As Microfinance Struggles, Simple "Guarantees" Keep the System WorkingAs Microfinance Struggles, Simple "Guarantees" Keep the System Working "As Microfinance Struggles, Simple "Guarantees" Bring Hope"
Microfinance is going through a tough time right now. But the laziest form of financial support may be just the tool the fund the most important work.
It may sound odd, but the laziest form of financial support, the "guarantee," could bring in funds to the microfinance industry in a difficult time.
Microfinance is going through a tough time right now. Bangladesh recently attacked the esteemed Grameen Bank for apparently political motives. In India, claims of loansharking led to a crackdown on some lenders. Academics are questioning the true social impact of many programs. All together, confidence in the very concept of lending to alleviate poverty has been shaken, and some investors are backing away. That means there's less capital to lend and less ability to do good through microloans.
In this difficult environment, a promise that microloans will be repaid can help keep them available. These "guarantees" are just about the easiest way idle money can be put to good use at a time when microfinace needs it.
Several microlenders already use guarantees from wealthy individuals as a way to get cheaper loans from commercial banks, that they then re-lend out as microfinance loans to the poor. Regular banks don't want the costs of getting involved in microlending but they will put up cash to a group if there's collateral. In that way, it's not much different from a home loan. The guarantors are a kind of non-donor, enabling microlending and poverty fighting without doing more than signing a promise to step up in the case of a default.
The Grameen Bank uses this technique a bit, as does Kiva, but the most explicit example is MicroCredit Enterprises, a nonprofit lender that has rounded up a group of 51 well-to-do folk who each sign a $1 million guarantee. Gary Ford, President of MicroCredit Enterprises, says that "in five-and-a-half years of existence... we've had one partial loss. The total cost to our guarantors was $7,600 per guarantor... And that's tax deductible." For some context, $1 million earns more than that in a single year sitting in a low interest savings account.
And in exchange, Ford says, "our guarantors have been able to help enough desperately poor people, mostly women, to fill a sports arena." As this scales, the risk dissipates even more. (MCE is looking for new millionaires if you know any.)
This is a smart plan because it opens the doors of impact investing to new socially motivated investors who might be too cautious to dive right in as well as a Mr. Moneybags who doesn't want to donate, nor even part with his hard earned fortune ever. He can use his money to guarantee microloans while it also earns interest, keeps his business running, or whatever. "You sign a piece of paper. You don't have to part with your assets," says Ford. But just like that, hundreds of thousands of dollars gets freed up for good.
"We take that piece of paper and go to a lender, which could be a bank or a foundation, and out of conservatism we only borrow half that amount, $500,000," Ford explains. Each guarantee is for a term of 18 months, but most people re-up after that. The connection to the recipient of a loan is by no means as direct as a donation to the Grameen Bank or even Kiva, which sends your money to a local microfinance institution, but if guarantees pull new money into the microfinance sector, it's a winning idea.
MCE has a significant due diligence operation to make sure the money goes to lenders seeking to alleviate poverty and doing it well.
Since the guarantors are getting their normal return on their money—because they still have it—they aren't looking for big profits from microlending. “This type of capital is more patient than the for-profit capital,” says Ayesha Wagle, the Senior Vice President in charge of lending at MicroCredit Enterprises. "So we are able to go into areas that other MFIs aren't." That could mean types of customers, or types of countries.
"Money doesn’t flow to where it should because of country risk," Wagle says. People don’t invest in Sierra Leone, for example, because of the risk of political upheaval." MCE is by no means the only group sending capital there for microlending, but the point is, the market isn't getting enough capital to Sierra Leone or unstable countries like it, in part, because more cautious capital stays away from high-risk, high-need markets that need money the most.
These kinds of concerns will only grow as the tumult in India and Bangladesh play out. Those were the model markets, the case studies of success in many ways. Now they are cautionary tales of accelerated expansion, on both financial and political fronts.
So new ways to overcome the risk in reaching the poorest potential borrowers will be especially welcome in the coming months and years. Expanding guarantor programs may be one way, Kiva style micro-donations from average people will be another. Other plans that leverage institutional investors may also come to the forefront. We'll be watching this impact investing sector grow and how it affects microfinance closely.
Image: courtesy of MicroCredit Enterprises. A borrower in Cambodia was able to expand her banana selling business because of a microloan.