Microlending in the U.S.: A Solution to the Economic Crisis?

As you may have heard, last month, Kiva announced they would begin offering microloans to entrepreneurs in the U.S. Traditionally, they have been devoted to enabling small loans to budding entrepreneurs in developing countries to alleviate poverty, but the economic downturn inspired them to lend a helping hand next door. Not surprisingly, Kiva felt some backlash for this decision, as a team of Kiva lenders felt it unfair to lend to individuals who have attended college, have access to health care, and don’t have to build their own homes by hand.

However, microlending in the U.S. is far from new. Accion USA, one of Kiva’s partners in the pilot program, started providing microloans in the U.S. in 1991, and Grameen Bank, perhaps the most renowned microfinance institution founded by Nobel winner Muhammad Yunus in 1976, brought their business model here in 2005 with the founding of Grameen America.

In fact, there are hundreds of microfinance institutions lending throughout the United States. Check out this directory from the Aspen Institute on institutions that specialize in microloans and microenterprise support throughout the U.S.  Association for Enterprise Opportunity estimates that there are over 24 million microenterprises in the U.S., representing 18% of all private employment and 87% of all businesses. By their accounts, one out of six U.S. private sector employees works for a microenterprise. Even Fed Chairman Ben Bernanke spoke about the opportunity of domestic microlending in 2007, and explained that while microfinance in developed and developing countries differs greatly because of the economic and social contexts, they share the same goals–to “expand economic opportunities for individuals and to foster community economic development by providing small loans and other business services to people who have been traditionally underserved by mainstream financial institutions.”

But is it really the miracle people say? There have been recent reports that it hasn’t been the godsend to poverty in developing countries that many had hoped, but still, it’s making a sizable difference.   So what about in the U.S. and other developed countries? To get an insider’s take on the growing movement, we spoke with Maya Chorengel, co-founder of Elevar Equity, a investment management company that focuses on high growth microfinance institutions and entrepreneurs in the developing world.

Laurel Angelica: Kiva, the peer-to-peer microlending organization, announced in June that it will begin providing microloans to entrepreneurs in the U.S. What are your thoughts on their decision to expand into markets in the developed world?

Maya Chorengel: I think it’s an interesting idea. Kiva is a very powerful marketing tool for the microfinance industry and its efforts in the U.S. will highlight the fact that there are many low income entrepreneurs in the U.S. who may have the opportunity to work their way out of poverty with the benefit of a loan product structured appropriately for them. People tend to think of microfinance as a tool for the developing world, but there are poor individuals in developed countries too. There are a number of MFIs (microfinance institutions) with projects in developed countries like the U.S.: Grameen has a U.S. initiative in New York and other cities. There are also many other purely domestic players, most often small and based in one city, like Opportunity Fund which operates in the Bay Area and is the entity that Kiva partnered with to provide microloans to U.S. entrepreneurs.

LA: From a business perspective, what are the fundamental differences between microlending in developed versus developing countries?

MC: Microlending in developed countries has proven more difficult to scale because 1) loan sizes required to start a business in the developed world are much higher than in developing countries; 2) there are often interest rate caps which limit the ability of developed world players to charge a high enough interest rate to recoup transaction/operating costs; 3) sources of funding like credit cards are available, which can be used as a proxy for microfinance; 4) the regulatory framework for lenders is different in developed countries; 5) operating costs for a microlender are much higher in the U.S.

LA: Though Kiva does not provide the opportunity to earn a rate of return, to explore the difference between the two markets, let’s imagine a microfinance group offering investments in the developed world that does. From an investor’s perspective, what are the differences?

MC: Evaluating the rate of return for U.S. microlending versus developing country microlending would be no different from an analysis evaluating the appropriate rate of return from investing in the U.S. public equity markets versus investing in the public equity markets of a developing country. On the one hand, there is the risk profile of the opportunity itself (the company, the microentrepreneur, the MFI as the case may be) and there is also the macro risk that needs to be taken into consideration (political volatility, economic volatility, currency risk, etc.). All things being equal in terms of the opportunity, the macro risk is often perceived to be greater in a developing country and so the rate of return expected from a U.S. investment would be lower.

LA: Do you think more microfinance institutions will gravitate toward lending in developed countries, or will they mainly remain models for assisting the poor in the developing world?

MC: Large scale efforts will largely remain a hallmark of the developing world. There are larger numbers of poor as a percent of the population and the ability to scale is greater due to some of the reasons enumerated above.

LA: What challenges or changes have you seen in the field of microfinance since the global recession?

MC: Some MFIs have seen deterioration in their loan portfolios (higher portfolio at risk) as their borrower’s income streams have been affected by economic slowdown. Another issue is that MFIs have had a harder time raising funding/debt capital that they need to lend to the microentrepreneurs and so growth has slowed for many. In general, however, MFIs have often fared better than mainstream banks during the global recession as their borrowers are less tied to the formal economy and therefore less affected by economic slowdown.

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So could microlending be the answer to the economic crisis? Probably not. But it could create a meaningful impact for people living in poverty from Baltimore to Bangalore.