Muhammad Cronus?

It may not have been as terrifying as Francisco Goya’s depiction of Cronus devouring his children , but the article by microfinance pioneer Muhammad Yunus in today’s New York Times had disturbing echoes of the story from Greek mythology of the titan who, fearing that his offspring will overthrow him, eats them instead.

“In the 1970s, when I began working here on what would eventually be called ‘microcredit’, one of my goals was to eliminate the presence of loan sharks who grow rich by preying on the poor.” Yet, he laments, “I never imagined that one day microcredit would give rise to its own breed of loan sharks.” Who are these loan sharks who have betrayed the great man’s vision? Mr Yunus goes on to name and shame microfinance providers like Compartamos in Mexico and SKS in India, which have tried to turn his ideas into a for-profit business. If his Grameen Bank can serve the poor by offering loans at an interest rate of 20%, those charging a rate of 50% or more are, surely, exploiting the poor, he argues, warning borrowers and regulators to beware anyone levying interest of more than 25% a year.

This is not a new argument. Mr Yunus has been campaigning against the for-profit school of microfinance since back in 2005, when he got into a spat with philanthrocapitalist eBay founder Pierre Omidyar at the home of Silicon Valley venture capitalist John Doerr. We discuss this incident in the book where we argue that the Nobel Prize-winning Mr Yunus has got this one wrong.

Even in wealthy countries, poor people are often excluded from the mainstream financial system because they are an expensive client group to serve. There is little difference in the administrative cost to a financial service provider of offering a loan for $100 or $1,000 but the interest rate required to cover those administrative costs (as well as the cost of raising the money to lend) gets lower the bigger the loan.  A $100 loan at 50% would pay the lender $50 over a year, while $1,000 lent at 10% would yield $100.)

For some microfinance providers, like Grameen, the way to keep down the interest rate is to take deposits from clients to fund loans. That is all well and good for Grameen but financial regulations in many countries stop microfinance providers taking deposits and the capital has to come from somewhere else. And, given the limited supply of the sort of philanthropic donations that helped Grameen get started, the only plentiful supply of capital is for-profit investors.

Of the billion people living in poverty about 150 million currently have access to microfinance, so there is still plenty of unmet pent-up demand. Providers like Compartamos and SKS have grown quickly and therefore helped more people because they have engaged the for-profit capital markets (and as they have grown, they have passed some of the savings from scale efficiencies back to borrowers in lower interest rates). If Mr Yunus has his way, this supply of growth capital will be choked off and hundreds of millions of people will be left waiting for financial inclusion.

It is true that some borrowers in India have got into financial dificulties, and a few have committed suicide, which has inspired local politicians to attack the fast-growing microfinance industry. There are some lessons for the industry here. But the idea that leading commercial microlenders like SKS and Compartamos are loan sharks is outrageous. They devote considerable resources to ensuring their borrowers are financially literate and capable of repaying their loans. Compartamos has a non-performing loan rate of under 2%, which suggests very few its clients are getting out of their depth. Nor, unlike traditional loan sharks, do these institutions rely on violence or other heavy-handed methods to get their money back. On the contrary, they are committed to the rule of law and promoting best practice throughout the industry.

Mr Yunus supports the idea that governments should impose caps on the interest rate charged by microlenders. He says this should be no more than 15 percentage points above the cost of raising the funds to lend. In the case of Grameen, he says, that would be an interest rate of 25% – a number that, it would be easy to conclude, is not far off what he thinks would be the right cap on interest rates elsewhere. Yet in countries such as India and Mexico, where interest rates are significantly higher, the consequence of a rate cap of anything close to 25% would be a dramatic decline in the number of poor people able to get access to credit, at a time when demand for credit is as strong as ever.

Although Mr Yunus has been criticising for-profit microlending for years, it would be easy to conclude that this latest article has been prompted by the ongoing attack on him by the government of Bangladesh. As we noted recently, this attack is outrageous, undeserved and alarming. Yet in his article, Mr Yunus is full of praise for Bangladesh’s prime minister, Sheikh Hasina – who has been leading the criticisms of Mr Yunus, even calling him a bloodsucker (aka loan shark).

Mr Yunus has inspired many of the leaders of the for-profit microfinance movement. They would have much to learn from his constructive criticism. Instead, it seems, he has decided to try to deflect the attack on himself by encouraging an attack on his children. It is unworthy of him and, if you take the lesson from Greek mythology, a strategy that is unlikely to succeed (the one son Cronus failed to deal with, Zeus, eventually killed and usurped him).