For most people outside of the business world, the name Muhammed Yunus doesn’t ring a bell. Yet this banker has managed to generate a profound social change through his unique system of microloans for the poor. Microloan borrowers use relatively small loans, usually ranging from $75 to $150, to finance new businesses. This helps to generate a steady stream of income for individuals otherwise destined for poverty. While many investors were highly skeptical of Microfinance at first, these days it is generally accepted that microfinance is an effective way of alleviating poverty. Indeed, the Grameen model is followed in over 100 countries, in places as diverse as Kenya, Sri Lanka, and Ethiopia. By founding the Grameen Bank in his home country of Bangladesh, Yunus pioneered the idea of microfinance and brought tangible improvements to impoverished rural communities; allowing him to win the Nobel Peace Prize in 2006. Aside from providing rural areas with much-needed capital, microfinance encourages borrowers to improve sanitation, reduce birth rates, and to increase women’s rights in their villages. But over the past few years, the business model of microfinance has taken fundamental shift towards free market capitalism, reigniting the classic debate of profit versus social progress.
Grameen Bank issues loans of approximately $75 at a fixed 20% rate of interest, a rate many would argue as exploitative. Yet with the explosive growth of microfinance, interest rates have gone even higher in certain countries as an increasing number seek to make Yunus’s model much more profitable by raising interest rates to shockingly high levels, often between 40 to 70%. This leads to an ethical dilemma about the nature of microfinance: is it predatory to charge these “usurious” interest rates to rural borrowers with limited financial education?
Compartamos Banco, a successful Mexican microloan lender, issues loans at interest rates at around 80%. It argues that while this may at first seem high, one has to consider the costs associated with operating a MFI. It has to employ people to collect payments door-to-door as well deal with the fact that that a good number of bowers will default on their loans, makes the cost of doing business extremely expensive. Also, since microloans are often short-term, usually lasting 6-12 months, the annual interest rates are usually not paid in full.
Compartamos dismisses claims that its loans are predatory, and in fact argues that its increased profit margins help it to give out more loans, thereby helping more people. The bank does not give loans to the poorest of the poor because it wants to avoid defaults, but does offers financial literacy classes to borrowers, which helps them to make educated decisions regarding their loans.
It is also important to consider that in many countries, the interest rates charged by profitable MFIs pale in comparison to those charged by local banks, many of which establish rates in excess of 100%. Not to mention that these local banks often employ brutal tactics to collect payments; if a family doesn’t pay, it is sure to face violence or long-term indentured servitude to the moneylender. In fact, many families in Bangladesh are mired in debts to such moneylenders, and as a result cannot enjoy any of the profits from their small farms or other enterprises.
Ultimately it is very difficult to discern whether such high interest rates are justified or ethical, and there are legitimate arguments on both sides of the issue. What is important is that all MFIs, regardless of profitability, are campaigning for positive social change. So while MFIs like Compartamos turn towards capitalism was perhaps inevitable, their efforts have done more to reduce poverty in rural communities than ever thought possible. For this reason these organizations deserve to be applauded.