From Armendariz and Morduch (2005 ): “(A) collection of banking practices built around providing small loans (typically without collateral) and accepting tiny savings deposits. . . .”
From U.N. International Year of Microcredit 2005 Web page: “Microfinance refers to loans, savings, insurance, transfer services, microcredit loans and other financial products targeted at low-income clients.”
“ Microcredit is a small amount of money loaned to a client by a bank or other institution. Microcredit can be offered, often without collateral, to an individual or through group lending. .”
From MixMarket.org : “To most, microfinance means providing very poor families with very small loans (microcredit) to help them engage in productive activities or grow their tiny businesses. Over time, microfinance has come to include a broader range of services (credit, savings, insurance, etc.) as we have come to realize that the poor and the very poor who lack access to traditional formal financial institutions require a variety of financial products.”
Mission Statement from Grameen Bank: http://grameen-info.org/index.php?option=com_easyfaq&task=cat&catid=80&Itemid=200 [“Grameen Bank provides financial services to the rural poor of Bangladesh. Those services include loans, saving accounts, pension plans and loan insurance. The overall goal of Grameen Bank is the elimination of poverty.”]
Mission Statement from Compartamos: http://www.compartamos.com/wps/portal/!ut/p/c1/04_SB8K8xLLM9MSSzPy8xBz9CP0os_gADwNLcw93IwP_UHcXAyNjR6cgIy9TY29jM_1wkA6zeAMcwNFA388jPzdVvyA7rxwAsAPlcQ!!/dl2/d1/L2dJQSEvUUt3QS9ZQnB3LzZfUEgwOTdIRzIwT1VHRDAyM0FCUjJKNTNLSjM!/?mosHist=1 [We are a social enterprise committed to people. We create development opportunities in popular market segments that are based on innovative and efficient models, distributed on a massive scale and on important values that foster an external and internal culture. In this manner we are able to achieve permanent relationships based on trust and that contribute to a better world.]
Assume you are a small bank. Each loan you originate costs you $10 to “wire” in the loan capital from another bank, $50 in labor and overhead, loan capital costs of 5%, plus the original amount of the loan.
Each loan will generate the following revenue: a small origination fee to the borrower of $10, plus you can charge the client his/her expected return as interest rate. You should consider the risk of default in your decision (e.g., a 10%, 50%, 90% and 95% prob. of repayment).
My name is Iwhiwhu and I live in Abraka town, delta State, Nigeria. I am a 34-year-old mother of three children. I have no formal education, though I was trained in domestic chores and farming as a girl. I have training in hairstyling, though, and used to own my own hairstyling business from 1991 – 2001, but was unable to make much progress due to an unpredictable power supply. I got started selling fruits on the roadside for an initial investment of US$56. I want to rent a shop someday, however in the meantime, I would just like to expand my offering of fruits which will require additional capital. I would like a one-year loan for US$64. I have no collateral to offer. I expect a 20% return on my investment.
My name is Nancy and I am a 40-year-old entrepreneur who is living her dream of owning her own business. I have been in business for 10 years running a party supply retailer (supplying everything from party hats to helium tanks). I have a college degree. I have 10 years worth of financial data that show that I had a rough start, but have generated profits in excess of $150,000/year for each of the past five years. Located in Escondido, I would like to expand my business to include an offering of inflatable “jumpers” for little children that can be rented out by the hour. This will cost me $50,000 and I am requesting a loan for $40,000 (with $10,000 to be financed from my own pocket). I am able to put up my two delivery vans (each worth $20,000) as collateral for the loan. My FICO credit score is 723 (this is the median FICO score from Fair Isaac ) and I expect a 25% return on my investment.
My name is Adonis and I live in San Diego, California. I am a 32-year-old Greek immigrant. I notice that the olives and olive oil here in California are not nearly as good as those in my native country. I would like to start importing olives and olive oil from Greece and sell them here in farmers markets. I have some business experience when I was in Greece, but I have no credit history in the US and only a little bit of cash ($5,000), which I want to put into my new business. I would like a one-year loan for $20,000 to start my business. I do not have any collateral, though, as I said, I am putting every cent I have of my own into this business. I have no FICO credit score. I expect a 10 percent return on my investment.
Banks prefer higher interest rates . . . at least up to a point (look at Case 2)
**With the higher interest rate (25%) in Case 2, Scenarios 3 and 4 generate positive net revenue for the bank. [Note: Even if loan amount were only $4,000, Scenario 3 would still generate a $250 profit.]
The higher risk of borrowers—i.e., lower probability of loan repayment—the less likely the bank will be able to generate positive net revenue. Note that defaults usually result in default on both the principal and interest—a double-cost for lender.
**In none of these three cases does a probability of repayment < 0.90 result in positive net revenue, even in Case 2
With this loan, Iwhiwhu was able to expand her business, followed by subsequent loans of US$96, $120, $200 and $240. In 2007, she made US$40/week in profits and saved $1.60/day through Olidara, an itinerant savings collector. ( Source: State of Microcredit Summit Campaign Report 2007, Sam Daley-Harris)
Okay, this is a hypothetical story . . . but . . . say Nancy failed to consider that several other jumper rental companies, with lower overhead, were able to lower their prices and keep her from being able to make this a viable part of her business. She closed down the business and had to forfeit her two delivery vans, which had been run down by delivering jumpers and were only worth $10,000/each.
The agency loaned $5,000 at around 10%, which he paid off within the first year. In 2007, the client had a $10,000 loan at 12% (interest rates went up slightly), with 11 employees and vendor booths at farmer’s markets. He also supplied hotels, restaurants and casinos with olives and olive oil from Greece. His sales were still growing, despite a slowing economy. He also had a FICO credit score in the mid-600’s in 2007. ( Source: personal communication with local MFI—thought name has been changed.)
What innovations have overcome these two obstacles (high transactions costs and lack of collateral)?
Group lending [creates social accountability and increases repayment rates—a social capital collateral, addressing “risk” issue and “transaction cost” issue—one “group” origination.]
Early Repayment [Begin repayment of loan right away reduces risk.]
Progressive lending [increasing the loan size over time to the same clients establishes a “track record” with client—essentially what a credit rating (e.g. FICO score) does, though with only one source—the MFI itself addressing “risk” issues and larger loan size addresses “transaction cost” issues.]
Public repayments [creates social pressure and reduces risk of default.]
Emphasis on female clients [associated with higher repayment rates addresses “risk” issues. Also addresses social justice issues.]
Microfinance Summit Campaign reached their goal on Dec. 31, 2007 of serving > 100 million poorest borrowers during the year. (Some of this is due to existing MFI’s serving more of the poorest borrowers; some is due to new MFI’s reporting.)
VI. Stylized Facts—Poorest Clients by Size of Institution Size of Institution (in terms of poorest clients) No. of Institutions Combined No. of Poorest Clients Percent of Total Poorest 1 million + 7 28,098,014 26.36 100,000 - 999,999 54 17,184,064 16.12 10,000 - 99,999 313 8,525,154 8 2,500 - 9,999 572 2,608,463 2.45 Fewer than 2,500 2,364 1,454,464 1.36 Networks 6 48,714,520 45.7 Source: Daley-Harris, 2009, Table 6
VI. Stylized Facts--Gender Of the 106.6 million poorest clients reached in 2007, 83.2 percent (88.7 million) are women .
VI. Stylized Facts—Regional Distribution Region No. of Programs Reporting No. of Clients in 2007 Asia and Pacific 1,727 129,438,919 Sub-Saharan Africa 935 9,189,825 Latin America and Caribbean 613 7,772,769 Middle East and North Africa 85 3,310,477 Developing World total 3,360 149,711,990 North America & W. Euro 127 176,958 Eastern Euro & C. Asia 65 4,936,877 Industrialized World total 192 5,113,835 Global total 3,552 154,825,825 Source: Daley-Harris, 2009, Table 7
Repayment rates: > 98% repayment rate in Grameen; “The poor know this credit is their only opportunity to break out of poverty. They do not have any cushion whatsoever to fall back on. If they fall afoul of this one loan, they will have lost their one and only chance” (p. 58)
“ Grameen assumes that every borrower is honest. There are no legal instruments between lenders and borrowers” (p. 70).
Women in Bangladesh (Purdah— “a range of practices that uphold the Koranic injunction to guard women’s modesty and purity” (p. 74). In the strictest sense, it forbids women to leave their homes or be seen by men except their closest relatives.
“ Not only do women constitute the majority of the poor, the underemployed, and the economically and socially disadvantaged, but they more readily and successfully improve the welfare of both children and men. Studies comparing how male borrowers use their loans versus female borrowers consistently show this to be the case” (p. 73)
A for-profit business whose mission is to provide a social benefit, not to be a profit-maximizing business (PMB). In fact, Social Businesses should not earn profits. Any retained earnings should be used to expand the reach and scope of the business.
A for-profit business whose mission does include profit-generation, but whose owners are the poor or disadvantaged.
“ In its search, BRAC revolutionized the poultry business in Bangladesh. Over the years, more than 1.9 million women have joined BRAC’s poultry program, but BRAC day-old chicks and feed have served a much wider community as well. In 2006, its feed mills produced just under 40,000 tons of poultry feed, and in 2008, its hatcheries turned out 12.8 million day-old chicks. The business has helped poor women, and it has earned money for BRAC as well” (Smillie, p. 99).