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The Harms of Commercial Microcredit


Social entrepreneurship strives to develop a system that funds solutions to social issues around the world, including poverty. Microfinance has become one of the most popular methods of implementing social entrepreneurship globally, especially within the last decade, during which microfinance companies doubled their lending. The growth of microfinance appears benign, as it gives loan access to an unbanked population that has historically relied on payday lenders or loan sharks, many of which charge absurd interest rates of up to 400% and threaten violence on their borrowers.

However, in a movement that started as philanthropy, more than 75% of microfinance organizations now describe themselves as for-profit, charging high interest rates to maximize revenue. These lenders have expanded to vast markets such as Cambodia, the Philippines, parts of North Africa, and Latin America, culminating in an overall gross loan portfolio of $80 billion in 2018. We must ask ourselves: are these for-profit microfinance companies inhibiting the positive social impact in the name of greed?

The core element of microfinance is granting steady microloans to individuals or small businesses after conducting a credit assessment. The goal of this microcredit system is for these microenterprises to have a safe and easy way to pay back their loans while advancing their businesses. For-profit microfinance lenders have morphed their views on the microloan concept to fit their liking, expanding the average loan sevenfold in Cambodia to around $4,000 to maximize profit—three times the average annual household income. Hence, many are perpetually struggling to pay off their loans and simply cannot because of the volume of their loan compounded with high interest rates. Moreover, this has started a troubling trend where retail impact investors are prioritizing the for-profit microfinance firms who have the greatest financial returns rather than those with a double-bottom line objective (focuses on social and environmental impact in addition to financial gain). Many microfinance companies have flocked to Cambodia over the past decade, partly because it is one of the only countries that require microfinance borrowers to post collateral, such as land titles. By 2018, 99% of Cambodia’s gross loan portfolio was from microfinance, and up to one in five adults had a microfinance loan.

Realizing its citizens were potentially being exploited by microfinance companies, Cambodia’s government tried to impose an 18% interest rate cap. However, microfinance lenders adeptly tripled commission fees and increased their loan sizes, resulting in a worse environment for borrowers. The consequences of these policies have been devastating for Cambodian borrowers; after a few harsh verbal reminders by loan officers, the borrowers’ assets are seized as collateral and sold if they cannot pay off their loans in time. Thousands of households in Cambodia were forced to sell their land and homes in 2020 due to reduced income during the Covid-19 pandemic. Strangely though, microfinance companies recorded record earnings and profits during the pandemic because of these unethical policies. While many have spoken out about this potentially irresponsible behavior by microfinance lenders, investors have poured even more money into Cambodia recently, which should raise a vast concern about the financial well-being of its citizens and the merits of for-profit microfinance ventures entirely. It seems that many for-profit microfinance organizations have been crossing the line in terms of their ethical comittments to business, which is a serious problem.

Many of the same for-profit microfinance organizations are also heavily involved in Sri Lanka, which has been under turmoil in light of its recent effects. The gross total of microfinance loans is estimated to be $3.2 billion: an amount that is 50-fold what it was just fifteen years ago. The harmful policies of these microfinance lenders were brought to light on the world stage by UN worker Juan Pablo Bohoslavsky, who claimed that aggressive collection tactics were common in Sri Lanka. Even more surprising was that he reported instances in which women were pressured into trading sexual favors or had offered to sell their kidneys to repay loans. Under these dire circumstances, where borrowers feel they have no way out, people have resorted to taking their own lives.

Microfinance intends to improve people’s lives financially by enabling them to receive loans. It is no secret, though, that for-profit microfinance companies have been crossing the line in terms of their ethical commitments in business. Both the governments of countries whose citizens have been harmed by microloans and the predatory microfinance businesses must be held accountable for their actions and change their policies. The microfinance industry must revert to its original message of financial inclusion, rather than exploitation of the unbanked population.

 

By Ryan Sullivan

 

Works Referenced

Cull, Bob. “The Microfinance Business Model: Enduring Subsidy and Modest Profit.” World Bank Blogs, 2016, https://blogs.worldbank.org/developmenttalk/microfinance-business-model-enduring-subsidy-and-modest-profit.

Finch, Gavin. “How Microfinance Pushes Poor Borrowers Deeper in Debt in Developing Economies.” Bloomberg.com, Bloomberg, 3 May 2022, https://www.bloomberg.com/graphics/2022-microfinance-banks-profit-off-developing-world/.

Weinberg, Brian R. “For-Profit versus Nonprofit Microfinance: How Are the Poor Affected?” UNT Digital Library, University of North Texas. Honors College., 2 July 2012, https://digital.library.unt.edu/ark:/67531/metadc86952/.


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