Microlending: Striking an Ethical Balance - TheStreet

When Gerhard Bruckermann left his position as chairman and CEO of the European bank DEPFA late last year, he took his knowledge of the banking world and public financing to good use. He took a position as head of a microlending outlet called Angkor Mikroheranhvatho Kampuchea.

AMK, a subsidiary of a Dublin-based nonprofit called Concern, provides small loans to villagers in rural Cambodia. Its aim is to build the economy and provide opportunities for people who have never stepped foot into a bank.

As microlending has gotten more attention for its success in developing countries, and its profit potential,

a heated debate

has begun to brew.

Microloans come with high interest rates because small loans are costly to service, especially in poor, rural areas. Advocates contest that profit-driven private-equity firms and companies like Mexican lender

Banco Compartamos


, which had a very successful IPO last year, are taking advantage of their clients by pushing interest rates far above what it costs to grant loans.

Compartamos and its peers argue that loans are expensive to provide, that the extra cash is needed to expand services to additional needy clients, and that they never purported to be not-for-profits in the first place.

As someone with experience at a profit-driven public bank, and now as the head of a non-governmental organization, Bruckermann offered some wisdom about balancing out the ethics of microlending.

TheStreet.com: Tell us about AMK.

Gerhard Bruckermann:

It has existed for four years now and it's growing very fast. We're serving more than 120,000 customers, and as is typical for a microfinance institution, something like nine out of 10 customers are women. So far we only operate in rural areas, which is of course much more complicated than urban areas. You spend a lot of money simply getting to the village.

The average loan size is less than $100, so what we're really talking about is buying fertilizers, buying seeds, helping thorough drought times, when there are emergencies in the family and they need medical treatment. We're not talking about

starting up small companies -- this is micro, micro, micro.

TheStreet.com:How do you determine the interest rates for loans, since there aren't traditional banks in the area to compare rates with?


There are money lenders there who charge 100% to 200% interest. With us coming in, this is the first time any of

the customers have had access to a real financial institution. Our interest rate is between 28% and 32% percent.

And you say, 'Wow, how the heck are they going to survive this?' You look at the high interest rate and say, 'This is really exploitative.' But this is really all absorbed by the high operating expense. The loans are really small and you need this interest rate simply to cover your costs.

TheStreet.com:How does the lending process work?


Most of these loans are so-called group loans. These groups are mostly eight to 10 women and they choose it themselves in the village. They spend for each others' obligations. They have several obligations to pay, so the lender can pick one out of them to pay all of it or her neighbor's loan as well.

This leads to very low default rates. You use the social fabric -- the solidarity between neighbors in a village -- for providing loans. The better-off have perhaps a water buffalo or an ox and they can plow. Then you have the ones in the field who use the water buffalo to plow the rice, or they weed and they organize the work among themselves. If you have half a hectare, you don't do all the work yourself.

TheStreet.com:How do you leverage your experience at DEPFA in this new position?


When you look at the world of microfinance there are about 7,000 institutions worldwide, and something like 6,900 are operated by NGOs.

They give loans and have to fund themselves -- through equity or some debts. They somehow get structured into something that you would call banking. These people don't have access to respectable financial institutions. NGOs come across these situations and they create these institutions.

I personally come from the other side -- I come from banking, but in my bank we had a close cooperation with this Irish organization, Concern.

It wasn't like we gave monthly payments to their operations in Africa, but Concern had an internship program, where bank employees could work at Concern for a few months and we considered this not an interruption of work for the bank, but an essential part of our bank business as well - to work with a nonprofit NGO on the development side. It was a wholesale bank so to work with the development side wasn't so odd.

TheStreet.com:What do you think of the debate over the commercialization of microlending?


You should initiate something that is sustainable. In finance, sustainable means you should come above the break-even point, otherwise you rely on donations. What one side calls sustainability, for corporate finance is the break-even point. The two seem to be from completely different worlds but they're just different terminology.

You get into this philosophical discussion of, Are donations good or bad? And it's probably both. On the one end, you have the NGos that have all the right intentions, and on the other end you have the businessmen who are all about the profits. And when you look at the microfinance world, you have all the shades in between.

To take your clients serious, you make them your business partners, you meet them on equal terms. Funds that are seeking investment possibilities are looking for 20-30% return on equity. My personal feelings about this one is when you want to get involved in something like this, don't call it ethical. When you're in a money-making mood and you say, 'Well I take a lot of risks, this is why I have these return ideas,' don't call it ethical investments. I think it becomes ethical when you say, 'I want to stay above the break even point or to reach break even.'

TheStreet.com:Do you have any advice for socially responsible investors who are interested in microlending?


Initial investors will make a lot of money at the time of

a microlending group's IPO. We have committed ourselves to reinvest the profits into other social investments.

That's how we try to fit the square box into a round hole. And if we make something out of it, that's okay -- as long as you don't spend it on a cruise to the Caribbean.