Lending a Billion, $25 at a Time

Charitable giving is a tricky thing. On the one hand, you want to you want to do good. On the other, there is often a worry that some or all of that good might end up being wasted. A few scare stories of wasteful NGOs or misfiring programs later and you’re in full paralysis about what to do. If you’re really diligent, you can even read extensively about how international aid might even be a huge cause of economic stagnation in recipient countries.(1)

The end result of this might be a conclusion that it’s easier to go and have a drink and spend some more time thinking about what to do.

While researching options a few years ago, one of the charitable causes I came across Kiva.org. Kiva uses donor provided funds to provide small loans to disadvantaged households, individuals and small companies worldwide. The loans can be as small as a few tens of dollars but often significantly larger. As loans are repaid, funds appear back in the donor’s Kiva account and can be lent out again to a new applicant. Since setting up a Kiva account in 2015, the money I deposited has already been used to make nearly 500 loans in 34 countries. The total funds lent out is nearly 2.5x the amount of money I put in (so every dollar has been “used” nearly 2.5 times).

All in all, it’s been one of the most impactful charitable things I’ve done recently and I’d highly recommend looking into it. Even small amounts are impactful and you can actually also withdraw the money again at some point in the future if you wish.

The effects of the loans are often spectacular for the recipients: buying goats for a farm, buying cloth for a clothing business, financing stock for a shop and so on. See some of the active loan requests here.

On the site, it’s possible to decide which types of loans you’d like to fund, in which places and also whether you’ll lend to women, men or both(2), plus a number of other parameters.

Microloans

Although I also gave to some other causes, I found the lending aspect of Kiva a really compelling idea. When starting our company 3scale back in 2007 we had very limited resources. We did have some savings and ultimately some capital from friends and family but it was a hard climb.

Making the company succeed would have been impossible without any help at all.

A good way to think about this is that it’s useless to know that you have a way of turning 10 seeds into 20, if you don’t have 10 seeds. When starting any kind of venture, you start small, but starting from a place where the tiniest investment can’t be made makes the endeavor nearly impossible.

Donate or Loan?

The broader Microfinance category has gotten a lot of attention. In 2006, Muhammad Yunus and Grameen Bank jointly won the Nobel peace prize “for their efforts to create economic and social development from below” and Micro-lending has taken off worldwide.

A deep dive into the impact of microlending and microfinance more generally is probably a separate blog post. However, it is worth asking the question:

From the point of view of a donor is it better to simply donate? Or is lending approach like Kiva a better choice?

The is no definitive answer to this. The effect of the two approaches is very different:

• Donations often reach the people in greatest absolute need: unable to survive without support or extremely disadvantaged.
• Donations are one time events: once the money is donated, it will be used once and applied to a particular problem. Aid is a one-time event.
• Donations can be used by the recipient (be it the person in need, or the charity operating a particular program) in a wide variety of ways. There are rarely any conditions attached to it.
• Microloans, on the other hand, are most useful to those who have a business opportunity of some sort but can’t act on it without support.
• Microloans are returned to the lender and can often be lent out to someone else.(3)
• Microloans create a long term relationship between the lender, the intermediary (often a Kiva partner) and the borrower. (More on this below.)

If you’re able, perhaps try a bit of both. The two approaches serve different needs and complement each other. By helping people help themselves, Microlending extends to many communities an access to credit we take for granted in richer countries.

But is it all Sunshine and Roses?

In a word, No. Creating a functional credit system where none exists is difficult. Whilst Kiva has pioneered awareness of Microlending and encouraged more people than ever before to donate funds, it does face challenges.

One of these is that Kiva works with local Microfinance Partners in each of the countries that it works in. Kiva charges no interest on loans to these partners (or to borrowers). However, the partners themselves often do. They do this to cover operational costs of administering the loans and to cover some defaults.(4) There has been some criticism of higher rates when they occur (see here and a response here).

There are a number of Kiva alternatives which try to tackle this challenge more directly. The most prominent is Zidisha which focuses on direct loans without a microfinance partner in between. Zidisha’s founder explains some of the issues in making both Kiva and Zidisha work in this post.

Another criticism is that while microlending donor sites show individual loans which are funded (and these are genuinely the projects that are funded) it is sometimes not clear that sometimes the Kiva partner has already agreed to fund a loan and fund-raising happens post-funding. There is some logic to this since if a loan is creditworthy it doesn’t necessarily make sense to make someone wait for their loan to fund. On the other hand, it can feel a little odd as a Kiva donor to know that you are funding something which is already approved and paid out. Kiva does try to make this clear, but arguably still doesn’t do a great job.

From my point of view, I see this primarily as an optimization that’s needed to make the system work and I really see Kiva as getting funds into the broader microfinance ecosystem where it can do good. I can still determine which types of loans I support and almost all the lending is automated anyway.

Returning to the interest rates though. It’s logical that there are real costs in administering loans, particular many small loans. These come in the form of fees and some interest rates. What does “high” mean?

In the United States, interest rates are typically in the 10% range (annually). Outside the United States, however, interest rates (inc. fees) are 36% on average year. I checked the lender partners on the loans I currently have active and the interest rates/fees together range between 14% and 28%, but with one at 40%.

These are high numbers. High enough to potentially cause their own financial problems for borrowers. Digging further into this, one of the most useful documents is Kiva’s explanation which responds to a New York Time article. The original article is here.

Certainly, the aim is to have interest rates/fees as low as possible for microfinance and anywhere — the lower the better. Kiva also aims at this. They also work aggressively it seems to ensure that the interest rates/fees really reflect economic reality and are required to deliver the service. 80% of the finance partners are non-profits themselves, and the other 20% have a strong social aspect to their mission. Any organization which doesn’t follow guidelines or begins to generate too much return is likely to be downgraded by Kiva. There are also requirements on the clarity of communication about costs to borrowers.

Kiva’s reflection here is that they strive to keep the fees low, but they don’t cap them since to do so simply means microfinance becomes non-viable in some places.

It is genuinely more expensive to administer many small loans and do so in countries where legal, banking and other infrastructure is seriously lacking. As a result, on balance I think Kiva is making the right choice here.

I’d hope that over time Kiva, Zidisha and the other players in the space tackle this problem from multiple sides and try to bring costs down everywhere. The influx of more money available to lend hopefully will help make such operations more efficient. It’s also worth saying that education is key. Sometimes a business opportunity is worth vastly more in terms of return than (for example) 20% interest on a loan. In this case, it makes a lot of sense to make/take the loan. In others, an opportunity may be a poor choice to pursue even if the loan were interest-free.

What about “Microequity”?

Loans are a key liberator of economic opportunity. However, they are only one financial tool. Microbanking and Microinsurance are others (an interesting treatment on what does/doesn’t work can be found in Banerjee and Duflo’s Poor Economic Book).

An interesting further evolution which seems to be rarely discussed is Microequity. In other words, rather than lending funds for repayment, investing in a business for an ongoing return but with no requirement to pay back the loan. Equity financing is available in developed economies and drives the majority of startup ecosystems. It is also often the basis between many small and medium family businesses.

A micro- equivalent of equity financing would have the advantage that small businesses do not incur debts or need to deal with high-interest payments. Financing parties participate in the outcome, not via an interest revenue stream. Such financing might also foster stronger partnerships than simple loans. There have been some attempts in this direction already such as Mark Wein’s Micro Equity Development fund but it is a complex problem. Bhagwan Chowdhry’s article here provides some insights into why this is.

The key hurdle is often that it is even more challenging to track income/profits/losses for business than loans returns. In many countries, it is also prohibitively expensive to establish the legal rights that might come from being an investor. As such, the over-head of equity participation is simply too great.

Hopefully, we can find ways to make progress on this front. Adding another sound financing mechanism for businesses to complement loans would likely be a big win in many developing economies.

Conclusions

Starting a business is tough, no matter where you are. While aid and donations often alleviate severe deprivation, microlending and microfinancing in general play an important complementary role. Kiva and other platforms provide means which already work and hopefully with more support they’ll be able to continue to drive down costs for borrowers. They are already providing an economic lifeline to many.

In the long run, it would be great to see the full range of financing options available in developed economies be available to many more people worldwide. As more capital becomes available to these channels, hopefully, they will become more innovative and adapted to local needs.

The last thing I wanted to say was a shout out to the Red Hat team on Kiva which just crossed $100k in loans. Great result and may there be many more loans!

Photo by Steve Johnson on Unsplash.

Notes:

(1) Something which I only believe is true in a narrow sense.

(2) I set Kiva to lend only to women. I did this not because women more likely to repay (repayment rates are high anyway), but because in many parts of the world women are still economically disadvantaged, better access to credit might help.

(3) Note that clearly a donation may also be re-used multiple times if the charity running the program chooses to apply it in a loan-like way. In fact, this is exactly what Kiva does, though it permits donors to withdraw money if they wish.

(4) The high rates of repayment shown on Kiva and other micro-finance dashboards are what the donors see. However, the underlying rate of default is somewhat higher and Kiva partners often cover the shortfall to stay in good standing.

Originally published at area67.org on February 23, 2019.