Microcredit: sometimes it’s just like Wall Street

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There is a lot of money to be made in the world of microfinance. At a conference hosted by Radio Netherlands Worldwide earlier this year, Princess Máxima of the Netherlands had harsh things to say about the phenomenon. She warned that some microcredit institutions put their own financial gains above the welfare of their clients. Today, Princess Máxima will again address the issue when she gives a speech at the United Nations Millennium Development Goals Summit in New York.

How does development aid organisation Cordaid Microcredit weed out dubious institutions?

Cordaid Microcredit appears to have its financial house in order. The investment officers at the Dutch head office in The Hague are able to present annual reports that the average commercial bank would drool over. More than 95 percent of the 12 million euros that Cordaid Microcredit invests or lends annually is paid back on time. And it is paid back with interest, at a rate that sometimes tops 10 percent.

For the vast majority of the loan recipients - all of them poor people - the money represents a last chance to start a business and escape poverty, and most of them put repaying the loan at a premium. After all, a good record of repayment means a chance at another loan and climbing another rung on the ladder leading out of poverty. It's hardly surprising that all sorts of investment companies, some of them of dubious reputation, want to get in on the act and make money.

Pineapple sellers
Cordaid's Gauke Andriesse, responsible for microfinance programmes in Indonesia and the Philippines says, "we do business with local microfinance institutions (MFIs). We make the money available and they assess the requests from small shopkeepers, farmers or pineapple sellers and the grants and loans. It's up to us to find good local partners; in order to do that we make several trips a year and take a good look at what they're doing and meet personally with our local partners".

In the early days, about 15 years ago, it was generally assumed that every MFI was legitimate but "we have dispensed with that naive assumtion," says Mr Andriesse. "You really have to be on your guard, especially in countries like India, where a great deal of commercial money flows into the microfinance sector. We've developed tools in order to evaluate and control MFIs. For example, do they know their clients? Do these banks offer tailor-made loans or just one standard package? What do the institutions do when their clients have trouble making payments, do they ruin them or do they look for a solution?

Massive profits
Jan Postmus, responsible for Cordaid's microfinance programmes in India and Vietnam says, "it's now five years after the UN's Year of Microcredit and in that time, a lot of new players have entered the game. For Cordaid, the social aspect is the primary goal and profits from microfinance are only necessary to keep the whole thing running. However, there are other institutions that see it the other way round, some investors believe it's a way to make huge profits".

Gauke Andriesse: "Investors in some MFIs expect annual profits of 25 to 30 percent. An absolutely marvellous result in the financial world but we see it as exorbitant. The only way you can make that kind of money is at the expense of the poor. Cordaid would rather see loan recipients paying a reasonable two percent interest per month instead of an exorbitant four percent a month, even if that four percent is better for the annual report. MFIs charging high interest rates frequently have just one standard loan package that they trot out to 200,000 customers".

Jan Postmus: "Due to their size and the pressure to make a profit, those sorts of MFIs will only ever offer one standard loan package".

Andriesse: "That doesn't take much work and it's a fast earner".

Absorbing losses
Jan Postmus says, "we would much rather see a tailor-made loan package, with pensions plans, insurance and financial supervision built in. It is a combination that allows people to absorb losses and difficulties in life. In order to achieve that goal, you have to put time and effort into the clients. And that's how Cordaid selects its MFIs".

He adds, "With a lot of the new investors, you don't even see the word client in the documents. That is possible but don't try and sell it as a 'social entrepreneurship'. As with the rest of the financial world, if an institution predicts long-term profits of more than 10 percent, you have to ask questions about their legitimacy".

Mr Postmus says, "Two years ago, we had to withdraw from one Indian MFI. The promoters of that company were doing all they possibly could to push up the value of their shares and managed to secure bonuses of more than 2 million. It was just like Wall Street. That does nothing to serve or enhance the microfinance sector".

Gauke Andriesse: "Fortunately, nine out of 10 MFIs are still putting the interests of their clients first. However, commercialisation is a trend that we must continue to monitor".