Microfinance

I have been wanting to write on microfinance for quite some time and I thought that tonight would be as good of a time as any. Awareness, at least in my case, of microfinance has been rising quickly. I was first introduced to microfinance by Dave McClure of SimplyHired.com who works with and evangelizes Unitus, a microfinance accelerator. Before I get ahead of myself I suppose I should explain the basics of microfinance.

The integral piece of microfinance is what is called microcredit. Microcredit is giving out what we in the US would consider very small loans to the poorest of the poor around the world. The individuals who receive these loans are not "bankable" in any sense of the word. They have no collateral, an unsteady work history and no verifiable credit history. Microcredit is an innovation in the world of finance that originated in developing nations where it has successfully enabled extremely impoverished people to engage in self-employment activities that allow them to earn an income, but more importantly, build wealth and exit poverty. Although there were a lot of people who thought the idea would fail back when it began in the 1970s, microcredit has shown that it has staying power with the UN declaring 2005 as the International Year of Microcredit and a documentary (Small Fortunes) on microcredit being aired on PBS.

Below are the six fundamental principles of microfinance as found in the wikipedia entry:

1. A savings|investment as preferable aid
2. Entrepreneurial talent and energy are scarce invaluable resources for economic growth
3. Traditional private banks should not be expected to offer microcredit
   
4. A new generation of banking institutions [and the banking professionals to run them] is arising
   
5. Poor entrepreneurs possess the same survival skills as the toughest, most affluent business operators
6. A radically efficient, large-scale, NEW banking operating infrastructure required

The first of the fundamental principles hits home with me. I love the microfinance concept for the sheer fact that it teaches people to fish so that they can eat forever rather than giving them a fish which only allows them to eat for one day. Sometimes we think that helping someone equates giving them a handout of some sort. However, I believe that helping someone to help themselves is the best method. At the end of the day the person is not only better off but their pride is restored because they know that they have created a sustaining business and will not have to struggle again the next day to find another handout.

Just because these people live in poverty does not mean that they can't pull themselves up from their bootstraps with a little money and start a business that can support their family. They are smart and resourceful. As principle five points out, these microfinance entrepreneurs have the same survival skills as the toughest, most affluent business operators. These people have more to lose as well. If their business doesn't work than they can't feed their family. If a Fortune 500 CEO fails he is let go with a nice golden parachute and is most likely a multi-millionaire. Microfinance entrepreneurs need to make it happen.

Now that we have gone over some of the major strengths of microfinance I think it is only fair to touch on some of the criticisms. There is a concern that microfinance programs divert funds away from infrastructure projects (health/water/education) that are badly needed. I agree that these programs are needed in conjunction with microfinance to form a complete solution and can't comment on whether or not infrastructure problems do in fact suffer due to loss of funds to microfinance. Another problem people have pointed out with microfinance is that they believe some microfinance institutions charge excessive interest rates. This may have been the case in the past but I believe that with the advent of major microfinance organizations like Unitus this will be eliminated.

Some other concerns as listed in the microfinance wikipedia entry:

• Turning a profit on the loan
• Inability to reach the poorest of the poor
• Microcredit dependency
• Durability of poverty reduction

I am personally OK with profits being generated on the loans because that is how business works. Again, it comes back to treating impoverished people like people, like true entrepreneurs. When they take a loan to start a business they should pay interest. The money is not a handout and should not be thought of as so. I believe that people are happy to pay the interest especially when they see a great business developing in front of their eyes through their own blood, sweat and tears. The microcredit dependency problem falls along the same lines as the loan profits in the sense that the entire developed world is dependent on continual access to credit so why should the developing world be any different? The lessons of microfinance will apply all the way through an individual's, and even a country's, growth from "developing" to "developed."

I am excited to see what the future holds for microfinance. Unitus is taking large steps as far as making the microfinance world more connected and making it easy for investors to place money into programs. There is another organization which I have begun to help out on a project basis that I think is doing some very interesting things. The organization is called Seed Capital and they are working on a way to integrate web technology into the world of microfinance. I am not sure what they want said publicly at this point so I will stop there but I urge you to bookmark their site and check back for the release of their innovation. It will allow us all to easily become microfinance investors and start helping impoverished people help themselves. We can all be VCs with microfinance. Uh oh! I am going to have to change the name of this blog!