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Microfinance Experts Criticize Mexican Bank

Lauren Tara LaCapra

During a conference call Monday from the Asia-Pacific Microcredit Summit, several advocates chastised those who charge "loan-shark" interest rates and criticized Compartamos' initial public offering last year. Microlending should be performed by banks and nonprofits that operate within the country, they say, and better oversight is needed to ensure competitive rates and ethical collection practices.

"Microfinance doesn't need the capital markets," says Muhammad Yunus, who won a Nobel Peace Prize in 2006 for his work as founder of Grameen Bank, a microlending pioneer for impoverished Bangladeshis.

Such charges have implications not just for profit-hungry microlenders but for socially responsible investors who want to put their money to good use and also see healthy returns. While the commercialization of microlending has expanded the availability of loan capital, Yunus predicts it will "lead to a lot of speculation and an eagerness to hike up the prices."

Interest rates on microfinance loans vary widely, depending on the market and size of the loan. Chuck Waterfield, founder of Microfin, a microfinance software company and former microenterprise director of the anti-poverty group CARE, estimates that the typical loan in Bangladesh has a 20% to 25% interest rate, due to broader availability, while those in Latin America are in the range of 40% to 45%.

In Mexico, where Compartamos dominates the microfinance market, interest rates are often above 100%.

"It's not a market rate," Waterfield says, "it's what-a-market-can-bear rate."

Waterfield's firm is collecting data on lenders' microloan rates in developing countries to add transparency and boost competition. The smaller the loan, the higher the interest rate, because the cost of servicing those debts is much higher.

Compartamos notes that its customer base operates on relatively small loans and that if its average loan size were double the current level, it could slice interest rates in half. The bank argues that its rates may seem high compared with those in other markets but are on par with those of other Mexican lenders.

Carlos Danel and Carlos Labarthe, co-CEOs of the bank, also note that the Mexican economy is pervaded by informality, unemployment, weak property rights, inability to size or price assets, feeble legal recourse and a lack of consumer credit history. These factors make servicing small debts even more costly and difficult than doing so in more developed markets.

"A plea for lower interest rates is in fact a plea to increase the size of our loans significantly," they say in an open letter defending the bank's business. "Doing that can only have two outcomes: the over-indebtedness in our clients or moving to a different segment of the market, which amounts to mission drift."

Still, Yunus argues that lenders should "look at it from the cost side, not the market." He estimates that interest rates should factor in the cost of acquiring funds, plus 10% for other business expenses. He said 10% to 15% is "slightly on the high side," while those who tack on more than 15% have "just left the microcredit area and joined the loan-shark area."

Socially responsible investing has grown in recent years, with a special focus on microlending, which tends to be quite profitable. Compared with regular lending, microloans also have a very low risk of default -- in part because of the informality of the system.

For instance, clients of Compartamos' Crédito Mujer group are women who request loans to fund their small-business ventures -- for instance, selling food and clothing locally or making textiles to ship abroad. The women gather in small groups of 12 to 50 to review how their businesses are doing and what the next steps are in the lending process. If business is slow for one member, the others will assist her in repaying her share of the loans, and peer pressure leads to low default and delinquency rates.

Interest in socially responsible investments has surged as investors look for profitable opportunities that allow them to give back to the less fortunate or develop environmentally friendly technologies.

U.S. assets invested in socially responsible funds rose 18% to $2.71 trillion in 2007 from $2.29 trillion at the end of 2005, according to the Social Investment Forum. The group says that nearly one out of every nine dollars under professional management in the U.S. today is invested in a socially responsible manner.

Microlending has attracted increasing attention, as investors are "increasingly embracing international microfinance opportunities to promote positive social and economic development abroad," the group's year-end report says.

The World Bank's arm involved in microfinance -- called Global Call to Action Against Poverty, or CGAP -- says that several large firms, including Citigroup(C Quote), Credit Suisse(CS Quote), Deutsche Bank(DB Quote), Merrill Lynch(MER Quote) and Morgan Stanley(MS Quote), have also entered microfinance investments in recent years.

However, as Compartamos and its peers receive more scrutiny for their profit-seeking goals, investors who place social responsibility above returns may start moving assets into projects that don't make money by taking it from the pockets of needy citizens in the developing world.

Yunus advises investors and pension funds against putting their assets in poor countries and microfinance. It's too difficult to monitor deposits, he says, and currency fluctuations can affect returns.

"Lending becomes complicated when you're out of the country," he says, adding that "if you want to support microlending ... put your money into the [microcredit] bank."