No silver bullets? The online funding revolution and micro-finance sector

When Muhammad Yunus, founder of Grameen Bank, which revolutionised credit for the poor, won the 2006 Nobel Peace Prize, micro-finance became a household concept. Now, online lending sites such as Kiva and NamasteDirect, give everyone a chance to help fight global poverty and, in the words of one new investor, “teach people how to take a small investment, grow their business and eventually become self-sufficient”.

Kiva offers investment options that appear to revolutionise the interface between giver and receiver, lender and client. According to Jonathan Morduch, co-author of The Economics of Microfinance, “Kiva and the micro-finance world are set up not just as a better way to fight banking but also an important way to rethink traditional modes of giving and global social justice."

The founders of Kiva are bullishly promoting their new approach while experienced micro-financing institutions (MFI) remain cautious in their assessment and others critical. Nevertheless Yunus’s prize and the arrival of online lending have prompted debate about the virtues of online micro-financing as well as the virtues of micro-finance per se in addressing poverty.

Kiva's lead has been followed by others. Internet giant eBay completed a complex regulatory process to launch the online micro-finance service, MicroPlace on 24 October. MicroPlace differs from Kiva in that lenders are purchasing securities - investing in MFIs, not making loans to individuals - and are paid interest.

Attacking poverty through loans

One of the biggest challenges for the poor is gaining access to capital and formal financial institutions. According to the UN, about one billion people still live on less than a dollar a day - a poverty trap that is virtually impossible to escape. But in the past two decades, micro-credit has become accepted as a potentially successful development tool.

Now the micro-finance sector is in the middle of a boom: “Micro-finance will grow more and more,” claims Nairobi-based director of Inclusive Financial Systems, Stephan Staschen. “More commercial entities will also get involved as they realise its profitability and the result will be that many poor people will be served.”
Micro-credit programmes extend small loans to the very poor, previously viewed as bad-credit risks, through rotating savings and credit circles, which take deposits and give loans at certain intervals and in strict amounts.

Such loans allow people to invest in the material, livestock, skills or machinery they need to generate income as well as pay for emergency needs such as medical expenses or death and marriage costs. “One of the great aspects of micro-finance is that it smoothes the financial lives of the poor when they face sudden outgoings as a result of some catastrophe, disaster or just an expensive wedding,” says Staschen. Although the definition of small loans varies, most are less than $200.

Photo: Manoocher Deghati/IRIN

Small businesses are one of the main means of survival in Dhaka, Bangladesh

Most micro-loan programmes focus on women. Experience has shown that women are a good credit risk and invest their income in the wellbeing of their families. “Now 96 percent of our four million borrowers in Grameen Bank are women,” said Yunus in 2004. Grameen was founded in 1976; by 2005, it had the equivalent of $678.28 million in total assets with 5.05 million active borrowers.

The Consultative Group to Assist the Poor(CGAP) is a consortium of 31 public and private development agencies working to expand access to micro-finance. In June 2004 they agreed 10 key guiding principles emphasising that MFI’s core aim is to fight poverty by creating transparent, sustainable and lasting private financial services that should be rolled out to the largest number of low-income clients.

“Loans that change lives”

Kiva.org was co-founded in 2005 by Matt and Jessica Flannery as the “world's first and only online micro-lending opportunity”, teaming up with international organisations working in low-income communities. It lists 61 partners in 37 countries that are responsible for deciding which borrowers will be posted on the website. The loans are disbursed to the partners - local MFIs - for ultimate disbursement to the borrowers.

Photo: Muhammedyunus.org

Muhammad Yunus, founder of the Grameen Bank

While browsing through the site, a potential lender sees brief descriptions of the borrowers, making it easier to create a connection with one or more entrepreneurs. By using the internet, Kiva claims to have reduced costs.

It appears that many “ordinary” people are choosing this route, perhaps over more traditional methods of donating money. As of 13 November 2007, Kiva.org had raised $14 million from 142,000 people to fund 20,769 loans - and the count changes daily. That represents a sizeable amount of cash from a large number of people who, more likely than not, did not previously know about micro-finance or MFIs.

But with the support that Kiva.org has received from high-profile supporters such as former President Bill Clinton – who featured it in his new book, Giving, How Each of Us Can Change the World – Kiva will continue to serve as a conduit for those wanting to reach the poor.

“Our biggest challenge has been keeping up with our growth,” says Fiona Ramsey, Kiva’s public relations director. “To date, our biggest growth restriction has been partnering fast enough to keep up with the growing demand by lenders to place more loans. We have been managing this challenge by expanding our partnerships team and bringing on micro-finance experts.”

Can micro-finance deliver?

The sector has its share of critics, who think institutions charge interest rates that are too high and the loans do not reach the poorest. Some say the exaggerated focus on micro-credit has led to neglect by state and public institutions in addressing the employment and livelihood needs of the poor.

In Bangladesh, 30 years after Yunus's invention, poverty statistics are worse than ever

According to research by CGAP in 2003, evidence of the effectiveness of micro-finance as a tool for development remains slim, partly because of the difficulty in monitoring and measuring impact. Questions have arisen about whether micro-finance can ever be as important a tool for poverty alleviation as its proponents and practitioners suggest. “It’s an important contribution but only one of many interventions,” admits Staschen.

Thomas Dichter of the Cato Institute, the Washington DC-based think-tank, calls the potential of micro-finance “grossly overestimated”.

Dichter claims: “In Bangladesh, 30 years after Yunus’s invention, poverty statistics are worse than they’ve ever been, so something else is the source of the problem and micro-credit is not helping.” Economics journalist Gina Neff has also written that “after eight years of borrowing, 55 percent of Grameen households still aren't able to meet their basic nutritional needs - so many women are using their loans to buy food rather than invest in business.”

Photo: Manoocher Deghati/IRIN

Market vendors in Merkato, Addis Ababa. Ethiopia's agricultural production is low and poverty levels are high

According to the Institute for Food and Development Policy, this brings into question the social mobility of loan recipients, especially the poorest of the poor. Scholars argue that micro-credit is more often used as a form of disposable income, rather than being reinvested.

Dichter also criticises the influx of micro-finance institutions, claiming that agencies are “jumping into this field” under the assumption they can alleviate poverty without actually looking at the different causes of poverty in different regions.  In recent writings he argues that micro-finance could be doing more harm than good.

Micro-finance may not be a panacea for poverty but as Kiva has shown, technology-based financing methods could provide a solution to future pro-poor funding issues for organisations keen to remain at the forefront of technological opportunities. Despite the concerns of conventional MFI practitioners, it may be too early to judge whether the Kiva model is just a clever mechanism to attract resources or a genuine revolution in individual funding to the aid and development sector. In the meantime, thousands of low-income individuals and families are gaining new hope as they try their hand at small enterprises that were previously outside their reach.

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