Turning Lenders into Partners

A microfinance self-help group meet up at a community center in a village near Pune, Maharashtra.

By William H. Bohnett

Earlier this year, SKS—India’s largest microcredit organization—posted a $358 million IPO, bringing worldwide attention to the global microfinance phenomenon that has brought economic opportunities to tens of millions. Yet the promise of microfinance has yet to be fulfilled. SKS and other microcredit institutions have now come under scrutiny from the Indian state of Andhra Pradesh due to onerous debt burdens that have led to a spate of suicides. The issues raised in this controversy are serious, especially against the backdrop of a much larger question: Where are the IPOs for the microbusinesses that have made microfinanciers wealthy?

Begun in the 1970s by pioneers like Women’s World Banking and Nobel Prize winners Muhammad Yunus and his Grameen Bank, the microfinance industry is now a sizable global presence. Roughly 2,400 microcredit organizations currently serve more than 150 million people worldwide, mostly through very small loans to women in developing countries. The statistics speak of success and growth: excellent repayment rates, increasing loan volume and assistance to an ever-increasing number of women. Yet, in terms of widespread business and job creation, the indicators are not there. The literature reveals only scant evidence at best that 35 years of microcredit through loans alone has substantially improved education, health, jobs, or created sustainable economic growth. Undeniable social good, yes; increased societal wealth, no.

Microfinance organizations are not unaware of this shortcoming. The most effective organizations, of which there are many, provide an integrated approach to helping the world’s poor. Groups like Pro Mujer and ACCION do not just make loans, but also provide job training, education and health resources. Acumen Fund and Unitus now incorporate promising new approaches: microcredit 2.0, if you will. Vittana, for example, raises loans for students in five countries through peer-to-peer online lending. This is a longer-term investment than most microfinance loans, which tend to involve short-term payback.

These innovations are welcome and important. But they do not go far enough in addressing the central limitation of microcredit. Very few, if any, successful businesses have been built on debt alone. Lending is only half of the equation. The loan gets you started, but equity––the uncle, the venture capitalist, the whole village––provides the real magic. 

Various forms of microequity are emerging. Some refer to small grants aimed at promoting social justice. These grants’ goals include “social,” not financial, equity. Yunus himself proposes a hybrid of both kinds of equity. Under his model, small entrepreneurs receive loans which are forgiven if an entrepreneur reinvests in the community.

Entrepreneurial microequity––the next frontier in microfinance––provides capital to fund a small business in exchange for an ownership stake, thus aligning the interests of the financier and the entrepreneur. InVenture, for example, uses an online platform to match investors, who provide $1,000 to $5,000 in equity capital, to promising entrepreneurs who have demonstrated consistent loan payments. Financing education is attracting micro-equity investors like Lumni in Latin America and Enzi in India and Iran, which fund students’ education in exchange for a percentage of their post-graduation earnings.

Microfinance should do more than simply make loans; it should nurture entrepreneurs. In a recent study of the impact of microfinance, MIT’s Poverty Action Lab found that entrepreneurial households––which made up about three in ten surveyed––were more likely than others to use their earnings to buy more durable goods that could build their businesses.

A dramatic illustration that entrepreneurship accelerates economic growth can be seen in China, from 1980 to 2010. Xiaofeng Peng, a 34-year-old self-made billionaire, has used his solar energy company, LDK, as his ladder to wealth, accessing China’s rapidly growing capital markets to go public within 15 years of graduating from trade school.  His story of equity capital building on a grand scale plays out in a manner that Americans lionize. Peng is the Bezos or Zuckerberg of China, if you will. And there are many more like him.

For now, however, most access to equity capital is at the multi-million-dollar tier––not at the level that allows micro-entrepreneurs to grow and graduate from the “micro” designation.   To jumpstart growth, countries need many things, from improvements in governance to capital markets development. Encouraging entrepreneurialism may not be the sole ingredient in the Chinese “secret sauce,” but it is undeniably a key to rapid societal change and job creation.

Here’s where the microfinance industry can transform itself and help the developing world do the same. Don’t abandon or diminish your mission. Instead, expand it. First, find ways to identify and link those gifted few in your purview who can recycle waste in 100 villages and not just their own. For those entrepreneurs most likely to scale up and succeed, think “80/10/10”––the first step in transforming lenders into partners. Require only 80 percent of each loan to be repaid, and turn the remaining 20 percent into microequity, split equally between borrower and lender. You’re now a partner. Watch, learn, participate and help grow your new business as a stakeholder in building true, sustaining prosperity.

William Bohnett is of counsel to the international law firm Fulbright & Jaworski and an advisor to the World Policy Institute, a non-partisan center for global thought leadership.

Photo from Flickr via lecercle.