When will the truth about microloans be known?
Finally, in the April 13, 2010 New York Times article entitled Banks Making Big Profits From Tiny Loans, micro-loan lending practices in several South American countries were revealed to the dismay of many believers. With the World Bank and several well-known donor organizations supporting micro-loan lenders, the general perception has been that it is one of the most effective ways of making capital available to the poor to start businesses and come out of poverty. So much has been written about the virtues of micro-credit that the general public is led to believe that it might be the long-sought panacea for poverty alleviation.
The New York Times article made it known that most micro-loans in South America charge annual interest rates in excess of 75%, with the global average rate around 37%. Even well-known micro-loan donors like Kiva has been funding loans that charge over 80%. Yet, they all make claims that borrowers are mostly poor people, and they succeed in starting and sustaining businesses. Further, they assert that poor people are highly credit worthy and over 99% of the borrowers repay the loans in full. Gaining support from financial institutions, international agencies and even major donors, the for-profit microcredit industry has built up a fairly large business in billions of dollars on the backs of those just above the poverty level and very small businesses. Even major media organizations such as the New York Times have been touting the virtue of micro-loans in their editorials as well as with examples of spectacular success stories among a small number of recipients of micro-loans.
Even those claiming more reasonable interest rates – say, around 2% per month – are not telling the truth. It is common practice in India to make micro-credit available at a monthly charge of 2-3% on the original principal, without making any adjustment for declining balances. For example, a borrower of $100 in equivalent rupees is given $88 initially at the start of the loan, deducting $10 toward initial principal repayment and $2 in interest. In each successive month for the next 9 months, repayment of $12 is required -- $10 toward principal and $2 toward interest. This micro-loan is usually described as a 2% interest loan for 10 months, or at an annual rate of 24%, when in fact the effective rate is 51.30%.
For the past seven years or more, I have been writing articles and blogs (http://www.abrahamgeorge.blogspot.com/) pointing out that micro-loans are not what they are made out to be. In this brief note, let me simply restate three observations I have repeatedly made in the past:
a) Most micro-loans are made to those above the internationally defined poverty level of $2 per day.
b) Most micro-loans to small businesses and individuals charge exorbitantly high interest rates, and these loans do not result it sustainable businesses. In a majority of cases, these loans end up forcing the borrower to seek even higher interest loans from local money lenders to make repayments.
c) Many micro-credit lenders use unethical and illegal practices to pressurize borrowers to make repayments.
In conclusion, micro-credit as practiced today does not directly address poverty, and in many cases, results in creating greater indebtedness on the part of borrowers.
I have written extensively on the above observations and conclusions in my previously published papers, and hence, I end this one without further elaboration.
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