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David Roodman's Microfinance Open Book Blog

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This is a reply from Hugh Sinclair to my review of his book. If you haven't read the book, I think you will get a good sense of his views and style from this post. ---David Roodman

Fury and delight: I thank David for performing “due diligence” on my book, and am pleased to see genuinely new issues appear to be attracting attention, long over-due perhaps. Identifying where yet more scrutiny is required in the embattled microfinance sector can only be a constructive development. The mysteriously over-looked principal-agent problem is indeed the central theme of my whistleblowing book, and to refer to my suggestions as laughably conservative may be premature. I am suggesting a new degree of scrutiny and regulation be applied to those entrusted to manage a significant proportion of capital flows to MFIs. Start asking too many questions about their activities and impact, or, God forbid, regulate the likes of Kiva - and such suggestions may not generate laughter amongst our trusted intermediaries.

The book is an insider’s memoir, and not a text-book. It is aimed at the non-academic audience; the (wo)man on the street, who is largely spared the subtleties of these blogs and quasi-academic debates, and yet maintains a limited, at times uninformed impression of the wonders of microfinance. Insiders know this idealism, optimism or hype, is fantasy, but the (wo)man on the street usually does not. I attempt to plug this gap. We are not all experts in everything, sometimes we have to trust the experts, but in microfinance extreme caution is required.

The NYT article alas discussed LAPO in minimal detail, and failed to mention one key supporter of LAPO: Grameen Foundation USA (also of Washington DC, also guarantor for the Citi and Standard Chartered loans to LAPO). The irony of such a supporter, given Muhammad Yunus’s traditional stance on interest rates, will be lost on few. It is true that I do not define the zealots by name, though a sample of their institutions are listed, as are a few individuals. Neither do I name the exploited poor individually: this is a nonfiction novel, not a telephone directory.

Evidence that loans don’t tend to go towards entrepreneurial activities is stated rather clearly. The Harvard Business Review article “Beware Bad Microcredit”, referenced in the book and available on the website, is a good source of data from respected practitioners and individuals. The recent Banana Skins report 2012 states over-indebtedness (i.e. excess of microcredit) as the single greatest threat facing the sector, and the recycling of loans in the great Ponzi scheme of debt spirals as witnessed most recently in Nicaragua is clearly described. It should come as little surprise that most MFIs fail to report on the proportion of their loan capital spent on consumption or for refinancing loans from other institutions, if they even bother to collect such data. We need to look elsewhere for evidence and clues. John Hatch (founder of FINCA) suggested that 90% of microcredit is directed to consumption – perhaps David has more reliable information on this estimate? My personal gut-feeling (note: opinionated, uncorroborated gut-feeling) is that it is closer to three-quarters perhaps, but preferring instead to cite a respected, independent practitioner in a worthy publication, I went with the Hatch estimate. The text following the Hatch reference, not cited in the book for the purpose of brevity, reads as follows:

Abhijit Banerjee and Esther Duflo [highly respected academics], of MIT’s Poverty Action Lab, recently evaluated dozens of rigorous studies on the economic lives of the poor, finding that regardless of country or continent, very little of each additional dollar of disposable income is spent on any form of investment, or even on food and shelter. In Bangladesh, where in 2001 approximately one out of four households had at least one microloan, microcredit seems to have had little impact on the country’s relative development performance. In 1991, for example, Bangladesh ranked 136th on the UN Development Programme’s Human Development Index (a measure of societal well-being); 15 years later it ranked 137th. And aside from the shortage of data showing benefits, there is evidence that some microcredit programs may actually be harmful, plunging the poor deeper into debt.

Even if we assume it is “only” 50% - does that add up with the claims on the websites? Show me an MIV that openly advertises “Half our loans finance micro-businesses, the other half refinances loans from other MFIs or good, old-fashioned consumption”, rather than bury such topics on the CGAP website for insiders to mull over. MIVs can’t even seem to publish the interest rates their investees charge the poor, so can we expect them to come clean about the actual use of loans?

MIVs are underpaid, and in many cases not very profitable. I believe my explanation of how an MIV operates is clear, and distinguishes between debt and equity investments, which many MIVs combine regardless of the obvious conflicts of interest involved. The examples of massive profiteering (SKS, Compartamos etc) were clearly stated as equity related. It is not the MIV who lends $1 million at 10% a year to an MFI that makes such astronomical returns, but the MIV who can slip in some equity investments alongside often “soft” loans that stand to gain.

There is some confusion over LAPO, and I go to lengths to cite independent, publicly available documents. I did not discover any family members at LAPO, I read it in their 2005 annual report, a feat that presumably evaded most of their investors. The other family members were discovered by Planet Rating I believe – which came as quite a shock to me. Are there more?

But then we have David’s only serious weakness in his review. In a nutshell David suggests: LAPO may not be “squeaky clean”, but it’s better than nothing. Grameen Foundation suggest that if a loan at 126% is cheaper than the money-lender rate, this is okay. It is only here that I take serious issue with David. LAPO is a long-way off from squeaky clean and by no means unique. By supporting and rewarding such an institution with substantial capital after rating withdrawals, a major rating downgrade, manipulative interest rate policies, nepotism, operations described quite simply as illegal, extortionate interest rates despite high profitability, chronic client desertion etc. we set a disturbing precedent. To fail to transmit this information honestly to the investors of the MIVs sets a second disturbing precedent. And to justify such behaviour with reference to (also) illegal moneylenders as some benchmark of good practice sets a third. Turning a blind eye is what got us into this mess, and justifying such actions on the basis of “someone else is worse” – history is full of such false relativisms - is unlikely to get us out of it. No one criticised Yunus when he lamented the MFIs becoming loansharks – so why are the likes of Grameen Foundation investing in LAPO – because we haven’t defined “loansharks” yet? “Extortionate” is another word the sector has collectively, and conveniently, failed to define. Yunus suggested a rule of thumb of cost of capital plus 15% is a reasonable interest rate. What does he make of LAPOs interest rates, and of Grameen Foundation’s support of the institution? This remains an open question.

Finally, as David accurately observes, I do not provide a neat solution to rid the world of poverty. Had I one, I would probably have published it by now. But I do provide very clear advice to the man on the street, my target audience, on how to avoid getting duped. I provide substantial evidence that he or she is being duped, and this book will hopefully empower the non-academic, the non-practitioner, the non-expert to make a more informed decision about how to wisely invest in microfinance for the actual benefit of the poor. In a word – beware.

A hypothesis may be challenged by the accuracy of its predictions, and here lies a valid criticism of my book which none have picked up on. I anticipated vitriolic attacks from those named, as has occurred previously as I describe. In fact none have dared to comment - yet. Even the likes of Calvert Foundation, World Relief and Grameen Foundation failed to attack while I recently spoke in DC – the lion’s den. Deutsche and Citi have remained silent, and we eagerly await Triple Jump’s press release. Holland’s ethical bank ASN, as well as Oxfam Novib, have remained ominously silent. BlueOrchard have kept quiet, which is surprising given their vocal (but flawed) statement in response to the NYT article on LAPO when they defended their investment. As David pointed out, I dedicate substantial space to Kiva (the main face of microfinance to the typical US lender), but not a squeak from them despite their knee-jerk reactions to previous criticisms. One almost suspects they are desperately hoping this issue will blow over. Those with nothing to hide have nothing to fear.

Microfinance has been left to the “experts” for more than 30 years, with the taxpayer, armchair investor or development enthusiast mainly being used as the ultimate source of easy money and easy support; my book paints a picture of the results, as seen from the inside. Instead of justifying our actions, it is time to take stock. We’ve suffered a catastrophic mission drift, and we need to place the interests of the poor firmly back in the centre of the equation. Creating an industry is good and fine (David’s main defence of microfinance), but it needs to actually work. This shock therapy will certainly irritate some – mostly those who benefit from microfinance investing. They are remaining rather quiet currently, no doubt hoping this will all blow over and they can revert to business-as-usual. I hope for the opposite – that this sparks genuine debate that encompasses the entire chain of microfinance, including the man on the street who provides much of the fuel and enthusiasm for the sector. Let’s start the real microfinance revolution, and be clear about who we are fighting for.

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CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.