One topic of endless concern within impact investing, and microfinance in particular, is what interest rates borrowers are charged, and why. This is an important and worthy discussion because it speaks to a fundamental ethical concern —that the needs of borrowers are not exploited and that the debts they assume do not outweigh the benefits of the loans they receive. If a borrower works harder for the loan than the loan works for the borrower, there is a problem.
When I look at this issue, I start with some basic truisms: 1) borrowers should receive the cheapest rates possible, 2) legal protections should be in place and enforced to prevent exploitative rates, and 3) there must be a regulated, standardized and highly transparent global reporting mechanism to ensure that organizations rendering services to the poor are truly supporting the poor and not engaged in egregious profit taking.
An important fourth is that interest rates must be evaluated in the proper context to achieve an honest understanding. Unfortunately, information presented through the news media is often sorely lacking in this regard. For example, in 2010, the New York Times published Banking Making Big Profits From Tiny Loans, a widely discussed article that addressed this very issue. The article cited a Mexican microfinance institution (MFI) called Compartamos, which had been charging borrowers "nearly 82% in interest and fees." Another theme that was addressed in the article was the political impact of interest rates, with a quote from Nicaraguan President Daniel Ortega regarding his outrage that "interest rates were hovering around 35%” in Nicaragua. (It should be noted that in both cases these figures were based on 2008 data.)
Where the article erred significantly (a type of error by no means exclusive to the Times), was in comparing interest rates from two discrete economies, and connecting them as if they were apples to apples. This conflation misinformed the public, and misinformation always has the potential to negatively impact worthy programs.
To ground our understanding of why comparing interest rates between discrete economies is apples-to-oranges rather than apples-to-apples, I’ll begin by providing some insight into the interest rates one would likely pay in the US.
The number one risk of issuing any loan —regardless of whether that loan is to a microfinance borrower, to an AAA-rated multinational corporation, or to a sovereign government%mdash; is the inflation rate of the currency in which the loan is issued. This trumps the projected default rate, because even if the borrower does not default, inflation will diminish the value of money.
And herein lies an important piece of context. Let’s say I loaned a friend $1,000 to fix his car on January 1st, did not charge him any interest, and he repaid me in full on December 31st. That $1,000 would now purchase approximately 3% less than it did at the time I gave him the loan. Why? In simple terms, the rate of inflation in the US (assumed at 3% per year) deteriorated my purchasing power, and what cost me $1,000 a year ago costs $1,030 today. To break even, I’d have had to charge my friend 3% annual interest. But, hey, what’s $30 among friends, right?
But for a business that issues loans, this becomes an entirely different issue, which brings us back to the Compartamos and Nicaragua examples.
First, there’s Compartamos, the MFI that, according to the Times, charges borrowers "nearly 82% in interest and fees." In 2008, the annual inflation rate in Mexico was 5.1%. To account for the impact of inflation, a monthly interest rate should start at 0.415% (inflation compounds over time, so we need to compound this monthly rate for 12 months to arrive at the 5.1% annual inflation rate). That’s less than half a percent each month. Yet, at the time, Compartamos charged 82% annual interest, thus requiring a borrower to pay 6.85**% monthly interest!
The wide spread (nearly 6.5%) between the monthly interest rate necessary to account for inflation and the rate actually charged Compartamos borrowers practically begged for more transparency. For example, what were Compartamos’s labor costs and operating expenses? Without that type of context and further operational transparency from Compartamos, it isn’t unreasonable to conclude that their lending practices at the time were at best poorly managed, or at worst, exploitative.
For Nicaragua, though, we have a completely different scenario.
Remember from the Times article, Nicaraguan President Ortega expressed outrage over 35% annual interest rates. That means, on average, that an MFI was charging borrowers monthly interest of approximately 2.65%. And, by looking at Nicaragua's inflation rate, the reason becomes clear. Nicaragua had an inflation rate of 19.8% in 2008. So, just to account for inflation, an MFI would have to charge a monthly interest rate of 1.52%. In other words, the Nicaraguan MFIs were charging slightly over 1% extra per month to cover all of their operating expenses, with a profit margin that was just healthy enough to facilitate growth (to support other borrowers) and to protect against defaults. That is a sizably leaner spread than what we saw from Compartamos, and entirely reasonable.
And that brings me back to my original point. Context provides clarity, and from clarity emerges truth. Further due diligence by the Times would have revealed that Compartamos’ interest rates were so out of line with respect to inflation that they practically demanded closer examination; on the other hand, the annual inflation rate in Nicaragua at that time accounted for, and justified, the majority of interest rates that were charged to borrowers. And when MFIs in Nicaragua are incorrectly and irresponsibly compared to the more questionable practices of Compartamos, it is ultimately Nicaraguan borrowers who unfairly suffer the consequences.
The interest rates borrowers are charged is an issue that will always be important to the mission success of microfinance. The industry itself has a responsibility to provide greater transparency, but that deficit isn’t helped by sensationalist media coverage. To keep yourself properly informed, you may want to check out MfTransparency, a non-profit organization whose own mission is to bring needed transparency to this critical issue.
** The microfinance industry utilizes a “Flat Rate” means of calculation. While this method is largely absent in developed economies, it is widely used throughout developing economies, including by microfinance institutions. Thus I used a flat rate to calculate the monthly interest rate,, as this is very likely the rate borrowers see when they are offered loans.
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April 18, 2012
My Two Cents on Impact: Exploring an Interest in Interest (rates)
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| Image from TaxBrackets.org |
For those of us who follow microfinance news closely (I’m not the only one out there who gets “microfinance” Google alerts, right?) it’s been hard to see some of the trash talking about the industry in mainstream media in the last couple of years — since I’ve been watching. Critics point to greed via excessive interest rates imposed on the poor, and inappropriate money collection methods by some
MFIs, questioning whether microfinance is even effective. Andhra Pradesh and Grameen Bank have been in the news so much, they’re practically household names these days.
The negative publicity could certainly give a brand new, wide-eyed impact investor pause. But I’m beginning to realize that the bad publicity feeds an important system of checks and balances, helping expose harmful practices for the benefit of the entire microfinance industry.
Also, what I’ve learned so far from talking to experts in microfinance is that there are bad apples here, as in every other industry; nothing about microfinance is black and white; and poverty alleviation is exceptionally complicated.
One person I recently had the privilege of talking to is Sharlene Brown, National Director of Oikocredit USA, the issuer of my Fonkoze security on MicroPlace. (Fonkoze is Haiti’s largest microfinance institution.) I wanted to find out directly from her about Oikocredit’s due diligence process in selecting MFIs, the interest rates their MFIs are allowed to charge, and what kind of impact she’s seen.
(Feed My Starving Children, Flickr)I found out that Oikocredit has 36 regional offices staffed with locals, doing the initial due diligence work on MFIs in their regions. Local Oikocredit teams ensure that their partner MFIs’ business practices meet the organization’s strict quality criteria, which take into account commitment to social and environmental impact, interest rates, fees, and product prices, among other things. To some degree, Oikocredit has a decentralized governance system, empowering the local offices to operate within the cultural contexts of their regions, which means they also don’t interfere with the operations of the MFIs, unless they find a problem. And when they do spot opportunities for capacity building, Oikocredit offers grants to MFIs to help them strengthen their skills, competencies and offerings.
Sounds good to me, but I’m still plagued by the question of interest rates imposed on the poor in developing countries, probably because the media has had a field day publishing horror stories of poor people killing themselves because of the shame and pressure of not being able to repay their microloans. I wondered if Oikocredit imposes a cap on what their MFIs can charge in interest? Are traditional interest percentages in the 30s? 40s? 100s?
It turns out there’s no magic number for what’s acceptable, which explains why I can’t find specific information about interest rates anywhere. Sharlene said that what seems preposterous to me (anything above a few percentage points) could be acceptable in a local context. And yes, that could include a 70% interest rate. One reason for this is that MFIs aren’t like banks, where clients go to them. Their reps go to clients, even if that means traveling for hours to rural areas that no other financial institution wants to deal with. They also offer additional services that are built into their cost factor – clinics, women’s empowerment classes, literacy programs – which makes the cost of doing business much higher.
Oikocredit has a tool that allows them to spot extreme rates in the regions they work in, but their first step is to understand whether there’s something going on that makes this acceptable. An example would be that an MFI is trying to get deeper into rural areas, which involves hours of travel by transport and by foot. Naturally, somebody has to get paid to do this, so rates and product prices must be higher.
(Lee Cohen, Flickr)As a real-life example, Fonkoze focuses on women, many of whom can’t even count. In a great article about Fonkoze in a recent issue of GOOD magazine, its director, Carine Roenen, said that some of the women she works with recognize small bank notes by their color, but wouldn’t recognize large bills because they’ve never seen them. Clearly, these people need more than just loans, so Fonkoze has its borrowers, each receiving an initial $25 loan, form groups of five to help each other manage their money and their businesses. They also give them savings accounts, plus life, credit, and catastrophic insurance, and have borrowers attend four training sessions before taking out a loan, plus weekly meetings thereafter.
As of December 31, 2010, Fonkoze hosted 234,312 savings accounts with an average balance of about $100. And in the last ten years, the number of borrowers graduating from Fonkoze's basic literacy training has increased by 130%, which is incredible for a country with 52% of the population illiterate. Fonkoze has also seen its business skills training program grow by 550% in this same time period.
I’m no expert, but I would classify this as impactful and can understand that it would probably be pretty difficult to accomplish without charging interest.
There’s a lot to consider here, but the bottom line for me is that there are people and companies out there doing evil, and ones that are doing great things. The key seems to be to find ones that are trustworthy and are sincerely trying to make a difference and join them, or at least support their causes. Fortunately, MicroPlace has done the heavy lifting for me with its due diligence on the investment issuers to ensure my money is supporting deserving projects.
-- Lonnie Shekhtman
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April 9, 2012
Greetings from Art Stevens, MicroPlace's New General Manager
Today is my first day as General Manager of MicroPlace, and I wanted to waste no time in saying a hearty "Hello!" to all of you who make up the MicroPlace community.
After almost six years at Calvert Foundation —a pioneer in impact investing and the first issuer on MicroPlace— I felt there were very few opportunities as compelling as what I already had. But MicroPlace was just such an opportunity, and today I am excited and honored to be here and to be one of you.
I want to thank Ashwini Narayanan for her dedication and amazing work here. Having worked closely with Ashwini over the past four years, I know how much she has meant to this community, and how much she has contributed to this company. On behalf of everyone at MicroPlace, we wish her well as her own adventure continues.
So what should you know about me? I am a proud father of two beautiful children. I am a graduate of George Washington University with a BA in Political Science. Professionally, I spent over 10 years earning my sales and marketing stripes for a variety of firms, including TCW Investment Management, Franklin Management, Morgan Stanley Smith Barney and Shearson Lehman. With that experience in hand, joining Calvert Foundation allowed me to marry my professional capabilities with my personal passion for social and economic equality. As Vice President of marketing, sales and services, I am proud (and more than a bit humbled) to say I helped increase the foundation's assets from $155 million to over $400 million. Most importantly I got to meet some of the thousands of families who have seen their lives changed by access to capital, affordable housing, and critical services. I also got to meet a number of the investors whose own lives are changed by connecting their money with their values.
So why MicroPlace? I want to be part of something innovative and inspiring, something special that bridges the space between Forbes and Mother Jones. And MicroPlace fits that bill perfectly, with its unique focus on bringing impact investing to everyday investors, enabling them to help others secure economic opportunity while earning a financial return for their own hard–earned dollars.
Of course, what makes MicroPlace truly special is you, the MicroPlace investor. In the weeks, months and years ahead, I look forward to better knowing you and this community, and to understanding and effectively acting on your unique needs and desires as financially savvy investors and socially conscious consumers. We have great days behind us and even greater days ahead, with much work to do and tremendous things to accomplish.
And I, for one, couldn't be more excited.
Art Stevens
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After almost six years at Calvert Foundation —a pioneer in impact investing and the first issuer on MicroPlace— I felt there were very few opportunities as compelling as what I already had. But MicroPlace was just such an opportunity, and today I am excited and honored to be here and to be one of you.
I want to thank Ashwini Narayanan for her dedication and amazing work here. Having worked closely with Ashwini over the past four years, I know how much she has meant to this community, and how much she has contributed to this company. On behalf of everyone at MicroPlace, we wish her well as her own adventure continues.
So what should you know about me? I am a proud father of two beautiful children. I am a graduate of George Washington University with a BA in Political Science. Professionally, I spent over 10 years earning my sales and marketing stripes for a variety of firms, including TCW Investment Management, Franklin Management, Morgan Stanley Smith Barney and Shearson Lehman. With that experience in hand, joining Calvert Foundation allowed me to marry my professional capabilities with my personal passion for social and economic equality. As Vice President of marketing, sales and services, I am proud (and more than a bit humbled) to say I helped increase the foundation's assets from $155 million to over $400 million. Most importantly I got to meet some of the thousands of families who have seen their lives changed by access to capital, affordable housing, and critical services. I also got to meet a number of the investors whose own lives are changed by connecting their money with their values.
So why MicroPlace? I want to be part of something innovative and inspiring, something special that bridges the space between Forbes and Mother Jones. And MicroPlace fits that bill perfectly, with its unique focus on bringing impact investing to everyday investors, enabling them to help others secure economic opportunity while earning a financial return for their own hard–earned dollars.
Of course, what makes MicroPlace truly special is you, the MicroPlace investor. In the weeks, months and years ahead, I look forward to better knowing you and this community, and to understanding and effectively acting on your unique needs and desires as financially savvy investors and socially conscious consumers. We have great days behind us and even greater days ahead, with much work to do and tremendous things to accomplish.
And I, for one, couldn't be more excited.
Art Stevens
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Farewell from Ashwini Narayanan, outgoing MicroPlace General Manager
A couple of days ago, the MicroPlace team took me to lunch. A farewell lunch for a departing team member is a time–honored MicroPlace tradition. It was a really special occasion, not only because it was my last lunch with this team but also because it afforded me one of those rare, jewel–like moments that I will treasure forever.
In addition to my work at MicroPlace, I volunteer for an organization that does amazing work in a slum in Africa. This project is really dear to my heart and so the team decided to raise $1000 to support that work as a farewell gift to me. As I sat there trying to take that in, I realized how much this gift represents what inspired me to come to work every day for the last four years.
Yes, MicroPlace's mission is to enable individuals to make investments that help people out of poverty. But in reality, it is a way to come together as a community, to open our hearts, to get in touch with our humanity, with the goodness and generosity that is intrinsically a part of who we are. Helping someone else is a moment of transformation for the person who gives as much as it is for the person who receives. It is a moment of true compassion, where no sense of separation can exist; where there is no room for anything other than, dare I say it, love. There was so much love in that gift and the sheer beauty of that moment of openhearted generosity took my breath away.
I will miss this group of people. I will miss their infectious enthusiasm, their dedication and their passion for this work. I am deeply grateful for the opportunity to have been part of this team, this mission and this community of investors who have truly opened their hearts and wallets to make a difference in the lives of so many.
As I say farewell, I am also thrilled that MicroPlace's new leader is such an incredibly talented and passionate advocate of the work that we do. Art Stevens is a veteran of the impact-investing industry and has been part of the MicroPlace story since its inception through his role at the Calvert Foundation. I am delighted that he will take the lead in writing its next chapter.
Everyone keeps asking me why I would want to leave my dream job. It was a dream come true to be able to work for an organization like MicroPlace, where professional business expertise was in the service of creating social change. That was the adventure call four years ago. And now I am being called to a different adventure. I am leaving to pursue my spiritual practice as a student at the Zen Monastery Peace Center. Now, I have the incredible opportunity for my work to be my spiritual practice.
In the Zen tradition we greet and part with bowed hands and the word Gassho that translates, "as my heart and your heart are one." It was truly a privilege to be part of such a unique and amazing community. Thank you for opening your hearts and for your incredible generosity.
Gassho
Ashwini
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In addition to my work at MicroPlace, I volunteer for an organization that does amazing work in a slum in Africa. This project is really dear to my heart and so the team decided to raise $1000 to support that work as a farewell gift to me. As I sat there trying to take that in, I realized how much this gift represents what inspired me to come to work every day for the last four years.
Yes, MicroPlace's mission is to enable individuals to make investments that help people out of poverty. But in reality, it is a way to come together as a community, to open our hearts, to get in touch with our humanity, with the goodness and generosity that is intrinsically a part of who we are. Helping someone else is a moment of transformation for the person who gives as much as it is for the person who receives. It is a moment of true compassion, where no sense of separation can exist; where there is no room for anything other than, dare I say it, love. There was so much love in that gift and the sheer beauty of that moment of openhearted generosity took my breath away.
I will miss this group of people. I will miss their infectious enthusiasm, their dedication and their passion for this work. I am deeply grateful for the opportunity to have been part of this team, this mission and this community of investors who have truly opened their hearts and wallets to make a difference in the lives of so many.
As I say farewell, I am also thrilled that MicroPlace's new leader is such an incredibly talented and passionate advocate of the work that we do. Art Stevens is a veteran of the impact-investing industry and has been part of the MicroPlace story since its inception through his role at the Calvert Foundation. I am delighted that he will take the lead in writing its next chapter.
Everyone keeps asking me why I would want to leave my dream job. It was a dream come true to be able to work for an organization like MicroPlace, where professional business expertise was in the service of creating social change. That was the adventure call four years ago. And now I am being called to a different adventure. I am leaving to pursue my spiritual practice as a student at the Zen Monastery Peace Center. Now, I have the incredible opportunity for my work to be my spiritual practice.
In the Zen tradition we greet and part with bowed hands and the word Gassho that translates, "as my heart and your heart are one." It was truly a privilege to be part of such a unique and amazing community. Thank you for opening your hearts and for your incredible generosity.
Gassho
Ashwini
Read more!
March 30, 2012
My Two Cents on Impact: Why the Prospectus is my Friend
This past weekend I decided to spend some quality time reading the prospectuses of my two chosen impact investments, which I described in my last blog post. The sizable PDFs, found next to each investment on MicroPlace, summarize in great detail the terms of the investment, how/where it will be allocated, organizational and financial information about the issuer, and pages upon pages of risks (and risk management practices) associated with purchasing Notes, or investment offerings, from the issuer. If you're not used to reading stuff like this — which I certainly am not — brace yourself. It's like reading a contract: you have to sludge through it, even if it hurts. I recommend getting comfortable in your favorite reading spot and having a bottle of wine handy.
I wanted to share a few pieces of important information from my Oikocredit-USA prospectus, because I wouldn't have anticipated some of the issues it addresses, so I imagine other people might not either. I believe it's best to avoid major surprises when it comes to my money, which is why I propose that the prospectus is my friend.
(From the Oikocredit-USA prospectus)
There was consistent reinforcement throughout the prospectus that there can be no assurance that I will not lose all or a part of the principal amount and interest on my Notes. This is because if an Oikocredit-USA borrower — a microfinance institution (MFI) in a developing community that it serves, for instance — defaults on a loan because a person they've made a loan to defaults on theirs, there's pretty much nothing Oikocredit-USA can do. Plus, there are political and economic risks associated with doing business in developing countries that could affect the organization's ability to repay investors. This is unsettling, but I have to trust Oikocredit-USA's track record (average yearly write-offs of below 1% of its financing portfolio) and MicroPlace's due diligence process in selecting it as an issuer.
I spoke with MicroPlace's head of due diligence, Flavia Romero, about the process of allowing new issuers on the site and was quite impressed (and relieved!) by the rigorous vetting process. It takes three to nine months and involves MicroPlace staff, PayPal analysts and eBay legal, enterprise risk management, and audit experts. The team reviews each issuer's operations, financials, management team, IT capabilities, processes, procedures, and the MFIs they lend to before allowing them on the site. After the initial audit, the team conducts quarterly and annual reviews. So far, no MicroPlace issuer has defaulted on any of its loans, which is a good sign.
What the Oikocredit-USA prospectus didn't cover in great detail is specifics about its own due diligence process (is there a limit on how much interest its MFIs are allowed to charge borrowers?) and the social impact of the MFIs it loans to, especially the one I'm investing in: Sevis Finansye Fonkoze. I want more details, so in my next blog post, I'll take a closer look at the conditions on the ground in a couple of the countries where MicroPlace investors are targeting their funds.
--Lonnie Shekhtman
*MicroPlace actually allows its investors to opt out of automatic reinvestments. The option is in each investor's account settings. Click here to learn more.
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I wanted to share a few pieces of important information from my Oikocredit-USA prospectus, because I wouldn't have anticipated some of the issues it addresses, so I imagine other people might not either. I believe it's best to avoid major surprises when it comes to my money, which is why I propose that the prospectus is my friend.
- Allocation of my investment: The Oikocredit-USA prospectus gives a general statement of how my investment will be allocated: to a lending institution or group of lending institutions selected by Oikocredit-USA from a portfolio of about 879 project partners in more than 70 countries. This threw me off, since I had allocated my investment specifically to women in Haiti via Sevis Finansye Fonkoze, so I called MicroPlace to double check. I confirmed that my money is indeed going to Haiti. The reason for the blanket statement is that Oikocredit-USA's prospectus covers all of its Notes on MicroPlace.
- Increasing my investment: If I decide to increase the amount of my investment in an existing Note, I can't. I'll have to purchase additional Notes for the same project, given that the Note is still available.
- Withdrawing my investment: I will get emails from Oikocredit-USA prior to the maturity of my investment with instructions on cashing out or reinvesting. If I don't act on this information — which, unfortunately, I'm likely to do — Oikocredit-USA will automatically reinvest my principal.* When I finally realize what has happened and decide to withdraw the new investment before maturity — because I had intended to cash out to pay for a trip to Europe, let's say— I'll be penalized, if I'm allowed to do it at all. This is true of all withdrawals before maturity, although some issuers give you 90 days to pull out of an automatic reinvestment without any penalties.
- Taxes: Even though Oikocredit-USA is a nonprofit and the purchase of one of its Notes might feel charitable, it's not, so there are no tax deductions. On the contrary, interest earned on these investments — just like on most traditional investments — is taxable, so I'll be receiving a Form 1099 at the end of each year reporting interest earned on my MicroPlace investments.
- Default: My investment is not insured or otherwise protected in any way, so if, for whatever reason, Oikocredit-USA experiences losses, it would first tap its reserves of approximately $1.04 million to repay investors, and then. . . who knows? Oikocredit-USA has about $22.2 million in Notes outstanding, so there's no guarantee that I'd be part of the lucky few who get repaid if something goes awry. That's the picture painted by the prospectus, at least, which presents worst-case scenarios. In reality, the organization has more than $25 million in total assets — according to the financial stateemnt in its prospectus — so that would likely cover all potential losses.
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There was consistent reinforcement throughout the prospectus that there can be no assurance that I will not lose all or a part of the principal amount and interest on my Notes. This is because if an Oikocredit-USA borrower — a microfinance institution (MFI) in a developing community that it serves, for instance — defaults on a loan because a person they've made a loan to defaults on theirs, there's pretty much nothing Oikocredit-USA can do. Plus, there are political and economic risks associated with doing business in developing countries that could affect the organization's ability to repay investors. This is unsettling, but I have to trust Oikocredit-USA's track record (average yearly write-offs of below 1% of its financing portfolio) and MicroPlace's due diligence process in selecting it as an issuer.
I spoke with MicroPlace's head of due diligence, Flavia Romero, about the process of allowing new issuers on the site and was quite impressed (and relieved!) by the rigorous vetting process. It takes three to nine months and involves MicroPlace staff, PayPal analysts and eBay legal, enterprise risk management, and audit experts. The team reviews each issuer's operations, financials, management team, IT capabilities, processes, procedures, and the MFIs they lend to before allowing them on the site. After the initial audit, the team conducts quarterly and annual reviews. So far, no MicroPlace issuer has defaulted on any of its loans, which is a good sign.
What the Oikocredit-USA prospectus didn't cover in great detail is specifics about its own due diligence process (is there a limit on how much interest its MFIs are allowed to charge borrowers?) and the social impact of the MFIs it loans to, especially the one I'm investing in: Sevis Finansye Fonkoze. I want more details, so in my next blog post, I'll take a closer look at the conditions on the ground in a couple of the countries where MicroPlace investors are targeting their funds.
--Lonnie Shekhtman
*MicroPlace actually allows its investors to opt out of automatic reinvestments. The option is in each investor's account settings. Click here to learn more.
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