Case Analysis – Microlending – Jason Bonner
Cell phone provision of microfinance products and services
There are three major issues in microlending; Availability of funds, administration costs, and of course, the high risk associated with dealings at the bottom of the pyramid. Using cell phones as a provision of microfinance products and services, though still in its infancy stage, has proven to be an effective means of addressing the most prevalent issues. Elimination of these major hurdles can and will open the door for future growth in microlending as well as help millions more climb out of poverty.
The first major issue in microlending is the availability of capital. While there are billions of people that are at the bottom of the pyramid that can benefit from small loans, they are just that, small, leaving the profits minute as well. This does not attract many large financial institutions or investment firms simply because the profits are more attractive elsewhere. Much of the finances available to the microlending industry originate from charities and philanthropies. As stated by Stephanie Strom and Vikas Bajaj, there has long been debate over whether social enterprises should be turned into giant commercial operations that can use the money raised to provide even more loans to the needy rather than relying only on charitable donations. Issues arise as what starts as a social enterprise to help the poor gradually becomes big business in search of profits. The line gets blurred between doing right by the people and doing right by investors wanting higher profits. Many proponents of microlending believe it may be possible with the correct regulations and business plan, but being in its infancy stage still, that has yet to be determined. Making the microfinance industry more attractive and stable will open doors for increased capital availability. This can be achieved by lowering risks and costs associated with establishing and servicing micro loans through the use of cell phone communication.
Costs are a major factor when dealing in microfinance loans. The main reason for the high cost of microfinance loans is the high transaction cost of traditional microfinance operations relative to the loan size. This increases interest rates from 30% to 300% and possibly higher, depending on risks involved and late fees and penalties. Moneylenders are frequently accused of artificially inflating rates leading to increased poverty, the exact opposite of what this social enterprise was designed to achieve. Lack of regulation has been raised as an issue but with the many different requirements of the many different areas of poor throughout the world make designing a consistent and stable system near impossible. In developed parts of the world, the credit system has a credit rating system. This enables financial institutions to base rates on past credit performances. In undeveloped parts of the world, there are no such systems. Organizations like Accion, a network of financial institutions based in Boston and Washington, DC, started their microfinance endeavor with solidarity loans made to groups of poor people, believing they would provide a stable arena for loan acquisitions because the receiving members would keep each other honest for repayment. This system also backfired as members of groups receiving loans would often grow their businesses at different rates leading to some members covering other members’ debts. Again, communication breakdown can be blamed as the major issue leading once again to the use of cell phone technology as an answer.
The risks involved in microfinance are extreme. It is very difficult to see how lending money to those with none can be beneficial or profitable, especially in small amounts across large areas. This is the main reason for slowed industry growth. There have been few success stories in microfinance, but none that offer a complete answer or a business plan for future profitability and sustainability. Many of the success stories, like ProCredit and Grameen Bank, frequently face problems in new territories due to culture differences and or simply need more capital but are unable to acquire more investment. Among the few shining stars, there are many dismal microlending institutions that exploit the poor offsetting any good done by those that are successful, drawing much criticism in the world. The main problem stems from trying to make money off the poor. Turning a charitable organization into a for-profit company is an exercise in futility. This was proven by SKS Microfinance and its issues with going public and what to do with the profits from doing so. The only beneficiaries should be the poor that are being helped. Trying to justify a paycheck quickly turns the entire outlook of this young industry from caring to greed.
Communication can be the game-changer in the microfinance industry. The cell phone industry has exploded among the bottom of the pyramid as the poor realize the benefits of cellular technology and the often lifesaving information that can be had easily as explained by David Lehr in his article “Dialing for Development.” Cell phone technology keeps people in touch with one another and this model can be used to bridge the gap between moneylenders and the BOTP. A company called Zidisha is currently attempting the use of cell phones in its microlending business model. The average Zidisha borrower pays only 8.02% in annual interest and fees, dramatically reduced as compared to the current averages. Much of the savings are in administration costs. Zidisha puts borrowers in direct contact with lenders eliminating many middlemen all of whom used to pocket a percentage. Risks are also dramatically reduced by creating a Facebook-esque environment where borrowers are in steady contact sharing stories of success and failures for others to learn from. Risk is also diminished further because of a rudimentary credit history formed by the peer-to-peer network that can be followed by lenders similar to feedback ratings on EBay for buyers and sellers. Through the use of cell phones and its increased communication, Zidisha has effectively eliminated two of the three major issues facing the microfinance industry. Through its continued success, the third issue of acquiring more capital to lend should naturally fall into place as time goes on and the business model proves itself profitable and sustainable.
In order for microlending to survive and continue offering a way out of poverty for the bottom of the pyramid, communication is the key factor and cell phone use will be the tool used to achieve that. The BOTP has already embraced the technology and has enjoyed many benefits derived from information that would otherwise go unknown. To use this technology even further in microlending is the logical next step for this industry. It lowers risks by opening up communication channels and adding transparency. It cuts costs by eliminating middlemen and paperwork associated with loan origination and collection. And it will attract more capital as the technology is spread further among the BOTP, showing that microfinance can be both profitable and charitable.
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