Back in December, we expressed concerns about LAPO, one of Kiva’s largest microfinance partners. Last month, the New York Times ran an article implying criticism of LAPO. Now, Kiva has suspended its partnership with LAPO. A couple of questions this raises:

Which of the several objections to LAPO have led to the suspension?

Several concerns have been raised about LAPO:

• The New York Times article focuses largely on the high interest rates and forced savings (which cause the interest rates to be higher). We have argued that focusing on interest rates in isolation is a mistake.
• The Times article also raised concerns about LAPO’s transparency/accountability, including the question of whether it is collecting savings without the right legal license and the question of whether it is misleadingly presenting its interest rates to the outside world.
• To us, the most compelling concern about LAPO is its 49% dropout rate.

How many more of Kiva’s partners might have similar problems, and what is Kiva doing to address this concern?

As the case of LAPO shows, the interest rates reported to Kiva may not fully capture what clients are paying. More broadly, it appears to me that Kiva’s due diligence on partners is intended to assess the risk of money being lost and/or going to illegitimate organizations, but not the more difficult-to-assess risk encountered with LAPO: that a partner’s activities may be leading to overindebted, misinformed, and/or dissatisfied clients, and thus result in financial success but not positive social impact. The stories posted on Kiva’s website do not, in my view, help to address these risks either.

When the New York Times discovers a problem, makes it very public and causes change, this is a good thing. But I don’t think we can expect this mechanism to reliably address the broader issue. Kiva has had enormous success getting people excited about microfinance and getting capital to MFIs; I would like to see more work go into making sure those MFIs are benefiting the people they serve.

I’m very interested in the recent debate over microfinance interest rates (see our response to the NYT article, as well as Te-Ping Chen’s comments at Change.org).

It seems that realizing how high interest rates can be has been a wake-up call to many that microfinance can easily be doing damage as well as good. If someone is paying 150% interest a year, all it takes is some accounting errors for them to end up losing money and getting stuck in debt rather than helping themselves as intended.

But isn’t this concern equally valid for lower interest rates? The same people complaining about excessive interest rates imply that rates 10-30% above the cost of raising capital can be considered reasonable. 10-30% above the cost of raising capital is still significant - it’s more than most Americans pay on their credit card debt - and small losses could be especially risky and damaging to the very poor.

In my view, there is no substitute for asking tough questions about social impact and no excuse for donating to a microfinance charity that can’t answer them.

Recent coverage of microfinance has had a sharp focus on interest rates, implying some line between “reasonable” interest (associated with “social investment”) and “excessive” interest (associated with “loan sharking”).

In Nicaragua, President Daniel Ortega, outraged that interest rates there were hovering around 35 percent in 2008, announced that he would back a microfinance institution that would charge 8 to 10 percent, using Venezuelan money …

Damian von Stauffenberg, who founded an independent rating agency called Microrate, said that local conditions had to be taken into account, but that any firm charging 20 to 30 percent above the market was “unconscionable” and that profit rates above 30 percent should be considered high.

Mr. Yunus says interest rates should be 10 to 15 percent above the cost of raising the money, with anything beyond a “red zone” of loan sharking. “We need to draw a line between genuine and abuse,” he said. “You will never see the situation of poor people if you look at it through the glasses of profit-making.”

It seems very important that interest rates be transparent, i.e., clearly communicated to and understood by clients. It also is clearly important that there be no coercion, i.e., that clients not be pressured to take loans they don’t want to take. More debatable, but something that we support strongly, are additional measures to assess and improve the client experience, including monitoring overindebtedness, examining dropout rates, etc.

But if/when such things are in place, it is unclear to me on what grounds anyone can complain about interest rates being “too high.” If the terms of loans are clearly communicated, then I see no explanation for why clients would take out loans - unless they feel they have no better alternatives.

What objection can be raised to a 100% interest rate, if the next-best alternative is a 500% interest rate (as I have been told some informal moneylenders charge)? What objection can be raised to a 500% interest rate, if there is no other way for people to get credit? When a loan could result in a sick child’s being treated, or a profitable micro-business, what fee is too high for that benefit?

When MFIs charge more than they need to in order to make a profit, that’s an opportunity for someone else to come in and undercut them. If no one else is coming in, that implies that the costs and difficulty of providing credit in an area may be higher than they appear to an outsider. For an outsider to declare profit margins “too high” strikes me as ungrounded and unproductive, especially when that outsider has not tried to provide credit for less in the same area.

Microfinance exists to improve the lives of the poor. Ideally, then, microfinance institutions would be judged by their effects on people’s lives. Instead, they’re being judged by simplistic financial metrics that crudely attempt to get at the moral uprightness of the organizations. To me that’s a very familiar situation.

I believe the ideal way to evaluate an MFI is to look directly at its impact. When this isn’t possible, proxies for client participation and satisfaction may (debatably) be appropriate. I don’t see any place for universal rules about how much interest can be charged.

One of the more difficult things to understand about the microfinance institutions we’ve investigated is the “true” interest rate they’re charging their borrowers. In July 2009, David Roodman of the Center for Global Development wrote:

It appears that many MFIs impose subtle fees that effectively raise interest rates. Some charge one-time loan origination fees. Some require borrowers to deposit a percentage of each loan amount with the MFI in a savings account that pays interest at a rate lower than that on the loan. Some overcharge for credit-life insurance bundled with the loan. Another criticized practice is to charge interest on the full loan amount even as the outstanding balance declines over the repayment cycle. Such “flat-rate” interest effectively doubles the interest rate compared to “declining-balance” interest since the average balance over the cycle is half the starting amount. Also, MFIs may also prefer to quote their rates on a monthly basis, hoping to exploit borrowers’ ignorance of how a seemingly modest 6 percent per month compounds into 100 percent per year.

Our experience with the microfinance organizations we have investigated to date suggests that these are real issues that donors should be aware of when interpreting interest rate data.

To be clear, we don’t think charging a high interest rate signifies wrongdoing on the part of a microfinance bank. High interest rates may be the best way to minimize losses and serve more people, and client participation at high interest rates may be an indicator that they are getting a service they value. We just want to note how striking the difference is between the initial “cited” interest rate donors often hear about and the “effective” interest rate taking all factors into account.

We recently evaluated a microfinance institution (MFI) in Malawi, the Microloan Foundation, as part of our process for distributing a grant to an economic empowerment charity in Sub-Saharan Africa. Its stated interest rate for its most popular loan type is 20%, but:

• 20% is the rate over the course of the 4-month loan. The “nominal Annual Percentage Rate (APR)” (a common way of stating interest rates in standardized terms and the rate which U.S. lenders are required to provide to borrowers) of this loan, with no other costs, would therefore be 60%.
• Interest is calculated as a flat rate. 20% of the whole loan amount is charged each payment, instead of 20% of the remaining loan balance. This method raises the nominal APR from 60% to 93%. On a $100 loan of this type, a borrower would pay $20 in interest compared with only $12.80 on a loan with declining balance interest.
• Payments are due every two weeks, instead of every month, so that the first payment is due only two weeks after the loan is made. Requiring 8 payments instead of 4 raises the nominal APR from 93% to 102%.
• The Microloan Foundation requires borrowers to hold 20% of the loan amount in a savings account which cannot be accessed until the loan is repaid. On a loan of $100, this requirement reduces the effective size of the loan to $80, while decreasing the effective size of the last payment due by $20 (because savings are then accessible). The savings requirement raises the APR from 102% to 149%.
• Arguably, the APR used above (i.e. the “nominal APR”) understates the interest rate people are paying because it does not take into account the compound value of interest. (Wikipedia’s entry on APR has a discussion of the relevant issues.) At relatively low interest rates, such as the interest rates we’re used to in the U.S., the “nominal APR” (what is usually reported) and the “effective APR” (the “mathematically true” interest rate) are usually very close to each other - but at the much higher interest rates charged by microfinance institutions, the “effective APR” can be considerably higher, raising the question of which one should be quoted to give Americans the best picture of what people are being charged. The Microloan Foundation’s nominal APR of 149% is equivalent to an effective APR of 326%.

Not only are these final “effective” interest rates many times bigger than the initial “20%” figure, they’re also significantly higher than would be implied by looking at MLF’s nominal gross portfolio yield according to MixMarket (93% for 2008; Mix Market defines this as interest and fees divided by the gross average loan portfolio ).

MLF doesn’t charge fees on its loans, but other microfinance institutions do, and these can cause further significant increases in the effective interest rate. (For example, adding a 5% fee to the beginning of a loan that without fees would have a nominal APR of 40% raises its nominal APR to 66%.)

From what we’ve seen, fees, compulsory savings, and the flat interest rate method seem to be fairly common among microfinance institutions. Of the 65 MFIs who had submitted a Social Performance Standards Report to Mix Market as of late 2009, 42% use the flat interest rate exclusively, 29% held compulsory savings accounts, and 72% collected fees on at least some loan products (according to their Mix Market profiles).

Understanding the true cost of credit for a borrower is important for reasons discussed previously:

• High interest rates (combined with high rates of repayment and low drop out rates) show that borrowers are willing to pay a high price for the loan, arguably implying that they value this service.
• If interest rates are low, microfinance institutions may be effectively giving cash transfers, at which point the mere fact of participation becomes less meaningful, and it becomes more important to ask whom the handouts are going to.
• On the other hand, the higher the interest rate, the more we worry about whether borrowing is good for the borrowers (and about anecdotes like this one).

A fairly new initiative (started in 2008), MFTransparency, is working to create a more open discussion about microloan pricing, and has compiled and published interest rate data for two countries, Bosnia and Cambodia. We look forward to following the progress of this initiative and to drawing on its data to inform our investigations of microfinance organizations.

We’ve thought and written a lot about microfinance lately. As of now, here’s where we stand.

What microfinance is and isn’t

First, it’s important to recognize that most of what you’ve heard about microfinance is false. It isn’t primarily about funding business expansion.. It isn’t a “proven solution” to poverty. And it doesn’t leverage your donation far more than other options.

Rather, we think of microfinance as a way to help people with low, volatile incomes manage their financial lives, an idea that is well argued in the recent Portfolios of the Poor study. This study implies that microfinance is really about providing one more option for borrowing rather than the only way to borrow, and that the borrowing is continual rather than “one crucial loan to escape poverty” - more like a credit card than a business investment. (This would explain why “graduation” from microlending programs appears rare).

What to look for

Does microfinance do good? It depends on a lot of things.

• If loans are constantly and heavily subsidized, they can be thought of as similar to giving out cash, in which case our primary concern is that benefits reach the right people.
• On the other hand, if loans are not subsidized, a microfinance institution’s profits could be taken as a sign that it has paying customers. This in turn could be a sign that it is providing empowerment.

With the latter goal (which seems to be the more common one), there is a big question about what role donations can and should play. We have expressed serious concerns about mixing donations with for-profit enterprises, with the possible result that donations end up padding profits (concept; example). In addition, we worry that there are too many donations blindly chasing the microfinance “story,” with the result that donations end up disappearing into nebulous activities.

There is also a question about the extent to which loans are truly providing empowerment. There is evidence that borrowing is bad for at least some borrowers.

We have developed a set of critical questions both about microlending and microsavings, to get at the question of whether an institution is helping people. We’ve looked hard for organizations that can answer our questions.

What we’ve found

In trying to answer the above questions, we’ve become fairly pessimistic about the area of charitable microfinance in general.

• The large U.S. charities are rarely clear even about what their value-added is. To the extent that I’ve been able to see their due diligence on partners (most of which is unfortunately confidential), it seems focused on financial performance, with much weaker examination of social impact-related questions.
• Something as simple as the “repayment rate” turns out to be reported, by standard practice, in what we feel is a highly misleading way. We’ve been shocked at how hard it is even to get what we consider the “real repayment rate” out of a microfinance charity.
• We’ve also been surprised by how often people drop out of microlending programs, generally for negative reasons.
• All in all, the picture we have is of a sector that tells stories about helping people but largely measures and rewards financial performance. As a result, microfinance institutions seem to have strong incentives to maximize their scale and their profits, even if doing so isn’t good for the borrowers.

Bottom line

All in all, we would guess that microfinance as a whole has done a great deal of good, but has also probably done some harm. We are more pessimistic specifically about microfinance donations in the current environment. For the reasons outlined above, we believe that giving to an “average” or “typical” microfinance charity – or giving with an illusory “peer to peer” relationship as the extent of your due diligence – is a fairly bad bet. At the very least, it will deliver far less good, and far more potential harm, than the typical microfinance narrative suggests.

Yet we still find the basic idea of providing financial services to people with low and volatile incomes very appealing as a way to help people … if it is done in a way that stresses social impact and uses donations responsibly.

We believe that microsavings is a particularly promising area, although we haven’t found a microsavings charity we can be confident in.

We believe that the Small Enterprise Foundation is a microlending institution that is truly and appropriately focused on achieving positive social impact. We’ll be writing more about it.

I’m very concerned about the incentives for microfinance charities. As I see it, these are the things that they are “rewarded” for:

• Profitability, for obvious reasons. Any for-profit investors in microfinance institutions are presumably putting great pressure on them to produce a good bottom line. (We believe it’s not safe to use profitability as a proxy for social impact.)
• “Scale” (clients reached, loans made, etc.) and “repayment rate.” These are the numbers that are put front and center by charities like Kiva, Grameen Foundation, and Accion among others. (We have serious questions about what the “repayment rate” even means as well as whether repaid loans = people helped.)

We feel strongly that there are many more questions a microfinance institution must answer to give an idea of whether it is helping people, and worth donating to. And in theory, many others feel this as well. But looking around MixMarket shows how much more attention the “scale and profits” indicators are getting as of today.

• The frontpage cites “1,678 total MFIs reporting data” (and we have collected the data, which is overwhelmingly complete on the financial indicators front, for the 268 members of U.S. networks). Yet only 66 institutions have filed social performance reports.
• The independent ratings found on MixMarket also seem overwhelmingly focused on issues of scale and potential profitability, as opposed to social impact (for a representative example, see the Microrate documents at WISDOM’s profile).

The bottom line? It looks to us like all of the pressure that these institutions face is to maximize scale and profits, without much eye to making sure that they’re improving clients’ lives. And that could explain some eye-popping quotes from publicly available surveys of microfinance dropouts (full documents available at that link; emphasis ours below).

• “At the end of the meeting the research team watched the process of one group being pressured to complete payment. They were told that they should not leave the meeting until the money was paid. There was heated discussion among them, with members telling each other to contribute, and denying that they themselves had the money with which to contribute. There was Ush. 8,000 missing. Finally a man from another five person group provided the missing money. He told the team that he would probably get the money back from the defaulter (who was not present) and that the defaulter would ‘probably buy him a soda’.” (Uganda report pg 13)
• “The research team also found one instance where one MFI had started operations in a poor area, issued loans, experienced quite widespread problems with loan repayment and decided to withdraw the programme in its entirety. This resulted in many people’s savings being attached to repay the outstanding loans of others, and the MFI left behind a fair degree of chaos and bad feeling.” (Uganda report pg 13)
• “the treasurer said that the group’s monthly repayment (Tsh. 300,000) that was to be deposited in SEDA account had been stolen. Two days later the treasurer got very sick; he was bewitched by some of the group members. However after seeing a witchdoctor he recovered. We took him to the Ward Executive Officer; who forced him to repay the money in instalments. He did repay the money but then he was forced to leave Arusha town completely. If he had continued to stay they would have killed him through witchcraft. I lost Tsh. 4,000 through the ROSCA.” (Tanzania report pg 10)
• “Most MFI’s in Kenya have a very strong emphasis on credit but some are getting into the position where clients are virtually forced to take loans. This is partly because of the MFI’s needs to pump out loans to achieve operational sustainability and partly due to a belief that loans are good for small entrepreneurs – even if they don’t want them!” (Kenya report pg 7)
• “One of the key determinants of drop-out, often lost in the category ‘failure to repay loan’ by these studies, is the insistence by field staff that clients take loans. Irrespective of what official Head Office policy says, there is a clear understanding among most field staff that they should push out loans - often with little care for whether the clients need or can use them… Matin (1998) also notes, ‘MFI lending technology is insensitive to variations in household conditions. Most MFIs put all households on a treadmill of continuously increasing loan size and insist on a fixed repayment schedule.’” (Bangladesh report pgs 3-4)

We’ve written before about problems with the way a microfinance institution’s “repayment rate” is commonly cited. We’ve been surprised to find that most institutions do not report what most of us would think of as a “repayment rate,” i.e., the percentage of loans/dollars due that have been paid on time. Instead, they report proxies such as “portfolio at risk” that can (theoretically) be very different.

We now have an example of just how different they can be. ID-Ghana, a microfinance institution, has given us permission to post its application for funding from GiveWell. Page 2 discloses that “The write-off ratio has shot up lately because of the clean up that followed the phase out of our old loan products which proved to be inefficient and impactless,” yet the repayment ratio is reported as 99% (same paragraph). That’s because the definition of “repayment ratio” being used ignores loans that have been defaulted on and written off. Only “at-risk” (but still-on-the-books) loans lower this “repayment ratio.”

These charts show how drastic the disrepancy is, particularly from June 2009 on:

To be clear, we think ID-Ghana’s reporting is entirely consistent with standard reporting practices. To a large degree, that’s what worries us. By industry standard reporting practices, a 99% “repayment ratio” can be consistent with a 30%+ default rate - and is in this case.

This is why we’ve insisted on requesting what we call the “real repayment rate”, defined as the percentage of loans that have been paid off on time divided by the percentage of loans that have come due over a given time period (”loans” here can refer to number of loans or dollars lent).

What has shocked us is how few microfinance institutions are able to provide the real repayment rate. In fact, all of the major U.S. microfinance institutions we’ve contacted (excluding FINCA, which declined to apply for funding at all) have explicitly told us that they cannot or will not provide real repayment rates for their partners.

We’ll be writing more about the Small Enterprise Foundation, the only institution that we’ve seen be fully clear about its repayment rate.

Just because someone is repaying their loans doesn’t mean they’re benefiting from the loans.

We have given some conceptual/anecdotal support for this idea in the past, linking to David Roodman’s posts on possible “overlending” and comparing microloans to payday loans. Lately we’ve been investigating something a bit more concrete: how often, and why, do microfinance clients “drop out” of microlending programs?

The basic idea is that a client could repay a loan due to pressure (from their “lending group” or the microfinance institution), making sacrifices or borrowing from elsewhere (such as moneylenders) to do so. We would expect such clients to show up as “repayers” while not necessarily staying in the program for more loans.

Our observations (details and full sources below):

• Dropout rates appear substantial, averaging 28% and often exceeding 40%, among institutions that publicly report them (via MixMarket).
• Survey data on why clients drop out is limited, but what we’ve seen suggests that “graduation” (i.e., moving to better sources of credit or no longer needing credit) is not a common reason for dropping out. Business failure and dissatisfaction with the group/staff/institution are common reasons.
• A high dropout rate can be consistent with reasonably good reported client satisfaction.

Dropout rates

We have gone through all microfinance institutions that report “social performance reports” on MixMarket (you can see the complete list of institutions, with their publicly posted reports, at MixMarket’s social performance report section) and collected the data into this spreadsheet (XLS). (Note that dropout rates are not on the list of “standard” indicators and are not reported by all MixMarket participants, but are included in “social performance reports.”) Here’s a summary of the 60 institutions that report dropout rates:

Taking the average across all 60, weighted by number of clients, yields an “average” dropout rate of 28%. Details here (XLS). That implies that in a given year, 28 out of 100 clients become non-clients (see the “social performance reports” for the details of the calculation).

Reasons for dropping out

We don’t know of any comprehensive studies of the reasons clients drop out, but in the process of searching for an outstanding microfinance institution, we have encountered several small-scale surveys. We have posted the non-confidential dropout surveys along with a summary in Excel, and hope to clear a couple more in the future (they are broadly consistent with the summary below).

The Bangladesh study specifically states that “One of the reasons that is notable by its almost complete absence from these listings of grounds for drop-out is ‘graduation’” (pg 4). The rest of the studies give the same picture: “graduation” (i.e., the idea that clients now no longer need microfinance because they can access better sources of credit and/or do not need credit) is not cited as a significant factor in any of them, except in the Uganda study (which does not state how common this factor is, but cites it as a factor specifically for “Relatively Well-off drop-outs” (pg iii)).

Business failure is a commonly cited factor (37-58% of clients cite this factor, in the studies that report numbers - see Excel summary). Issues with the “lending group,” the organization or its staff are the other most common factors. The Tanzania study cites “The inability of clients to cope with the rigid MFI policies and procedures” (pg 9) and also vividly describes a group conflict in which the treasurer claimed funds had been stolen (pg 10). The Bangladesh study states that “One of the key determinants of drop-out … is the insistence by field staff that clients take loans” (pg 3-4).

Client satisfaction

The LAPO study (see previous discussion of LAPO, Kiva’s largest partner) looks not only at the reasons for dropping out, but at overall reported client satisfaction.

The former figures seem cause for concern: there is a dropout rate of around 25% (estimated from graph on pg 7) and reasons given include “poor business performance” (applying to 24.2% of dropouts), “Burden of paying for others who had defaulted” (29.5%), and “the attitude of some staff” (cited as a major factor but without quantification). But overall, reported satisfaction looks reasonably strong:

We feel these numbers should be taken with a grain of salt, since it seems possible to us that clients could have felt pressure to report positive experiences. But the numbers do serve as a reminder that microfinance institutions have many clients who are (apparently) happy repeat customers.

Bottom line

Most microfinance institutions don’t appear to publicly report dropout rates, much less the reasons for dropping out (this observation based on the small percentage of MixMarket participants who have shared social performance reports). Those that do are likely to have more encouraging numbers than the others, and yet their numbers seem to leave substantial room for concern. Clients seem to drop out, for overwhelmingly negative reasons, at rates averaging 28% and often exceeding 40%.

We don’t mean to overfocus on the negative here. Microfinance institutions could be providing valuable services for many people, and we wouldn’t want donors to stay away from an activity that’s doing good overall even if it is doing damage to some.

But it does seem that the more we dig through the information on microfinance, the less it resembles the stories commonly told about it. Making loans can do good or harm. We feel strongly that people donating money to microfinance institutions should be asking for substantial due diligence - not anecdotes and pictures, and not the commonly cited, misleading metrics like “repayment rate,” but systematically collected information that gets at services’ actual impact on clients.

Note: I’ve responded to the most recent batch of comments.

A lot of work has been put into estimating the “bang for your buck” in health initiatives. In the area of microfinance, though, things appear very murky.

Microfinance advocates say things like “As our clients repay the loans, the money is loaned again and again to help many more entrepreneurs. It’s giving that keeps going.” Skeptics reply that much of the cost of lending is in operating institutions, not simply loan capital. We should be able to agree that the cost-effectiveness of microlending is not literally infinite, but what’s the right ballpark? Does the impact per dollar dwarf that of health?

We can take a very rough - and very generous to microfinance - cut by looking at some global estimates by CGAP. Notes before we get to the numbers:

• We are trying to get a number that we can put alongside existing estimates of health cost-effectiveness, just to see whether the microfinance sector as a whole has a clear and large advantage in cost-effectiveness. The estimate will be extremely rough and will not apply to any given microfinance charity, but rather to the area of microfinance as a whole.
• Our estimate is essentially a “best-case scenario” for what microfinance cost-effectiveness would be if (a) there were a direct link between donations and people served (b) microfinance could reach an enormous “target population” at the same level of donation funding that’s being provided now.

CGAP looks at both dollars invested in microfinance (PDF) and people served. According to these links,

• $11.7 billion of funding went to microfinance in 2008, of which 19% - or ~$2.2 billion - was grants (not loans, not investments, not guarantees).
• There are currently between 130 and 190 million microfinance borrowers worldwide.
• CGAP implies a “target number” of borrowers: “Given that almost 3bn people live on less than two dollars a day, clearly the battle to bring financial access to as many people as possible is a very long way from being won.” I have major issues with this target - for one thing, I’m not sure that people living under $2/day should all be targets, or are the only targets, of MFIs.

A couple of ways to look at the “costs per MFI client”:

• A lot of money is spent on microfinance. $2 billion in grants is about 10% as much as the total official development aid of the U.S. government (according to the 2008 Index of Global Philanthropy (PDF)).
• We’re currently spending $12-$17 in grants alone for every MFI borrower. Of course, the grants could be paying for a lot more than borrowing (including savings), and could be made with the aim of expanding future services rather than maintaining existing ones.
• If you believe that microfinance will eventually reach the entire CGAP “target population” (or a population that size, which would be around half the population of the world) and that the current level of grants will be maintained (say, growing only at the rate that the size of the target population grows), then at the point where microfinance is reaching its entire “target population,” the grants per person reached will be about $0.75. While this figure could be overstating the costs per person served if grants eventually create self-sustaining institutions and become unnecessary, I think it is far more likely that it understates the cost because (a) those who can most practically be reached in a profitable/sustainable way are likely to be those already reached, and the hardest people to reach are more likely to require continued subsidies; (b) there is a huge amount of other investment in microfinance, and we have very little sense of the role that grants play in enabling the expansion of services; (c) 3 billion clients is an extremely ambitious goal - around 20x the number of people actually being reached today, and around half the world’s current population.

A couple of ways to think about the comparison with health:

• For $200, would you rather provide about 250 people with a year’s worth of financial services, or prevent a single death via vaccination?
• For $3.50, would you rather provide 5 people with a year’s worth of financial services or 14 children with deworming drugs, leading to one extra year of school attendance?

I would answer both of these questions mostly with a shrug. Certainly, under this extremely generous estimate of what microfinance could cost, it is “competitive” with the best health programs.

But this is assuming that all of that money going to microfinance is going to eventually succeed in reaching half the world, and also making the even bigger assumption that grants are the key factor. We think it’s very possible that much of microfinance’s reach has very little, or even literally nothing, to do with charitable support. (The less generous cost-effectiveness estimate of $12-$17 is fairly clearly not competitive with the best health programs: compare 12-17 person-years of financial services vs. 1 life saved, or 1 person-year of financial services vs. 3-5 person-years of extra school attendance due to improved health.)

Bottom line: we don’t see cost-effectiveness or “multiplying the impact of your dollar” as a strong argument for funding microfinance over health, on a general sector-level basis. This is the case even under the most generous model of the microfinance figures we’ve come up with.

We recently looked at Kiva’s largest partner MFI, LAPO (Lift Above Poverty Organization), as part of our evaluation process for an economic empowerment grant in sub-Saharan Africa.

In brief, we found two surprising pieces of information:

• LAPO is very profitable.
• There’s good reason to be concerned about LAPO’s social impact.

As Natalie recently described on our research list, we’ve contacted a handful of individual microfinance institutions in Sub-Saharan Africa to assess whether one might be able to answer the key questions we ask to evaluate a microfinance organization.

One of the steps we took was to look at Kiva’s largest MFI partners. Because Kiva partners are both (a) relatively well-known (due to its presence on Kiva) and (b) underwent Kiva’s due diligence process, we guessed that they might be a reasonable place to begin our search.

When we looked closely at LAPO, we found the following, all of which concerned us (Note: we haven’t yet contacted LAPO as our aim, at this point, was to identify the most promising organizations, not confidently dismiss any particular organization. Because our brief review of LAPO opened several relatively large questions, we chose to move on, as we often do).

• In the last 3 years (2006-2008), LAPO had significant profit margins (23-28%).
• In its Mix Market Social Performance Report (xls), LAPO reported a 49% dropout rate. As Holden wrote in our post on evaluating a microfinance charity, dropping out of a program may indicate participants “voting with their feet” and choosing to leave a program that they don’t find beneficial. It is also possible that “drop outs” instead consist of those who “graduate” from the program, i.e., improve their incomes/credit to the point where they can access credit from elsewhere (or no longer want/need credit). However, my instinct is that it’s unlikely that close to 50% of participants are quickly moving up to access more formal sources of credit.
• LAPO’s Client Exit Study report (doc) reports that individuals need manager approvals to withdraw savings, and that managers investigate the reason for withdrawal before approving (Pg 3). This seems to undermine many of the benefits of saving, which presumably aims to help people deal with risk and unexpected situations.

Does LAPO sound like an institution that needs (or should receive) Kiva’s interest-free funding?

Its appears highly profitable, but its social impact is much less clear given the high drop-out rate, significant hurdles for depositors to withdraw savings. These facts paint a slightly worrying picture of LAPO as an organization that may be earning significant profits through relatively restrictive regulations for clients while getting interest-free funding through Kiva. Perhaps there is a special arrangement here as with Xac Bank, but it certainly raises a concern about charity-minded capital funding profits.

David Roodman raises the concern that Kiva capital could be effectively “padding profits” at a profitable microfinance institution. He concludes,

If social investors provide capital at prices below commercial rates to enterprises with “double bottom lines” (profit and social benefit), how do the investors assure that their cheap capital isn’t being used to boost just one of those bottom lines?

We feel that this is a major concern, and one that also applies to larger-scale social enterprise investment (see last week’s discussion of Acumen Fund, particularly the part about VisionSpring).

With a for-profit, everyone is looking to get their investment back. With a nonprofit, everyone is (ideally) looking to achieve social impact. But an organization that has both charitable and for-profit investors can get caught in the middle: taking donations, but measuring its success in terms of profits instead of lives changed.

The situation is particularly dangerous when profits are viewed as a “proxy” for social impact, and thus become the only measure looked at. Imagine an enterprise that could sell food below market prices, thanks to support from donations. It could be distorting the local economy (by outcompeting local farmers), failing to reach those truly in need, and ultimately failing to accomplish anything besides selling food for less than it costs to people who turn it around for a profit. And yet, all of this could be consistent with a good bottom line, which would make both the investors and the donors happy.

One way to avoid this problem is to refuse to use profits as a proxy for social impact - to insist on rigorous assessment of whether an enterprise is changing lives, rather than settling for the logic of “if it’s selling it must be helping.” But such rigorous assessment costs money, and exacerbates the already great challenge of turning a profit. Jim Fruchterman’s recent comment illustrates the low likelihood that you’ll see much of this approach working in practice.

Another possible approach is to get very specific about how donations are and aren’t being used. Any sort of “hybrid” organization ought to be able to show a history of using donations to absorb risk, but ultimately creating ventures whose profitability and sustainability does not depend in any way on continued subsidies. Our basic feeling is that demonstrating such a thing would be harder than it sounds, and that we have not yet seen an organization that seems capable of doing so.

Bottom line: it’s difficult to hold an organization accountable unless all its investors are on the same page about what it’s accountable for. Blended value makes perfect sense in theory, but in practice, it seems like a huge challenge that nobody is clearly up to. In the meantime, it may make more sense for businesses to be businesses and charities to be charities.

We’re looking for a good option for U.S. donors interested in supporting microfinance. We’ve been examining the largest, most prominent U.S.-registered charities in this area: Grameen Foundation, Unitus, Accion, Women’s World Banking, Opportunity International and FINCA. All of these are large organizations that list a variety of “partner” microfinance institutions.

One thing that might surprise a donor in this area is that sometimes the “partnerships” overlap. For example, Women’s World Banking lists Enda Inter-Arabe in its network, and so does Grameen-Jameel (which itself is a joint venture of the Grameen Foundation). Neither organization’s profile mentions the other.

Grameen Koota lists the Grameen Foundation and Unitus (among others) as donors and lists Unitus and Accion as consultants. Unitus’s page on Grameen Koota doesn’t mention Accion; Accion’s doesn’t mention Unitus; the Grameen Foundation sounds like its relationship is currently more consultant-like than donor-like.

As you can see from the profiles linked above - and as we’ve found from talking to the large microfinance charities - most (not all) of their activities consist of consulting or “technical assistance,” rather than founding, directly supporting or investing in microfinance institutions. The relationship between them and their “partners” often appears relatively limited, and it’s difficult to pin down who’s responsible for what.

Focusing on technical assistance and consulting isn’t necessarily a bad thing - perhaps U.S. expertise is just what these institutions need to serve more clients and serve them better. But we aren’t sure this is the case - it’s also possible that the U.S. charities have sprung up because of strong donor demand for the “story” of microfinance, and are consulting because they have more than they can productively spend on investing and creating.

What we know is that it’s inherently hard to gauge a charity’s impact when its main activities consist of free (or heavily subsidized) technical assistance. Even if we had all the information we want about the partner MFIs themselves, we’d still need to understand the extent to which help with business planning or product design made a difference to them.

So far, we haven’t seen many signs that the U.S. charities are critically asking this question, or making it possible to hold them accountable for the answer.

Nathaniel Whittemore writes that it’s “time to move on” regarding the recent Kiva controversy. I disagree.

It’s true that Kiva handled the criticism admirably, and made significant changes to its website to improve clarity for donors. It’s also true that Kiva has a stronger case than many for being generally transparent and impactful. Finally, it’s true that those of us who have been blogging about Kiva are a bit tired of the subject.

But none of this changes the fact that many (I would guess the vast majority) of Kiva’s enthusiastic users don’t know how it works, and would be upset if they found out. If you doubt this, just look at the reaction to the recent New York Times story that brought this issue to the attention of people outside our corner of the blogosphere. We may be “over” this issue, but most people have still never heard of it.

The common perception of Kiva - repeated to us by supporter after supporter - is that it enables people to (a) make interest-free loans to (b) the entrepreneurs they personally select. In fact, Kiva users are effectively making gifts (since the loans are interest-free for them, but not for the borrowers) to microfinance institutions. If they knew this, they might prefer giving directly to microfinance charities instead, especially since they’d then be able to get a tax deduction and give significantly more. Or they might prefer another gift entirely - perhaps a health program that offers great impact but no “personal connection,” or perhaps a DonorsChoose project that offers “real” personal connection but arguably little impact.

The time to “move on” should not be based on Kiva’s “handling” the situation or our growing tired of it - it should be based on Kiva’s supporters, by and large, understanding how Kiva works. We think we’re nowhere near that point. We urge those who know the truth about Kiva to continue spreading the word.

How much of microfinance’s popularity in the world of philanthropy comes straight from this story?

I was shocked to discover a woman in the village, borrowing less than a dollar from the money-lender, on the condition that he would have the exclusive right to buy all she produces at the price he decides. This, to me, was a way of recruiting slave labor.

I decided to make a list of the victims of this money-lending “business” in the village next door to our campus.

When my list was done, it had the names of 42 victims who borrowed a total amount of US $27. I offered US $27 from my own pocket to get these victims out of the clutches of those money-lenders. The excitement that was created among the people by this small action got me further involved in it. If I could make so many people so happy with such a tiny amount of money, why not do more of it?

It’s an amazing and moving story. But it’s a story about one giver and 42 beneficiaries in one village.

In 2007, the Grameen Foundation alone saw over $16 million in donations and claimed over 7 million clients served (see its annual report (PDF)). It works in 32 countries on 4 continents. And it’s still putting that $27 front and center.

We know little about microfinance’s actual impact, and much of what we do “know” comes down to myths (myth #6, in particular, seems oddly fitted to the story of the original $27). We’ve seen very little interest in general in pushing skeptically on the appealing stories charities tell.

Dr. Yunus’s original loan was interest-free, while today’s microloans charge interest in the 30%/year range. We know that the for-profit participants in microfinance have been participating for reasons other than one great story.

I don’t feel nearly so confident about the philanthropic participants.

We’re excited about the idea of microsavings as opposed to microlending. But it isn’t enough to see that an organization offers microsavings. We need to know:

1. Are savings services being provided relatively efficiently? How many clients are served per dollar of operating expenses?
2. Are clients able to access their funds when they need them? We have heard anecdotal concerns about client dissatisfaction with the difficulty or bureaucracy involved in accessing savings. In addition to the proxies for satisfaction discussed in our earlier post, we’d like to see the “turnover” of client accounts: does money go in and out, or sit stagnant?
3. What are the interest rates/fees on the accounts? Excessive fees would concern us, but so would extremely generous interest rates, which would make the program less like a savings account than like giving out cash.

Some of the questions at our earlier post (regarding profitability, client income levels, and client satisfaction) also apply.