The Dark Side of Microlending

Business Week has a fascinating story on the dark underbelly of microlending, the antipoverty strategy used in Third World countries to provide small loans to the poor, promoting economic improvement.

It turns out that the market for poor lending has skyrocketed into a hugely profitable business for banking interests. More troubling is how microlending often results in more hardship for the poor, when usurious lending practices send people deeper to poverty.

Business Week's article focuses on microlending in Mexico. It's a fascinating story:

The transactions are so minuscule they hardly seem worth the bother. The average loan amounts to $257. But for Banco Azteca, a swiftly growing bank affiliated with Latin America's largest household retailer, the small sums represent a torrent of revenue that has caught even its founders by surprise. For three decades, micro-lending was seen as a tool of nonprofit economic development. Now poor people are turning into one of the world's least likely sources of untapped profit, primarily because they will pay interest rates most Americans would consider outrageous, if not usurious.

With no legal limits on interest levels and little government oversight, for-profit banks in Mexico impose annual interest rates on poor borrowers that typically range from 50% to 120%. That compares with a worldwide average of 31% among nonprofit micro-lending institutions, and the 22% to 29% that Americans with bad credit histories incur on credit-card debt. Azteca's business model succeeds not only because it can charge credit-starved clients almost whatever it wants. Equally important is that low-income Mexicans anxious about maintaining their reputation tend to pay back what they owe, regardless of the hardship. Those who slip behind receive frequent visits from motorcycle-riding collection agents. Default rates are infinitesimal. "We lend to them as much as they can borrow," says Azteca Vice-Chairman Luis Niño de Rivera, "and they can borrow as much as they can pay"....

The transactions are so minuscule they hardly seem worth the bother. The average loan amounts to $257. But for Banco Azteca, a swiftly growing bank affiliated with Latin America's largest household retailer, the small sums represent a torrent of revenue that has caught even its founders by surprise. For three decades, micro-lending was seen as a tool of nonprofit economic development. Now poor people are turning into one of the world's least likely sources of untapped profit, primarily because they will pay interest rates most Americans would consider outrageous, if not usurious.

Pawnshops and loan sharks, whose interest rates of up to 300% have plagued generations of Mexicans, now face rivals offering terms that are less harsh. But along the road to previously unavailable financing, some Mexicans are stumbling badly.

The Arana family is but a blip on one of the wide screens at Azteca's operations center. Beneath the digital glimmer lies a story of striving. Adrián Arana Sánchez, his wife, Francisca, and their extended family take whatever work they can find, adding a few pesos here and there. Last July, Adrián lost an $80-a-week job delivering soft drinks to stores in gritty, exhaust-choked San Martín Texmelucan, a city of 143,000 two hours southeast of Mexico City. He now brings home half that amount peddling vegetables door to door and making plaster-cast statuettes of Jesus. Francisca sells crunchy slices of jicama root outside an elementary school. With four children, two grandchildren, and a son-in-law, they live in a four-room cinderblock house in the shadow of snow-capped volcanoes once revered by the Aztecs.

Although indigent by U.S. or Western European standards, the Aranas see themselves as aspiring consumers and even as entrepreneurs in a society that makes all manner of goods and services available for what seem like manageable weekly payments. Banco Azteca plays a central role in that emerging credit economy. Started five years ago, it operates from the nearly 800 locations of its parent, Grupo Elektra, Latin America's largest electronics and home appliance chain. Elektra/Azteca has the sort of ubiquitous presence that Wal-Mart enjoys in the U.S.

Read the whole thing.

Muhammad Yunis, who won the Nobel Peace Prize in 2006 for his program of providing microcredit to millions in Bangladesh, is a hero among global activists and developmental economists (and interestingly, Yunis turned out to be no saint, see here and here).

Certainly market forces should be maximized to help lift the global poor out of poverty. But it's interesting to know that the bloom is off the rose a bit on microcredit.