As much as this story makes my stomach churn (I’m a member of both Kiva and MicroPlace; in fact, I’m currently working on the MicroPlace website redesign), I’m glad this issue has drawn widespread attention so something can be done to remedy the situation.

Banks Making Big Profits From Tiny Loans

http://www.nytimes.com/2010/04/14/world/14microfinance.html

In recent years, the idea of giving small loans to poor people became the darling of the development world, hailed as the long elusive formula to propel even the most destitute into better lives.

Actors like Natalie Portman and Michael Douglas lent their boldface names to the cause. Muhammad Yunus, the economist who pioneered the practice by lending small amounts to basket weavers in Bangladesh, won a Nobel Peace Prize for it in 2006. The idea even got its very own United Nations year in 2005.

But the phenomenon has grown so popular that some of its biggest proponents are now wringing their hands over the direction it has taken. Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 percent or more.

Though pressuring banks to lower high interests might be possible as more and more prominent leaders speak out, the reality of the situation is more complex than expected:

Mr. Yunus says interest rates should be 10 to 15 percent above the cost of raising the money, with anything beyond a “red zone” of loan sharking. “We need to draw a line between genuine and abuse,” he said. “You will never see the situation of poor people if you look at it through the glasses of profit-making.”

Yet by that measure, 75 percent of microfinance institutions would fall into Mr. Yunus’s “red zone,” according to a March analysis of 1,008 microlenders by Adrian Gonzalez, lead researcher at the Mix. His study found that much of the money from interest rates was used to cover operating expenses, and argued that tackling costs, as opposed to profits, could prove the most efficient way to lower interest rates.

Many experts label Mr. Yunus’s formula overly simplistic and too low, a route to certain bankruptcy in countries with high operating expenses. Costs of doing business in Asia and the sheer size of the Grameen Bank he founded in Bangladesh allow for economies of scale that keep costs down, analysts say. “Globally interest rates have been going down as a general trend,” said Ms. Javoy of Planet Rating.

Many companies say the highest rates reflect the costs of reaching the poorest, most inaccessible borrowers. It costs more to handle 10 loans of $100 than one loan of $1,000. Some analysts fear that a pronounced backlash against high interest rates will prompt lenders to retreat from the poorest customers.

But experts also acknowledge that banks and others who dominate the industry are slow to address problems.

On it’s blog, Kiva addresses some questions raised by the New York Times article. Interestingly, it stands behind LAPO, the Nigerian microloan non-profit criticized in the piece for its high interest rates and “forced savings” practice, where the lender keeps a portion of the loan.

Kiva makes the point that lending to the poorest tends to cost more due to a lack of infrastructure that we take for granted. It also points out that LAPO is innovative in its lending practices, thus providing further benefits to its borrowers. This point makes me question the reporter’s analytic, numbers-and-stats perspective of the situation, versus the more nuanced perception of Kiva, familiar with tangential issues relevant to microlending.

In any case, I hope we don’t see one more example of greedy banks gorging their bottomless bellies at the cost of people needing the most help to help themselves.