Microfinance problems in the developing world – let’s look at the math

Last month (in 2010) this blog had reported about the microfinance industry problems  and  now there is a story in the NY Times . Let’s get the math straight- if you hire a CEO at a salary of 0.5 Million $/year   and the the typical loan you give out is $200 at let us say 10 %  ( rates for microfinance loans are reported at 30-70%)  you make 20 $ a customer on interest. Just to make up the CEO salary you need 25,000 good microloans and this number would be  about 10 thousand loans if you went up on the interest rate. If you counted the whole other administrative costs of putting loan officers in  every village the  number of loanees  needed to break even would sky-rocket.That’s hard (find “good” loans to give out) for a populous country like India, very hard for less populated Latin America and truly difficult in many sparsely populated parts of Africa.

[Note: This post from November 19, 2010 was updated on May 31, 2021 for formatting issues]

The microfinance logic for lending is that the developing country poor ,including much of Asia,Africa and Latin America i.e. 80 % of the world’s population, are not able to really come up with a business plan and a credit report. Folks don’t have a bank account-let alone a credit score. Sort of similar to unqualified US home loan receipients before the mortgage meltdown.

Since there is no or minimal paperwork what’s happening is that the loanee takes one loan , can’t pay and takes another one from a competing micro-finance organization and so on till the loans snowball to ten times of  $200 i.e. $2000.  This is “re-finance” without paying off the first loan ! After this the loanee absconds- or stops paying and so do other friends of the loanee who are at various stages of what can be understood as bankruptcy in the developed world.

It’s really important to sort this one out before,yes, billions of people get affected.

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