By Julio Godoy
For several decades, microcredit presented itself as a magical and benign financial tool for the poorest people in the world, who were otherwise completely excluded from conventional commercial banking services, to secure easy access to loans in order to set up their own businesses and live a dignified life.
Such was the hype surrounding the concept of microfinance that in 2006 its leading practitioners, the Bangladeshi economist Muhammad Yunus and his Grameen bank, received the Nobel Peace prize for, as the Nobel Foundation in Stockholm put it, “their efforts through microcredit to create economic and social development from below.”
Such prestige quickly lured activists, investors, and tycoons like Bill Gates, George Soros, Bono, William and Hillary Clinton and even the Queen of Spain, to fund and endorse microfinance projects around the world.
Now, new evidence suggests that even microcredit was not protected from the greed that characterises modern international finance.
Two recent studies show that microfinance was simply another profit making scheme for global private finance corporations, such as the Deutsche Bank, Citigroup, and Standard Chartered, who started pouring money into microcredit initiatives.
In his book, ‘Confessions of a Microfinance Heretic’, released Jul. 9, former investment banker Hugh Sinclair claims that such banks and funds use microcredit, through local operators, to charge usurious interest rates – of up to 200 percent – on even the smallest loans.
Sinclair said in an interview that microfinance has been “hijacked by profiteers”. According to Sinclair’s interpretation of the microfinance business, “neither (is) the entire sector evil, nor (is) the basic model fatally flawed.” Still, he argued that most of the financial sector involved in the business does not care about microcredit’s actual impact on poverty reduction.
By his own account, Sinclair worked with several microfinance institutions and funds in countries such as Mexico, Mongolia, Nigeria, and Mozambique.
“I couldn’t help but notice that even with a booming 70 billion-dollar industry on their side, the poor didn’t seem any better off in practice,” he told IPS. “Exorbitant interest rates led borrowers into never-ending debt spirals, and aggressive collection practices resulted in cases of forced prostitution, child labour, suicide, and nationwide revolts against the microfinance community.”
European Investment Bank under fire
Similar criticism constitutes the backbone of yet another study, focused on the European Investment Bank (EIB)’s approach to microfinance in developing countries.
The study, by Italian economist Valerio Carboni, was published last June by Counter Balance, a European coalition of development and environmental non-governmental organisations, formed in 2007 specifically to challenge the EIB.
“Microcredit originally was meant to help the poor to escape the poverty cycle,” Carboni recalls in his report. Microcredit “was designed to short circuit the poverty trap that condemned poor people excluded from the banking system to rely on usury loans or accept slavish working conditions.”
Hence, Carboni concludes microfinance addressed primarily the needs of micro entrepreneurs and vulnerable people.
Western governments, through their financial agencies, have for the last three decades been pouring funds into local microfinance initiatives in emerging markets, and helped to turn the original niche sector into a multi-billion-dollar business.
It was in this context that the EIB started its own microfinance activities. Carboni pointed out that though the EIB’s microfinance portfolio still represents a very small fraction of its total budget, it has been growingly steadily through the years.
“Since the EIB’s first operations in Morocco, back in 2003, the average deal size has been increasing constantly and is now expected to hit 10-50 million dollars,” Carboni told IPS. According to the EIB’s own figures, the bank has, since 2003, committed some 881 million euros to microfinance activities, in nearly 50 countries.
“Nowadays microfinance encompasses a wide range of financial services, from micro-insurance to mobile banking, and seems to have lost its original vocation: instead of helping the poorest the question has been turned upside down and it is now how to make money out of them,” Carboni added.
Due to these changes, microfinance is no longer contributing to self-reliant development processes based on domestic resource mobilisation and local institution building, but has instead become “in some cases a significant blockage for the development of the poorest by dragging them into speculative market dynamics and generating a renewed dependency on international financing and actors”.
Carboni’s primary critiques of microfinance in general, and of the EIB’s activities in the sector in particular, are that there is a general lack of strategy and vision. “The EIB just follows the markets,” Carboni said.
He also lamented the fact that in countries with limited capital markets, “the EIB is simply involved in investment projects, rather than in reaching out to the poor.” Furthermore, he said, “the accountability chains are long and obscure, and the management of portfolio is insufficient.”
Sinclair called attention to the lack of regulation on microfinance. “The ultimate investors are not in practice protected by any meaningful regulation, have a limited idea of what their funds are being used for and rely entirely on the funds to reassure them,” Sinclair writes in his book.
While none of the private financial corporations questioned by Sinclair’s book have reacted, the EIB issued a statement in which it “recognise(d) the challenges posed by the lack of standardised social performance measurements used by both microfinance investors and donors”.
But the EIB added that, as an active member of the Social Performance Task Force (SPTF), it has contributed to the establishment of the Universal Standards for Social Performance Management.
The SPTF, a coalition of over 1,000 academics, agencies, donors, investors, and others active in international microfinance founded in 2005, formulated a common social performance framework and an action plan to improve the industry’s social performance.
The SPTF defines social performance as the effective translation of a microfinance organisation’s mission into practice in line with commonly accepted social values.
The EIB also recalled that it has endorsed the Client Protection Principles in microfinance, which are incorporated in all microfinance contracts to encourage improved social responsibility and have helped improve best-practices across the microfinance industry.
