Microfinance: Predatory?

From what I have seen, often the government of the country receiving the $$ may provide some guaranty to the international lender to insentivize business development. Now, if it is a Sub Saharan African country you'll need to weigh how good their word/credit history is.

There was some Canadian firm that used to provide loans to sub African start ups - business like funding a chicken egg farm. Sometimes the government may also be in partnership with a UK based trade organization that can assist with the loan guaranty/insurance to sweeten it for the lender.

How is it predatory? Learn what cost of capital means.

Because a lot of these "microfinance" loans are basically grants in disguise. Like lending to a student who goes to a shit private school and majors in Communications only for the government to forgive his loan two years after graduation anyway.

From my understanding, in Africa specifically, microfinance has been found to be woefully ineffective relative to just giving out small grants.

Alternative lenders have some potential, look up what Tala is doing. Basically they look at tons of unconventional data points (GPS location, phone contacts) and use them to generate a credit score for those who have no financial identity.

https://digital.hbs.edu/platform-rctom/submission/tala-providing-loans-…

It is predatory but let’s be real here. Chase isn’t going to open a branch in Xbukunlumpinto to fund some farmers. It could though. Lending is a very simple business because you can make money lending to anyone. All you have to do is make sure your interest rate is higher than your default rate.

However I believe the issue here is prestige. Good bankers, as in the ones who already have money and have no need to extort poor people in Africa, like their comfy jobs in big cities. Offer anyone in WSO double their comp to go open a microfinance branch of their bank in rural India and 100% of them would turn it down because Chad, Brett and Trent from his MBA class would all make fun of him.

Therefore the market is completely lacking real bankers. All that is left is shady money. Money from ex-(or current) druglords, warlords, corrupt politicians, etc. It now gets invested in some weird microfinance fund and because no one would want to do that job, the only people who get in are also people with shady backgrounds. People who would not pass a background check at any proper corporation. If a couple of decades pass eventually the fund becomes a bit more professional. They may even hire locals. But the reality is that no one would want to work in microfinance if they had any alternatives. It is just a cycle of misery.

I advised a Cambodian non-profit with a microfinance program a few years back. From what I saw, it wasn't predatory at all. The rates were crazy high, but there was an incredible amount of competition. There is a ton of money available to legit MF programs. At least in Cambodia, the industry is starting to consolidate and inefficiently run programs are no longer able to compete. The spectrum of sophistication is incredible. The top programs operate like banks - we had one guy and an Excel sheet. Nobody ever paid us back because the collector was friends with all the town people. I tried to help but it was too late. We closed our lending arm down and it was a great thing, this is exactly what markets are meant to do. That money can now flow to better operators.

The gold standard in microfinance is Grameen Bank. They not only track financial returns, but Progress Out of Poverty (PPI), As another user said, they utilize group loans with self help groups and training. Savings is incorporated as well. When done correctly, it's an amazing program. Very few groups operate like Grameen do, however. 

As a person from a place with a lot of Microfinance institutions, it's 2 things.

1. The amounts are usually quite small. So a high-interest rate of ~20% wouldn't be that difficult to pay back if the total loan amount is 100-1000.

2. The main recipients of Microfinance loans are by far farmers who are completely unbanked. But, just because they're unbanked doesn't mean they don't make decent money.

I wouldn't say it's predatory at all, just that higher interest rates are the norm in these countries and that it's difficult to accurately assess the credit worthiness.

My grandfather runs an informal credit shop in southeast Asia which he inherited. So informal credit in agriculture is a 40-50 billion-dollar market in southeast Asia, these farmers won't go to microfinance companies or banks since they have no official credit history and are unaware of any cheaper options. 

What lenders do is buy the farmers basic necessities like the seeds and fertilizers (which the lenders themselves buy on credit and is cheaper in bulk) and then they give that to farmers with some cash for irrigation and miscellaneous expenses 

Farmer is obliged to sell their agricultural produce through the lender,

At the time of harvest, the lender's operational arm sells the agricultural produce, then the lender recoups the original loan amount, then the lender takes a fixed commission at 8%-20% and then a variable commission on sales price ( better the crop price more the commission )

mostly commodities are inflation-adjusted but the lenders make sure that if there is any currency devaluation, they charge fees and adjust for that 

After that, they check their credit books and see whether the farmer owed them money in the past where he might have defaulted and deduct money if they have and after that due diligence, they transfer the farmer what they are owed 

this cycle enforces farmers to be dependent on lenders and they get crumbs for their effort, the farmers get enough to survive 

lenders are usually making $400,000 to $10,000,000 depending on the initial amount loaned 

The Government doesn't regulate it and since the business is mostly in cash so they are no taxes paid by the lender 

The Default rates are in single-digits 

The issue is underwriting costs. You have to go from the capital city...drive several hours away potential to deploy very small dollar amounts. Therefore its not overly predatory in that regard. Its not like many of these lenders are squeezing the small guy. Underwriting costs are just high on a relative basis and those need to be recouped. Also the alternative would more expensive loan sharks. Another point would be that these aren't businesses with low return returns. It can be something as simple as buying milk to make yogurt to sell in your town where the margins are 50%. Overall the reality is this is better than any alternatives. 

Nobody's just gonna admit none of us know anything about microfinance?

A couple of thoughts:

Defaults rates are high, hence high interest rates.

Correct, the folks that go into Microfinance have a different drive than us. I will need to charge 10,000 basis points on every deal to survive, so wouldn't work.

The hardest part of finance for most / a lot of world is guaranteeing payment.

People don't have a similar morality to Americans and don't care about their reputation or credit, so the incentive model is totally different. You need to see the world with a different lens.

(Unless it is their neighbor, then informal finance systems work, you do m need to maintain a steadfast commitment to your local community, but if you are 5000 miles, you are out of luck)