Microfinance Charity

Microfinance is the practice of providing loans and other financial services (such as savings accounts or insurance) to poor individuals (largely) in the developing world.

Assessing the impact of microfinance charities is difficult, partly because microfinance is commonly portrayed in misleading ways. (See also our discussion of "6 myths of microfinance.")

We would guess that microfinance as a whole has done a great deal of good, but has also probably done some harm. In the past, we have reviewed many microfinance organizations including most of the largest ones.

Our current view is that microfinance is not among the best options for donors looking to accomplish as much good as possible.

For donors intent on supporting a microfinance organization, we suggest the Small Enterprise Foundation, which stood out most in our previous investigations of microfinance and which we have visited. For those interested in learning more about microfinance, we recommend the book Due Diligence.

Published: May 2012

How do charities help?

Microfinance organizations generally provide financial services - particularly loans, savings, and insurance - to people who are unable to obtain these services via traditional banking.

Microfinance is different from how it is usually presented. We feel that much discussion of microfinance - particularly microlending - is clouded by commonly held, appealing myths that have little or no basis in reality. Our 2009 blog post, 6 myths about microfinance charity that donors can do without, discusses and debunks myths including "microfinance has been shown to reduce poverty," "microfinance has been shown to work best when targeting women," and "microfinance donations get lent out again and again, and thus leveraged far more than other donations."

One point we feel most donors are particularly misled on is the question of how people use, and benefit from, micro-loans. Microlending is often presented as a way to help people escape poverty by giving them the capital to start or expand small businesses. However, the reality appears more complex: it appears that loans are often used for food, visits to the doctor, and other consumption. This isn't a bad thing - the poorest people in the world face considerable financial uncertainty, and loans may empower them to manage their own lives.

For those interested in learning more about microfinance, we recommend the book Due Diligence.

What are the challenges of finding a great microfinance charity?

There does not appear to be strong direct evidence that microfinance improves clients' incomes (or other measurable aspects of well-being), and the highest-quality studies of microloans in particular do not appear to show strong effects. (See our discussion of these studies on our blog as well as a more recent update by David Roodman of the Center for Global Development, whose work in this area we are very familiar with and believe to be of high quality. )

Most microlending institutions do report data on their interest rates and repayment rates, and one take on microfinance is that when clients are taking out loans at relatively high interest rates and paying them back, this itself is evidence that the clients are being empowered (see our discussion with David Roodman). However, in examining microlending organizations, we have generally seen high dropout rates many clients seem to pay back their loans but drop out of the program), and have seen some reasons to be concerned that loans can do harm as well as good to the borrowers. (See our discussion on our blog.)

Previously, we examined microfinance organizations using a set of critical questions both about microlending and microsavings. In searching for institutions with strong answers to these questions, we found that:

The large U.S. microfinance charities were rarely clear about their value-added.

To the extent that we were able to obtain and review due diligence on partners (most of which is unfortunately confidential), it seemed focused on financial performance, with much weaker examination of social impact-related questions. (See also our discussion of the NIgerian organization LAPO as a case study.)

There is an argument for focusing on financial performance over social impact, in the hopes of creating self-sustaining microfinance institutions and reaching as many people as possible. However, we have concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). We found that organizations hoping to use donations to start for-profit microfinance institutions are (perhaps for good reasons) rarely willing to share substantive information about their track record.

Another obstacle to finding great microfinance charities is the fact that telling oversimplified stories, and using oversimplified numbers, seems so widespread in the sector. See our posts on the potential difficulty of understanding a microfinance institution's true interest rates and repayment rates.

We have done substantial investigation of microfinance organizations and have not seen it pay off in finding outstanding giving opportunities, so for the time being we have de-prioritized this area (though we may revisit it at a later point).

Giving to microfinance organizations

In a research process conducted from 2009-2011, we identified microfinance organizations to contact, completed in-depth reviews of promising organizations and identified the Small Enterprise Foundation (SEF) as a standout organization. SEF is a microfinance institution operating primarily in the Limpopo province of South Africa. SEF demonstrated a strong focus on collecting the information necessary to assess its social impact, including (a) data on how many clients are dropping out of the program (and why), and (b) data on whether SEF is succeeding in its attempt to target people with very low incomes. We also had a positive impression of SEF when we visited its operations in South Africa (see our site visit notes).

That said, we have concerns about SEF's social impact, particularly regarding its substantial dropout rates, and we have not followed up on its progress since early 2012.

Introduction to Microfinance Institutions (MFIs) Part I

I joined the Calvert Foundation investments team in 2012 to manage our microfinance portfolio. Given how long it took me to sort out all the different players, I thought I’d try to make it easier for other microfinance newcomers by writing a series of blogs on the industry and its component parts.

This blog series will attempt to answer some of the common questions about microfinance using examples from our portfolio, but it won’t include a lot of beneficiary stories. If you are more seasoned in microfinance, read our microfinance sector profile and Impact Report. For deeper information on the topics in this post check out the Microfinance Gateway.

What is a microfinance institution?

An estimated 2 billion people globally lack access to basic financial services, according to the World Bank. At a basic level, I would define a microfinance institution (MFI) as a financial institution that provides small loans to people who otherwise wouldn’t have access to credit. The definition of “small loans” depends on the geographic context. India defines microfinance as loans less than 1 lakh which is about $1,500 today while the US SBA defines microloans as loans less than $50,000. It’s important to remember that there is no globally defined amount. India and the US are the only countries that even have defined limits (as far as I know). In this blog, I’ll be focusing on international microfinance, outside the US.

Why do MFIs charge such high interest rates?

The small size of the loans is directly related to the high interest rates that MFIs tend to charge. You might expect MFIs to charge low interest rates because they serve poorer segments of the population, but in fact the opposite is true. To serve the base of the pyramid, you need to provide small loan amounts, and small loan amounts are much more expensive to provide operationally than large loan amounts. If an MFI wants to be self-sustainable--meaning not dependent on grants--they need to charge a high enough interest rate to cover their costs.

Microfinance impact

There is an ongoing debate over whether the goal of microfinance is poverty reduction or financial inclusion. Part of the debate stems from the lack of studies (PDF)that show microfinance as an effective poverty reduction tool. However, there is still general agreement that microfinance helps improve the lives of the clients it serves. While we may still be waiting for studies showing microfinance alleviates poverty, it is clear that microfinance is helping create institutions that are improving the lives of the people it serves.

Should all MFIs scale?

Another ongoing debate is around the commercialization of microfinance. Take for example Kompanion in Kyrgyzstan and Fonkoze in Haiti, both in our portfolio. Both MFIs operate in very poor, small countries. The combined GDP of both countries is less than ½ of Vermont, the smallest state in the US.

Kompanion has scaled using only commercially-oriented debt and equity (from SRI lenders), while Fonkoze still receives grants/donor funding. This is also reflected by the relationship each MFI has with its US non-profit shareholder. Kompanion may be a potential source of income for its founder, Mercy Corps, by paying future dividends. On the other hand, Fonkoze US is primarily a source of capital and aggregates both social investments and some donations that are used to support Fonkoze operations in Haiti until they are able to make the transition to being completely self-sufficient. These differences are partially reflected in their respective balance sheet sizes of $80mm and $20mm, respectively.

We don’t believe one approach is better than the other. It is important to have both, because both reflect the diverse needs and experiences of MFIs around the world. There are many MFIs that are much larger or more commercial than Kompanion and many MFIs that are much smaller or socially-oriented than Fonkoze.

It’s clear that scaling up requires commercial capital. To attract that capital you need to be self-sufficient, and it is difficult to be self-sufficient in challenging operating environments or if you provide many non-income earning services to clients. While Kompanion and Fonkoze are at different points along the social/commercial spectrum, I consider both to be part of the investable MFI universe of around 500 MFIs globally. According to responsAbility, there are an estimated 10,000 additional MFIs that probably don’t have the operations, structures or processes required to take and repay a commercial loan from an international investor.

An MFI scale model in Kyrgyzstan (with an interest rate example)

Kyrgyzstan is a small, landlocked, mountainous country in Central Asia. With a population of 5 million (estimated 1 million working in Russia), they gained their independence from the Soviet Union in 1991. I was there from 2009-2012 and in 2010 there was a revolution, their second since independence. This is a good example of the type of headline risk that scares off traditional investors. While many people were directly affected, the longer-term impact was more political than economic. The resulting turmoil caused the largest commercial bank in the country to shut down because of its political connections but in the end no MFI defaulted on any of their international loan obligations.

Kompanion is an MFI in Kyrgyzstan established in 2004 when Mercy Corps consolidated five affiliated loan programs. By 2011, there were close to 400 MFIs in Kyrgyzstan with a combined loan portfolio of $450mm (for an average MFI loan portfolio of $1.1mm) serving 400,000 borrowers (for an average end borrower loan size of $1,100).

Kompanion clients. Photo courtesy of Kompanion.

While originally founded with grant capital, today Kompanion completely funds itself through commercial sources: equity, debt, deposits, and retained earnings. With a loan portfolio of nearly $70mm they are the 3rd largest MFI in Kyrgyzstan after Bai Tushum and FINCA Kyrgyzstan, according to the MIX. Kompanion currently has about 100,000 borrowers for an average loan size of around $500. When I was an intern at Kompanion in 2009, their average loan size was $300 and their portfolio yield was around 60% (portfolio yield is calculated as interest income divided by loan portfolio and is used as a proxy for the average rate MFIs charge on the loans they make). One day I gave a talk to a group of Peace Corps volunteers and put together something like the following table to illustrate the effect of loan sizes on operational sustainability.

Impact of doubling loan size

Row (2), interest income, represents portfolio yield in the % of total columns (B) and (D). Row (3), cost of capital, is how much it costs for an MFI to borrow the money it uses to on-lend. This is a variable cost, the more money the MFI borrows to on-lend, the more interest they will pay. The assumed rate includes things like hedging costs and provisions for expected losses. Row (4), operating expense, is mostly salaries and assumed to be fixed, it doesn't automatically go up if you just increase the average loan size. Row (6), net income, is assumed to be zero, break-even.

This very simplistic example shows how if you do nothing else besides double the average loan size you can drop the rate you charge from 60% to 40% with no impact on your bottom line. That is because of the operating leverage you get from fixed costs of mostly salaries of loan officers. For example, a loan officer with 300 clients would go from representing $90,000 in loan portfolio ($300 average loan size x 300 clients) to representing $180,000 in loan portfolio ($600 average loan size x 300 clients).

Impact for one loan officer assuming 300 borrowers

Today, Kompanion’s portfolio yield is around 40% and each loan officer sees an average of around 260 clients, with an average loan size of about $500. What typically happens is that an MFI will be forced to lower its rate as competition increases. The impact of the lower rate is offset by increased efficiency from general economies of scale as well as larger loan sizes as repeat borrowers seek larger loans.

A direct service MFI model in Haiti

Fonkoze is another MFI in our portfolio. Fonkoze was founded in 1994 by Father Joseph Philippe, a Catholic priest. Fonkoze operates in Haiti, an extremely challenging environment, which is also why the services they provide are so important. Haiti is the poorest country in the Western hemisphere and also particularly vulnerable to natural disasters such as the earthquake in 2010 that killed over 100,000 people and more recently Hurricane Matthew in October 2016.

A Fonkoze-funded entrepreneur in Haiti. Photo courtesy of Fonkoze.

Fonkoze’s clients are a good illustration of what we mean when we talk about impact in the context of poverty alleviation. Their clients may still be poor after taking a loan but their lives have improved based on several indicators Fonkoze collects. After two years, the percent of clients living below $1/day drops only slightly from 53% to 51% but the percent food insecure drops more, from 72% to 63%, and their average savings increase from $13 to $30 .

We made a small investment in Fonkoze over 10 years ago to support their transformation to a legal for-profit and are happy to continue supporting Fonkoze indirectly through other loans. Our current borrower MCE Social Capital has a loan to them and our borrower Oikocredit has invested equity.

Over to you

My goal in this post was to provide an intro to microfinance and discuss some of the common questions about microfinance institutions. Did I miss anything important? What would you add? I invite you to leave a comment below.

In my next post, I’ll give an overview of microfinance networks as owner/operators of MFIs.

Ready for the next post? See Part II and Part III.

If You Went To These Schools, You May Qualify For Student Loan Forgiveness: Here’s What To Do

WASHINGTON, DC - JANUARY 27: U.S. Education Secretary Miguel Cardona delivers remarks at the ... [+] department's Lyndon Baines Johnson Building on January 27, 2022 in Washington, DC. (Photo by Chip Somodevilla/Getty Images) Getty Images

Hundreds of thousands of borrowers may qualify for federal student loan cancellation under a program designed to address school misconduct.

Several developments in the last few weeks initiated by both the Biden administration and student loan borrowers will have sweeping impacts on eligibility, and could dramatically expand student loan forgiveness availability. Here’s what you need to know.

Student Loan Cancellation Due to a School’s False Promises and Misrepresentations

The new developments concern Borrower Defense to Repayment — a federal student loan discharge program designed to remedy certain forms of school misconduct. Borrowers can apply for federal student loan forgiveness if a school misled them about key aspects of their program such as admissions selectivity, job or income prospects, or transferability of credits.

According to the Department of Education, “Under the Borrower Defense to Repayment [program], certain conduct by a school you attended might make you eligible to receive a discharge of some or all of your federal student loans... The most common types of conduct that might make a borrower eligible for loan relief... are misrepresentations of the truth made by the school or its representatives during their efforts to recruit you to enroll at the school or to continue your enrollment at the school. These misrepresentations typically take the form of untruthful representations of the school's selectivity in admitting students, its rankings... the job placement and earnings outcomes of its prior graduates, or the likelihood that its credits will be accepted by another school.”

But the Borrower Defense to Repayment program has been plagued by political, legal, and bureaucratic challenges since regulations governing the program were first enacted in 2016. The program rules have been changed several times, and tens of thousands of applications have been denied or have remained unprocessed, in some cases for years.

Student Loan Forgiveness for Corinthian College Students

Earlier this month, the Biden administration announced that it would be automatically cancelling $6 billion in federal student loans for over half a million former students of Corinthian Colleges — a now-defunct national chain of for-profit schools that included Everest College, Heald College, and Wyotech.

Several lawsuits, investigations, and enforcement actions brought against the schools alleged that the Corinthian schools intentionally misrepresented job placement rates, engaged in false advertising, and misled prospective students abut the transferability of their credits. When Corinthian colleges shut down in 2015, former students were left with useless degrees (or no degrees at all) and significant student loan debt burdens. Dozens of these former students organized a debt strike that year to convince the government to cancel their debts. This eventually led to a formal regulatory and application regime for the Borrower Defense to Repayment program.

But after the program was created, tens of thousands of applications languished. In an effort to speed up processing, the Biden administration will be cancelling the federal student loan debt associated with any student’s attendance at Corinthian Colleges. Importantly, to benefit from this initiative, borrowers do not even need to submit a formal Borrower Defense application.

"As of today, every student deceived, defrauded, and driven into debt by Corinthian Colleges can rest assured that the Biden-Harris administration has their back and will discharge their federal student loans," said U.S. Secretary of Education Miguel Cardona in a statement announcing the initiative.

Student Loan Forgiveness For Borrowers Covered By New Settlement Agreement

In a separate development, the Department of Education and a class of student loan borrowers announced a settlement agreement last week in Sweet v. DeVos, a lawsuit brought by borrowers against the Department several years ago over stalled Borrower Defense applications.

Under the terms of the settlement, any borrower who submitted a Borrower Defense to Repayment application before June 22, 2022 and went to one of the schools covered by the agreement would have their federal student loans cancelled and any payments refunded. Over 200,000 borrowers may benefit from the agreement. The covered schools include (but are not limited to):

American Career Institute

Argosy University

The Art Institute

Charlotte School of Law

Colorado Technical University

DeVry University

ITT Technical Institute

Kaplan College

Le Cordon Bleu

New England Institute of Art

Ross University School of Medicine

University of Phoenix

The full list of covered schools can be found here. Importantly, the court must approve the settlement proposal before any student loan forgiveness can be implemented.

Even for borrowers who have not yet submitted a Borrower Defense application yet, it’s not too late. While only borrowers who submitted applications by June 22, 2022 would be covered by the automatic student loan cancellation benefits of the settlement, borrowers who submit a Borrower Defense application between June 22, 2022 and the date of final approval of the settlement (which could be months away) would be entitled to a final decision from the Department of Education within 36 months; if no final decision has been made by then, the borrower would be entitled to student loan cancellation.

In addition, the Department of Education has made clear that borrowers who attended one of the covered institutions may stand a reasonable chance of approval for student loan forgiveness. The settlement agreement states that “attendance at one of these [listed] schools justifies presumptive relief [under Borrower Defense to Repayment]... based on strong indicia regarding substantial misconduct by listed schools.”

Resources for Borrowers Seeking Student Loan Forgiveness Through Borrower Defense

For more information on the Sweet v. DeVos case and the associated settlement, the Project on Predatory Student Lending — which has been representing the student loan borrowers in the lawsuit — has set up a detailed information website. The site includes a flow-chart illustrating who may benefit from the settlement agreement, as well as a comprehensive list of schools that are covered.

Borrowers looking to submit a Borrower Defense to Repayment application can do so via the Department of Education’s website. The application is long and somewhat complex; borrowers can check out this detailed guide on how to complete the application.

Further Student Loan Reading

Education Department Approves $8.1 Billion In Student Loan Forgiveness Under Expiring Program — Will Biden Extend It?

264,000 Borrowers Will Get $6 Billion In Student Loan Forgiveness In ‘Landmark’ Settlement Agreement With Biden Administration

Biden Reportedly Nears Decision On Widespread Student Loan Cancellation — Here’s Where Things Stand

Want Student Loan Forgiveness? To Qualify, Borrowers May Need To Do This First