It seems the tide has turned on microfinance, and the assumption that small loans miraculously alleviate poverty is increasingly treated with skepticism.
Greeks are making similar discoveries regarding large loans. I have lost track of how many frauds, collapses and scandals within the microfinance industry that there have been in Ghana.
In addition, some of the data emerging from FINCA, a leading microfinance agency, is deeply disturbing. India is embarking on the same trajectory that ended in tears in Andhra Pradesh.
Media coverage challenging the wisdom of indebting poor people en masse has continued unabated.
Yet there may be some glimmers of hope in the sector. As players are under increasing pressure to demonstrate actual positive impact, things can only improve. Pressure, even if merely reputational, sharpens the mind.
I periodically receive tip-offs and leaked documents or hear rumors about frauds and failures within the microfinance industry, and these have been few and far between these last few months.
Yet significant challenges remain, of which I’ll note three.
1. There is an expanding awareness of the widespread use of child labor in microfinance-funded projects.
During a conference in Guayaquil, Ecuador, I spoke to Isabelle Barres, director of the Smart Campaign, a microfinance initiative with the stated mission “to keep clients as the driving force of the industry.”
I confronted her with the obvious and disappointing observation that their client protection principles fail to address the interests of children and that microfinance is disturbingly correlated with high incidents of child labor.
She did not deny that illegal child labor was taking place – the vast majority in the informal sectors that are the hunting grounds for the microfinance sector – but that including the rights of children is utterly out of the question. The reasons for this are obvious:
First, the microfinance sector is facing huge criticism, and associating it with yet another crime, especially one as sensitive as child labor, is a reputational hit they can ill-afford currently.
Second, if Smart Campaign dared to include child labor in their otherwise watered-down principles, very few microfinance institutions (MFIs) would want to get certified, and that is, after all, Smart’s business.
Third, perhaps the main driver behind their refusal is simply that microfinance depends on child labor. Who else can do the hard work for minimal or zero salary in the typical low-margin, labor intensive, competitive activities that so-called micro-entrepreneurs engage in?
Bolivia is probably the birthplace of Latin American microfinance. Illegal child labor is chronic in the country, so the Bolivian government decided to legalize child labor.
The legal labor force for micro-sweatshops just expanded – paradoxically this is probably good news for the microfinance sector. Now naÃ¯ve micro-finance investors can comfortably lend to micro-enterprises in Bolivia that employ 10-year-olds, and this is entirely legal.
2. MFTransparency (MFT), one of the few effective transparency initiatives, closed, as it was no longer sustainable.
But what is the concept of sustainability when it comes to transparency? Surely it is a public good?
In a nutshell, there were too few people out there willing to pay someone to actually report on the actual interest rates paid by the poor.
Naturally, the insiders publicly lamented this, while quietly breathing a sigh of relief that their dirty laundry will no longer be aired in public.
Without MFT, global micro-lenders can go about their exploitative businesses with even less scrutiny than before.
Once again, the call is for local, sensible regulation and the wise use of interest rate caps to prevent overt exploitation.
Interest rate caps of 20 percent will distort the market and reduce the supply of capital. Interest rate caps of 100 percent prevent exploitation.
We do not have to look far for examples of where such protections are enforced, such as within the payday lending industry.
While these loans remain exploitative and often trap individuals in a cycle of debt, the interest rates are far lower and the terms less problematic than those within much of the micro-finance industry.
As Ha-Joon Chang famously documents in his stellar book, “Kicking Away the Ladder,” our suggestions for developing countries are very different to the practices we ourselves engage in currently, and engaged in when we were at comparable stage of development.
In other words, do as I preach, not as I do, or did.
3. I have dug up some new salary data for a leading micro-lending agency, which is sobering and reflective of trends within the entire sector.
The excessive salaries of lending agency leaders was noted in a June 2015 article appearing in The Guardian, written by Jason Hickel, an anthropologist for the London School of Economics.
“The only consistent winners in the microfinance game are the lenders, many of whom charge exorbitant interest rates that sometimes reach up to 200 percent per annum,” Hickel said.
He added, “In the past we would have called such people loan sharks, but today they’re called microfinance providers, and they crown themselves with the moral halo that this term carries. Microfinance has become a socially acceptable mechanism for extracting wealth and resources from poor people.”
Even if the poor are getting a raw deal, some people are pocketing vast salaries.
Hugh Sinclair is a microfinance consultant, blogger and author. He works with organizations seeking to provide ethical, beneficial microfinance to the poor. In 2012, he wrote “Confessions of a Microfinance Heretic,” highlighting some of the more nefarious activities within the sector. A longer version of this article first appeared on his blog and is used with permission. You can follow him on Twitter @MFHeretic.