The Microcredit Backlash

Fighting poverty has along and divisive history, but nothing's shaken up the pundits, wonks and windbags like microfinance. The United Nations declared 2005 the year of microcredit—small loans for the penniless—and last year's Nobel Peace Prize went to Muhammad Yunus, founder of the Grameen Bank, which pioneered such lending. Governments from Brazil to Bosnia have launched massive microloan programs, and commercial banks like ABN AMRO, HSBC and Citicorp are rushing down-market. Some 500 million poor worldwide have reportedly benefited from some $6 billion in microloans, which aficionados want to ramp up to $300 billion. "One day," Yunus predicted, "our grandchildren will go to museums to see what poverty was like."

That was then. Now a backlash is growing. Critics on the left charge that micro-finance privatizes social safety networks, while conservatives dismiss it as charity disguised as enterprise. Wonks weigh in with studies like "The Myths and Magic of Microcredit" and "Money Is Not Enough." Insiders turn on the industry. Loïc Sadou-let, a former World Bank economist who worked in microfinance in Guatemala, estimates that only about 300 of nearly 25,000 microlenders have reached financial "sustainability," meaning they are able to cover all costs. Now comes "Microfinance Reconsidered," a recent essay from the Cato Institute, a conservative U.S. think tank.

This attack hurt. ("It nearly caused a knife fight in our offices," says a spokesman for Deutsche Bank.) Its author, Thomas Dichter, an international-aid expert, spent two decades working in microfinance, and his conclusions are grim: poverty lending is bad social policy, a bad development strategy and bad business. While some borrowers never get off the debt treadmill, he says, others squander their credit on consumer goods. The few lenders who can pay their way, he says, only rarely serve the poor. "Classical microcredit start-ups are not working," says Dichter. "There's a feel-good factor for lenders, but no solid evidence that [microcredit] makes a difference, either in developing the economy or reducing poverty."

The row over microfinance arises from colliding views on everything from the power of money to human nature. If there is any consensus, it's about the paucity of reliable data. No one knows how many microlenders exist or how solid they are, much less how their millions—or is it hundreds of millions—of clients fare. Some forecasts have projected a future market as (absurdly) large as 3 billion customers, or nearly half the current world popu-lation. All sides are arguing in the dark.

That doesn't seem to quiet the debate. Yunus and his followers say that unlike handouts, credit gives the underclass a tool to leverage its way out of want through enterprise. The skeptics retort that most small businesses got their start not thanks to formal bank credit but through personal savings or raising cash among family and friends. Thrift came before credit, that is. "The idea of borrowing one's way out of poverty is passing strange," Richard Posner, a U.S. circuit-court judge and economic historian, commented recently. "I am unaware of any historical examples of nations that climbed out of poverty on the backs of small entrepreneurs financed by credit."

Microloans' champions answer that it's unreasonable to judge, say, street vendors or bicycle mechanics by the same yardstick as U.S. or European start-ups. Alex Counts, director of the Grameen Foundation, which is in charge of replicating the Bangladesh-based Grameen Bank around the world, admits that only a tenth of the bank's 7 million clients are "true entrepreneurs" who "started borrowing $100 and are now borrowing $10,000 to $20,000," but says that most are making ends meet. "In developing countries, where there are few jobs and no safety nets, your alternatives are to work for yourself or starve," he says. "Not everyone is an entrepreneur, but everyone is a survivor." Jean-Philippe de Schrevel, managing director of Blue Orchard, a Geneva fund that taps wealthy investors for microlending, says it's much more sustainable than traditional charity. "It's not like writing a check every Christmas to a tiny NGO in Africa," he says.

OK, but is survival a real business model? Grameen Bank claims it's making a profit, with a repayment rate of 98 percent on loans to business at 20 percent interest rates for business, discounted to 8 percent or less for households and students. But critics say lenient accounting masks higher real default rates. Yunus is unapologetic. "We created a bank based on a completely new set of premises and procedures," he says. Other institutions have quietly upgraded their client base to make a profit (liberal analysts call it "mission drift"). Still others charge rates up to 100 percent, inviting comparison to loan sharks they were meant to replace. Bernd Balkenhol, chief of social finance at the International Labor Organization, says the "initial euphoria over profitability" underestimated the cost of reaching out to the poor, and "probably needs to be re-viewed and diluted."

Consider: in Brazil, chronic underpayment by 1.3 million struggling subsistence farmers has forced the treasury to pick up nearly half the lenders' costs for the mass rural credit program, PRONAF. Critic Milford Bateman argues that international microlending in Bosnia bankrolled "a primitive 'bazaar economy' redolent of life 100 years ago." Chinese lenders are floundering because "they are small-scale" and lack professional management, says Jiao Jinpu, a top researcher at the People's Bank of China. In Bangladesh, birthplace of microfinance, poverty is worse than ever, says Dichter. "Fixing poverty is hard work," he says. "It takes institutional reform and cultural change. You can't fix these things by bringing in a truckload of money."

Does that mean the microfinance boom will end as a bubble? "Perhaps, if lenders are looking for a short-term return," says the Grameen Foundation's Counts. "People get a reality check when they're trying to serve the poorest 3 billion people in the world." That may be the one claim in the poverty-lending business that everyone should bank on.

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