Summary: in my quest to find a noble cause for the proceeds from our Swear Jar challenge, I thought I’d revisit a topic I was pretty excited about back in college; micro-lending. It’s one of these ideas that everyone seems to love, and is a compelling story as one step that could be taken to start eliminating poverty in the third world. As with a lot of stuff I thought was great in college, after researching with a little bit more of a skeptical mindset, I found that it may not be the silver bullet I used to think it was for ending poverty, but I still think it has its place, despite criticisms, and I still think it’s a great vehicle for the GoodGuys to invest in. So let’s start out with the broad description of Micro-Finance. Micro-Finance is providing financial services to very low-income individuals or groups that traditionally do not have access to conventional banking services. This is stuff we, in the west take for granted: Having a safe and secure place to hold your money (savings), having a way that you don’t have to pay for everything in cash (checking), paying small regular payments in order to make sure a disaster doesn’t destroy your finances (insurance), and finally, a way to purchase things up front, and pay for them later (credit). Micro-credit/micro-lending is generally understood as providing small loans to borrowers that live in poverty, and is designed to spur entrepreneurship. The idea is that small amounts of capital can mean big opportunity for the poor to improve their situation. Here is one example of a micro-borrower that couldn’t make a profit with his water-selling business, and $360 microloan allowed him to buy an underground water tank and start turning a profit and growing his business. So these are borrowers that conventional wisdom would say are horrible credit risks. They generally have no collateral that the bank can go after if they default, their income is shaky at best, and they usually don’t have access to other financial services that we take for granted. Savings accounts, insurance, etc. Also, there’s an economy of scale issue in that there are costs to banks to servicing loans. If you were a bank, would you rather do the paperwork, research, followup on one $5000 loan, or one hundred $500 loans? So enter micro-lending institutions; banks that specialize in lending to these types of borrowers. There is a lot of literature out there, and many different setups that I don’t really want to get into. Some banks require borrowers to form groups to “keep each other honest,” some banks focus on lending to women because they have been shown to have lower rates of default, etc. Because these loans are so expensive to service, borrowers are usually expected to pay a higher interest rate that we, in the US, would expect. Shout out to listener Chris, who actually develops web-interface tools to analyze different data from microfinance institutions. Using his dataset, it looks like these banks yield upwards of 30% on their loan portfolios. This may seem a little extreme to charge a borrower 30% APR on a loan, but the alternative sources of credit to these borrowers typically charge even more. There are reports of loan sharks charging upwards of 100%/month. The final piece of the puzzle is that since it’s hard for banks to make money on these loans, several non-profit groups have cropped up that work to finance these loans through the local banks like Kiva.org. Kiva allows individual lenders from all across the world to “donate” as little as $25 towards a loan to an entrepreneur in another country. Kind of like adopting a foreign child, you are adopting, in this case, a small business. It truly is an investment, so when/if the borrower pays back the loan, you can re-invest, or pull your money out. An important point to remember, though, is that this still costs money, so the borrower themselves is still paying an interest rate that goes towards recouping[...]
