The Economics of Microfinance – a must read

Participating in the growth microfinance (even if it is not the commercial growth) is one thing, and knowing why one should do that is another. After all, one is bound to ask sooner or later, does this really work. And if it does, what are the various challenges in the field and if it doesn’t work, then why is it so. It is not just about the execution of randomized trials and saying that there is a positive or no impact. It is everything from, how much interest should one charge the lender, should loans be given only to women, and if so, does that model create a positive impact, what should be the funding model – should it be based on subsidies or would it be a self-sustaining MFI, and more. Questions like these are the ones that are tackled in this book. The authors – Beatriz Armendàriz and Prof. Jonathan Morduch are well known in the field of microfinance.

Warning: long read. For starters, this is not a general read. It feels like a textbook and I guess it might be a textbook in some schools. So expect a little dry read. That doesn’t mean that the book is boring. On the contrary, each chapter lets the reader on one of the aspects of the field. There are instances where the reader is left with an a-haa ! moment, understanding why certain things are difficult from an institutional perspective (like for example, does group lending always work ? How does one model returns for lending in such a scenario).

There are 10 chapters in the book

  1. Rethinking banking
  2. Why intervene in credit markets
  3. Roots of microfinance : ROSCAs and credit cooperatives
  4. Group lending
  5. Beyond group lending
  6. Savings and insurance
  7. Gender
  8. Measuring impacts
  9. Subsidies and sustainability
  10. Managing microfinance

The first chapter is an introduction to the traditional banking model and how it needs a big shift in processes when it comes to microfinance. The usual model of – have collateral – get debt – repay it – get the collateral back doesn’t work with microfinance. Also, the traditional model is not used for consumption . And like Stuart Rutherford mentions, consumption ((did not read Rutherfords’ book yet) as an end for microfinance is not necessarily a bad idea.

The second chapter is about how to and more importantly, why, intervention into the traditional credit markets is important. And by traditional credit markets, you can think of either the (evil ?) moneylender or the banks. This chapter also covers, among other things, the adverse selection (the asymmetry of information, wherein the bank knows very little about the riskiness of the project), the moral hazard (ex ante – how motivated are the borrowers to allow for a good return, ex post – how motivated are the borrowers to payback after the realisation of returns). Not only are these issues dealt with, the authors also model these issues into nice mathematical equations (ok, may be not so nice sometimes 🙂 ). This provides a good grounding into the interest level and return calculations.

The roots of microfinance talks about how this field was operational long before Prof. Yunus made it famous, albeit in a different form. The idea of credit cooperatives and the various auction models for getting the loans are discussed. On a personal note, I kind of understood how the credit society that my dad used to be associated with operated and how they’d determine the interest rates and distribution mechanism (of course, in his case it was a very limited audience and there wasn’t as much an asymmetry of information and risk involved. I digress.). The authors also design a simple model for a random ROSCA, and even though I must admit the equations do look intimidating, it is worth the effort to bend your mind to understand it because it gives an idea into the functioning of the ROSCA.

The next two chapters go in depth into the well-known and possibly the prevalent model of microfinance these days – group lending. Borrow in a group, mitigated risk and peer monitoring comes free ! Hmm, that sounds like a marketing campaign 😉 !  These two chapters discuss the various flavours (if you will) of group lending.

The chapter of savings and insurance discuss the lesser known (or is less famous !) aspect of microfinance – micro-savings and micro-insurance. Both of these areas are still growing areas (growing – with my limited sphere of knowledge). The authors don’t  spend too much time in the specifics of either of the fields.

The chapter of gender is about whether women are better customers of microfinance and if there is a larger impact (what Prof. Yunus calls the double bottom-line) by lending to women than to men. Again, this possibly is a topic onto itself, so the authors don’t get too much into specifics.

Measuring impacts is a chapter on the various ways to measure the impact of microfinance. Apart from the recent interest in randomized trials, there are other ways to measure the impact of microfinance. These are not dealt in depth, but the reader is given enough to understand how an impact study happens. Like the authors write in the section titled Addressing the selection problem in practice

In the following sections, we consider a series of related approaches to impact evaluation. The overview is not exhaustive and we do not aim to provide a full survey of impact surveys to date. Rather, we aim to point to key methodological issues and to gather several important results. The results to date are decidedly mixed, with some evidence of modest positive impacts of microfinance on income, expenditure, and related variables, while other studies find that positive impacts disappear once selection biases are addressed.

And this seems to be still an open issue, with recent studies still not being very conclusive, but giving enough evidence that there is a positive impact if not uniformly across households.

The chapter on subsidies is about the MFIs. It tries to answer a very simple (well, not so simple) question – should the MFI rely on subsidies or should they operate on a commercial basis. How does the MFI become sustainable ? This is an interesting topic and the authors do point out the open questions in this area. Questions that need more research to find the answers.

Managing microfinance is about managing the MFI. Managing how the loan officers evaluate the potential borrowers, setting expectations, devising incentives for the staff. Irrespective of the microfinance becoming the poster-child of relatively risk-free returns, there are issues in the management of the MFIs which are very important, like the story of Corposol.

So, how does this book stand. Well, it is a must-read if your interest is more than as a lender / borrower. A 9 out of 10. Each chapter has quite a few open questions which still need answers and the authors clearly mark such areas (like interest calculations, measuring impacts, ‘mission-drift’ in subsidies’ cost-benefit analysis).

The book is like a textbook, so it does require some amount of patience. One problem I had was the usage of non-standard symbols in the mathematical equations. They might be standard symbols in Economics, I am not sure, but I found it little-to-lot annoying. The explanation for the equations though, is crisp, and the authors do mention the reference if you really want to get to the gut of the result. Oh, by the way, the reference list is amazing. I guess one can spend a life time just with the reference list :). Like always (sigh!) I didn’t work on the exercise problems. I am hoping that I will do that when I start re-reading individual chapters. Yes, I think this is a book which will require more than one read. Pick your area of interest, or if you don’t have any, solving the exercises and the reference should let you find it. So, go ahead and get the book. And looks like the second edition is out !

JSON support to Kiva .NET toolkit

JSON support for the Kiva .NET library

If you are interested in microfinance, then it is very likely that you’d know about Kiva. And if you know about Kiva, then it is possible that you might know that they have provided public access to their data via web-services. And once they did it, there were toolkits available in most of the languages.

One of the implementation that caught my interest was the Kiva .NET. I never worked on C# earlier, so I thought this might be a good project to start with. The reasons

  1. It’s a toolkit – so it is compact
  2. There is already an implementation for XML that was done by the original author
  3. I wanted to write some code using LINQ, even if it was not working off DB data sets

So, given the above, I added support for JSON data in the Kiva.NET library (can’t locate the link where the Kiva folks mentioned that they would release the JSON format first and then the XML for the API). Nevertheless, the JSON format support has been added.

Most importantly – this code is seriously beta. The reasons are

  1. The code is not backward compatible with the existing Kiva.NET implementation. Almost all the objects have changed with
    1. Attribute names (members of the class) have changed to make it possible to deserialize the JSON data (more on this further)
    2. For some objects, as the data returned by Kiva has changed, the object layout also had to change
  2. Exception handling is not done
  3. I did not check all the APIs to see if the XML implementation is full-featured as the JSON one
  4. Productizing the API is not done i.e.
    1. Versioning of the library
    2. Proper comments and documentation
    3. Test suite for the toolkit

But the code does work :). In the zip file attached, the KivaTest project has a very simple main() to test each of the APIs. Also, this requires atleast JSON.NET 3.5R5 as it has support for non-public default constructors. Thanks to James for adding this (you can follow the discussion here).

Coming to the point about the attribute names being changed. The reason this was needed because I was deserializing the JSON object using JSON.net and the library tries to match the attribute names with the JSON data. As mentioned in the Kiva API specifications, the variable names are separated with an underscore. The initial implementation of the Kiva .NET library didn’t use underscores for the attribute names. That is why my changes are not backward compatible. I did check the resolver interface in Kiva.net, but that is used to piddle with the attribute names of the objects but not with the JSON data. What I am looking for is to modify the JSON attributes so that I can remove the underscores for the attribute names before deseralizing them into Kiva objects. I am certain it must be possible, just that I am a n00b when it comes to C#, so will dig more and find out.

Will have more updates in the coming days based on how the owner of the library reviews my changes ! The patch file and the zip file for the changes are here

The patch file and the source zip with the test client are uploaded as part of the post.

Is it real P2P lending on Kiva?

The microfinance blogosphere was a little perturbed by the apparent misleading of Kiva about how the P2P lending works. Another story being the viability of microfinance; but more on this later. The cause for the concern in the microfinance community and more specifically the lenders on Kiva was whether the money they were lending was reaching the intended borrowers. And according to David Roodman, it happens around 4.3% of the time. So, the answer to the question is not an emphatic no, but it is not a yes either. And that NYTimes picked up the same topic generated even more interest (no pun intended !) in whether Kiva was being completely transparent.

Very briefly (you can read the post by David Roodman for  more details), the borrower to whom you think you are lending as a micro-lender on Kiva is most probably not the borrower who will get your money; though the money does reach the MFI and it will eventually be disbursed to some other lender. This is not something that was very clear to most of the Kiva lenders and some of them were disappointed by the revelation (as noted in the comment section of David’s post).

What is important to note is that Kiva was not lending ex post from inception. It was something that they had to do to handle the scale of operations. And this can be seen  with RangDe. RangDe is relatively smaller compared to Kiva RangDe’s lending is ex ante i.e the loan is disbursed after the wait period. In case there is a shortfall RangDe fills it from its funds. On a side note, I would be interested in knowing if the funds that are collected till the disbursal for a micro-loan generate any interest while they are parked with RangDe. I would like to see the good folks at RangDe write about it on their blog.

Of course, the fact that the loan was already disbursed should not cloud the fact that the money is not being misused or channelled to something else. The monies are still with the MFI, but that the entrepreneur whom you think is going to get it not going to get it. This is not a big problem on Kiva because there is no ROI, but it will be a major concern if there is a ROI that is involved, like on RangDe or MicroPlace. More on that in a different post.

Making agriculture viable in India

While reading this synopsis of the talk by Dr. B.D. Sharma on NgoPost, I came across an interesting point (which of course is the viewpoint of the OP of the post)

His romanticism with the agrarian economy and a hope that India would return to times when agriculture dominated the economy is something which is completely misplaced.

Before I write about my thoughts on the above, let us look at the key point of the post – the viability of agriculture in India. The two key points which work against agriculture are

  1. Under-valuation of labour prices at two levels. This, as we are very well aware of is rampant. I agree that policy makers need to not look at farming as an unskilled profession, thereby reducing the minimum wages being paid to the farmer. Given our reliance on the monsoon and proper irrigation facilities, the farmer is faced with more decision making than, let’s say a software developer working with or without a spec, whatever the degree of separation from what is required (I have been a software developer for a while,  so I think I can speak with some degree of confidence).
  2. Compound interests for agricultural loans. This is, in my view a bigger problem than (1). If the farmer who has only few months for farming his crop is lent at interests compounded, one bad monsoon would leave him and his family reeling. It is surprising that the banks and the rural institutions are not willing to consider better terms for lending to the farmers. My thoughts on this:
    1. A run-of-the-mill credit rating mechanism will not work in this case. A credit rating which considers atleast the following can help control the rate of interest
      1. economic condition
      2. family size
      3. amount of land owned vs. amount of land on which (s)he is tilling
      4. geographical region (an area like Punjab with rich soil can’t have the same index as a region like South TamilNadu)
    2. Microfinance might not be the best fit for lending funds to farmers. The increased rates of interest that farmer pays, make this option not very attractive. Though, if the MFI is willing to lend under a simple interest, for long term loans the farmer might be willing to borrow from the lender.

Given the above, I think there is a definite need for revisiting the perception of the populace and the policy makers about agriculture. Given the continuous influx of unskilled workers as day wage earners to cities, this not only creates economic pressures but also social pressures. Sadly, both the policy makers and the government seem to be ignoring this aspect. The government’s knee-jerk reactions won’t help the agriculture sector in the long term. And food security is something that can’t be taken lightly. As Earl Butz commented in the King Corn documentary, the surplus food that America has, is it’s best kept secret. And it is true too. The lesser one spends on food as a percentage of the total earnings, the more that one has to invest in other things. Of course, Earl Butz’s comment was in favour of industrialized farming, which is not the best of the option for India, as is corporate farming.

This brings us back to the  question of – should agriculture be treated like an industry to determine the wages?

Now, back to the point I raised at the beginning of this post. Is it romanticism to believe that the Indian economy can’t be an agrarian one? One shouldn’t equate an agrarian economy to a non-industrialized or non-service (if there were words like that) economies. India’s industrialization, post-independence has been rather limited. We still, I think, have a long way to go with respect to industrialization. And our so called service economy is concentrated in very small pockets of the nation (Bangalore, irrespective of the interest it generates from the media abroad is not a representative sample of the shining India). So, given the big-picture impact of agriculture, I think, there should be more investments in agriculture in the years to come. Come to think of it, if the government were to create institutions like the IITs for agriculture, even taking into consideration the brain-drain that’ll happen, there will be a percentage of the bright minds in the country staying back and creating a positive influence on the sector. I think energies are being spent trying to fight for statehood (sic.) rather than exercising jurisprudence in allocating the monies that states already have.

Microfinance as a business

If the term Microfinance brings images of charity, of handouts; then think again. Could it be possible that a business be created around microfinance. After all, if banks and financial houses can make big money by lending and investing money, then why can’t these big numbers be scaled down to the micro-entrepreneur? Can a business be build around that?

These are some of the aspects that the authors of this paper deal with. The first question to ask is – is there a market for microfinance. And the answer from the paper seems to be – yes, there is. Paradoxically, it is the poor who need to save more and borrow more than someone who is well-off. And the authors also provide evidence that for most part (geographical factors also play a part in this), the poor are willing to save money and borrow it when required. Then the challenge for the MFI (microfinance institution) becomes not just serving its clientele but to do it in a sustainable manner. Can the MFI recover its costs; what are the average margins that a MFI can realistically expect to achieve?

To be able to be sustainable, a MFI needs to be able to create products that can help it sustained returns; returns that can be reinvested into more communities. The various kinds of products that MFIs offer are discussed in the paper. The core product types are

  1. Group lending – money is lent to a group of individuals who are part of a community. The social pressure between the people ensures that the % of loans that are defaulted is minimum
  2. Individual lending – here the emphasis is on the individual, like any other loan product.
  3. Village banking – instead of the MFI deciding on where the money goes, the money is lent to a group of villagers and they decide where they would like the money should go to. This consortium (more a cohort actually) ensure that the repayments of the loans are not missed

Each of the products has its advantages and disadvantages. Grameen bank, for example concentrates a lot on group lending. The type of product is largely determined by the geographical location of the clients. In a rural environment, it might be easier to allow for group lending, than in an urban one where individual lending might be a preferred approach.

Another important part of a MFI’s success apart from the product design considerations is the MFIs view of itself – how does it structure its management. How does the MFI train its employees, should there be a strong command-control structure, or should the retail offices be allowed to have more freedom with only a general direction given by the parent office. What about compensation and incentives to its employees. That is a very important consideration if the MFIs have to keep its people motivated. Even though, the average person who is going to work for a MFI is not there just for the salary, that doesn’t mean that the incentives don’t factor in heavily. The authors talk about two metrics for incentives. One, the accounts per (field) officer and the second, outstanding portfolio (money to be repaid) per officer in currency terms (i.e. in INR / $ / some currency).

The final factor that affects MFIs is the environment in which they are operating. Regulatory hassles are not trivial for a MFI. Given that the interests that MFIs charge is not very far from what the evil moneylender charges, there might not be too many people who espouse the opposition of the MFIs by the governments. The authors narrate an incident, wherein the Chief Minister of Andhra Pradesh, India accused the MFIs of charging ‘moneylender’ interest rates and using ‘unethical recovery measures’. The minister went on to launch a plan to regulate MFI interest rates. These regulations have a huge impact on the commercial viability of the MFIs. Given the thin line that MFIs have to walk, between their no.1 priority of social empowerment and then commercial success, regulations of this sort can tarnish the image of the MFIs. And in the defence of the government regulation, allowing the mushrooming of MFIs can create an unhealthy appetite for commercial success ignoring the primary purpose.

Given these challenges, one does question the commercial viability of MFIs. At this point, there seems to be not enough proof that MFIs are commercially successful. But given the social impact, the numbers seem to indicate that they do have a considerable, if not silver-bulletish impact on empowering those people for whom credit is hard to come by. And it is not always very easy to measure social success that were caused by microfinance and only by microfinance. Various factors along with microfinance could have had a positive impact. AFAIK, there is no study that shows that microfinance as an area of Economics has always resulted in positive change. But while waiting for such studies to happen and the numbers to be churned, you could do your little bit by investing in a micro-entrepreneur. Head to RangDe and make an investment, as little as INR 100. And once you are done with that, you can read this paper; it will give you a 1000ft. view of microfinance.

Origins of Rangde !

The video on YouTube talks about the origin of RangDe and the ideas that the founders had before they decided on micro-credit (RangDe doesn’t cover the gamut of micro-finance yet !). The founders – Smita  and Ramakrishna share the 4 ideas that they had, and that was rather interesting to know

  1. A for-profit firm that certifies establishments that they are child-labour free
  2. A firm that allows for an non-exploited form of access to domestic help. (My note: people in India are very well aware of domestic help, and most are not sensitive to the right treatment of them, and that includes the majority of the middle class)
  3. Social media – a channel that focuses on the social aspects of development issues (My note: very true about the videos made in India not viewed by Indians, more on this later)
  4. A micro-credit organization

Watch the video, atleast to steal some ideas ;). And here is the embed video of the interview

P.S:  This is part of the wonderful interviews by D.Murali, Deputy Editor of Business Line, and his channel on YouTube, pitstop4performers

Creating a world without poverty

The book -  Creating a world without poverty by Muhammad Yunus is part historical anecdote and part suggestions to the actual theme. So, if you are expecting a complete treatise on how social business can provide a viable alternative to capitalism, you might not be very pleased.

The book is divided into three major parts

  1. The promise of social business
  2. The Grameen experiment
  3. A world without poverty

Each of the parts have multiple chapters delving more on the major section. The second part – The Grameen Experiment talks in detail about the genesis of Grameen bank and the growth of the Grameen group. It also details the growth of their first major social business – Grameen-Danone. If you are looking for specifics of the growth of Grameen-Danone, then this section is very interesting. Dr.Yunus goes on to describe the struggles the group went through to get the venture starting. And they are no different from anything an entrepreneur in the profit making business (PMBs) world would face.

Before that though, the first part is where Dr.Yunus differentiates the for-profit model of businesses, which he calls profit making business and the for-social-profit model of businesses which he calls social businesses. In his own words

..we need a new type of business that pursues goals other than making personal profit – a business that is totally dedicated to solving social and environmental problems.

….A social business is not a charity. It has to recover its full costs while achieving its social objective. .. And this makes all the difference in defining social business and its impact on society.

The foundation for social businesses is that humans are multi-dimensional and profit making is not the only drive for people. This is the most appealing part for me in the idea of social business. And the social business is not something that lives off hand-outs. It creates value for its customers by not only creating products and services but also by benefiting the society at large. Dr.Yunus then goes on to elaborate on the various facets of social businesses and how they differentiate themselves in their mission. The chapter 2 in Part I majorly deals with what defines a social business.

Like I mentioned, part II is dealt with the Grameen experiment and concentrates on Grameen alone. Of course, while reading about the Grameen story, one also picks up various titbits of interesting information. For example, Dr.Yunus talks about the story of trying to design a production plant for Grameen-Danone yogurt. It is about how Guy Gavelle, director of industrial operations, APAC tried to design a very small plant for the production of yogurt, instead of the usually large production plants that Danone created.

Part III of the book expands on the idea of social business. How the social business market place would look, how one could create a stock market where social business could be invested in. How the profit sharing mechanism of social business could be. He also talks about how IT can help in to further the cause of social businesses.

So, should you read this book ? If you are someone interested in social businesses and want to know how one can create a business whose primary motive is not profit, then yes, there are few refreshing ideas in the book. If you are a die-hard capitalist who sincerely believes that a free market is impartial and helps in making society better, you might learn a thing or two about how social business can operate. I would rate the book a 6 out of 10. There are some part of the book, specifically the ones related to Grameen which I thought didn’t belong in the book. What I would have loved to see in the book is more description of the pitfalls of social business or how the social marketplace can compete with profit making businesses. All said and done, there might not be a level playing field between social businesses and profit making businesses in terms of operational costs and hence the cost of the final product. Social businesses though have the ability to appeal to a different sense of people – but can that sense overtake the more pressing economic impact ? How can one work out a strategy where a social business could derive maximum value (both in terms of profit and social impact) from every unit of money invested. These were some topics I thought would have been more relevant to the book and could add more interest in the idea of social businesses.

Even if you don’t read the book, I suggest that you read the 2006 Nobel Peace Prize lecturePoverty is a threat to peace. It is so fitting that a man and the organization which provided credit to poor people were awarded the Nobel Peace prize. May be in that is where the value of social business is ! 

Micro loans for education

Rangde education is different from the traditional micro-credit option that Rangde offers. The difference – there isn’t any ROI for the investment. It is not to say that the principal amount is not returned, but that is the only amount that is returned. Unlike the income-generating micro-credit, for which the investor gets a return of 2% (3.5% APR), when the investor invests for micro-loan for education there is no ROI.

I am ok with the no ROI option for the micro-loan for education as the money is used for something that is important at the time it is most needed – when children go to school. It is sort of a scholarship program, but wherein the money is borrowed not given as a scholarship. So, if you are interested in making a difference at the right time, please invest in the children who could do with your help in their education. The Rangde site and Roshan Vikas have more details about how to go about investing.

As an aside, I made a gift purchase and gifted it to someone I know. Let’s see where they decide to invest the money in – whether a return generating micro-credit or more timely micro-loan for needy children.

Kiva introduces currency risk protection

Kiva introduced a new feature – currency risk protection recently. What is the feature and why is it important ? Oversimplifying it, this feature is a way to pass a part of the currency fluctuation to the lender, and only when the currency vacillates more than –20% (i.e. the borrower’s currency is devalued more than 20% pegged against the reserve currency, US dollars).

The Kiva site has a very simple example of how that works. I think the feature is not a bad idea. If a currency did indeed get devalued more than 20%, then I think the MFI shouldn’t be strained to get the difference funds, and the lenders should face the bullet.

This feature made me think of two things

  1. If the borrower’s currency was indeed devalued (due the economic conditions, not necessarily the current one but in general), and the lender also faces the risk of loosing some part of the investment, will that dissuade lenders from lending? Do lenders think actively consider the currency differences when lending? Do most of them lend assuming that their investment is charity ? (or with an idea to have a rotating investment – sort of a serial micro-venture-capitalist ! Hmm, am I the first one to use that term ? 🙂 ). At what point will this become an important consideration ?
  2. Continuing on the above and with wider ramifications, what can the MFI do to hedge its bets ? (did you hear the word hedge and bets and MFI all in the same sentence 😀 ). Well, agreed that the MFIs are not like the traditional lending institutions, in that they do have a social goal. But, is it possible that a MFI could hedge its investments by getting into future contracts ?
    1. Of course the knee jerk reaction for anyone is to scorn the idea, looking at me as if they won’t touch me with a ten foot pole. But, futures and options are not synonymous with evil isn’t it. So, why can’t there be an exchange which can help MFIs hedge their investments. And these will not be on the normal exchange, rather in a MFI exchange, where in these zero-sum contracts can be got by MFIs only. I still don’t have the details on how the options will work and will post again once I think through this (and if I realise it was a bad idea, I will write why !).

I’d be interested in knowing your thoughts on this. And while we are it, please do take a look at RangDe. They seem to be expanding their network each day and can definitely do with a little help.