. Meanwhile, the poor face amazing economic opportunities but cannot realize them for lack of cash. Microfinance acts as a conduit to channel capital from A to B. This belief has some validity, but digging a little deeper reveals fundamental flaws in the microfinance model.

The first flaw in economic debates about microfinance relates to the abundance of profitable economic opportunities. This is often used to justify the extortionate interest rates charged the poor. The poor can apparently buy tomatoes in one village, sell them in another, and make incredible profits in the process, so large in fact that they are more than happy to pay 100 percent annual interest for the capital to fuel this venture. Whats more, these opportunities exist indefinitely and are in near-infinite supply. While it is no doubt true that isolated cases of this nature do exist, it is highly questionable that 200 million people are able to find and exploit such opportunities indefinitely. It is true that some people win national lotteries, but it is dubious to generalize this fact as a solution to poverty across a whole country.

 

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