The Challenge of Cheap, Charitable Capital for For-Profits

November 28, 2009

Milford Bateman, “a confessed microfinance sceptic” made a serious and novel (to me) charge against Kiva on the devfinance mailing list, that Kiva’s cheap capital is padding the profits of any for-profit microfinance banks through which it lends. I tweeted his message, so I ought to share with you the reply I received from Kiva. First Milford:

If you go to Kiva’s website it is very bizarre to find that the default percentage is ZERO for every single current partner MFI but one (Zene za Zene from Bosnia which registers 0.13% default). Given we know that default rates do exist (it seems that Kiva has dropped several MFI partners as a result of high default rates – go to the bottom of their list of current partners to find ex-partners) and defaults are growing of late almost everywhere, how come current partner MFIs have an almost perfect record? Well, if you think about it, why would anyone want to risk interest free money by advertising a default rate over zero if they don’t have to? I mean, an MFI would be silly to risk losing interest free cash offered by Kiva. Even if it simply popped the cash into an interest bearing account, a partner MFI could benefit from the interest generated, present Kiva with a few photo’s of current clients every now and again to keep them happy, and then return 100% of the original cash amount to Kiva at the end of the year. Nice work if you can get it! How do we or Kiva know that some MFIs don’t simply do this? How do we know that MFI managers don’t simply use the juicy Kiva margin to inflate their own remuneration? After all, from a variety of websites it is clear that few if any MFIs offer lower interest rates to Kiva clients. This would ‘spoil the market’, as market fundamentalists would say. So Kiva clients (if such a distinction is even made) get exactly the same offer as other non-Kiva clients in the main. OK, I found one MFI – Xac Bank in Mongolia – stating that it offers Kiva clients the Kiva margin earned at the END of their Kiva loan, placed in a savings account at Xac Bank. This sounds better than if it were used to inflate managers/owners own salaries, but, still, it usefully helps to develop new savings clients for Xac Bank probably more than it helps fulfil Kiva’s stated aim to create jobs and incomes for the poor.

To which I replied in the same venue:

When I met with Premal Shah, the president of Kiva, he contrasted Kiva with other Northern sources of capital for microfinance by pointing out that most microfinance investment vehicles are looking for a hurdle rate of 6% or the like, where as Kiva’s users accept 0%. It is a special, highly risk-tolerant source of capital, so Kiva’s goal is to support the 2nd, 3rd, 4th-tier MFIs that cannot attract capital from elsewhere very easily. How well it is currently living up to that goal, I do not know. Milford points out a worrying example, the for-profit Xac Bank, whose profits are perhaps being padded by Kiva users. I don’t know all the facts here, nor how typical this case is. I bet it would be easy and interesting for someone to analyze how much Kiva money is going to MFIs that can easily obtain more expensive capital elsewhere, and who, being for-profit, have more of an obligation to maximize profits than to use the implicit Kiva subsidy for social ends…which is to say have a strong incentive to capture the rents inherent in underpriced capital by pocketing the spread—not what Kiva or its users want. The list of Kiva partners is at http://api.kivaws.org/v1/partners.html. I think Milford is raising an important issue, because it could mean that my Kiva charity is *not* going to a borrower, but to MFI shareholders instead. But he seems to be making the charge based on one case and I’d like to see a more comprehensive analysis to be convinced that this is a widespread problem.

Premal just wrote me this morning (quoted and edited with permission):

hey david –

just catching up w/ the devfinance thread. Real quick re: your 3rd point where Xacbank is mentioned as an example….

While XacBank is commercially focused and by no means a Tier 2, 3 or 4 MFI, they are—as a precondition to working w/ Kiva—utilizing Kiva’s 0% lending interest rate to return 9% of the interest paid from borrowers. Here’s an example listing:

http://www.kiva.org/app.php?page=businesses&action=about&id=156799&_tpos=1&_tpg=1

That said, this is the key thing for Kiva to get right—we need to constantly outperform all other MIVs [microfinance investment vehicles] in terms of channeling the internet community’s low cost risk tolerant capital towards less profitable and / or riskier MFIs / microfinance activities. This is the way we can make the most social impact in my opinion. i’m pretty sure that an analysis of our portfolio vs. just about any other MIV in microfinance would reveal that we have a portfolio w/ more Tier 2, 3 and 4 MFIs. We’re not perfect and we still have a long way to go, but this nuanced point is largely missed by the casual user and i suspect a lot of industry insiders.

p

Ben Elberger, a former coworker who is Kiva’s Regional Director for Anglophone Africa and South Asia, added:

David,

As a note on XacBank, they are using Kiva funding to do uncollateralized lending to borrowers. Prior to Kiva funding, my understanding is that they only offered collateralized lending so the securities pledged are lower and the risk to XacBank/Kiva lenders is therefore higher on Kiva loans.

Best,
Ben

A recurring theme from Premal here: we aren’t perfect and we will keep perfecting. I do think Milford raises an interesting question that goes far beyond Kiva. If social investors provide capital at prices below commercial rates to enterprises with “double bottom lines” (profit and social benefit), how do the investors assure that their cheap capital isn’t being used to boost just one of those bottom lines?

Tweet  

1. Elise Says:
   November 28th, 2009 at 12:03 pm

   Though this does not alter the main point of this post, Kiva lists both delinquency rates and default rates. Since the default rate is only the percentage of Ended Loans that have not been paid back, this will not be a realistic representation of the MFI’s portfolio since most loans have terms greater than a year and some of these partnerships are less than a year old.

   A measure that makes more sense to look at is the delinquency rate, which is the percentage of Paying Back loans that are past due. Rght now, out of 132 field partners, 32 have some reported delinquency, including ACCION USA (3.22%), EDAPROSPO (2.46%), and DINARI (6.69%).

   The point: just because the field partner has no reported “defaults” on Kiva does not automatically mean something fishy is going on.

2. Sam Says:
   April 19th, 2010 at 2:48 am

   David,
   Love the blog. I used to work for XacBank and helped start the Kiva program there. I just want to bring up the point that Kiva Financing is not free capital.

   It took a long time to get the program started. A full time staff member is dedicated to running the program now. She required a lot of training along with several staff. Other Kiva partners at a similar borrowing volume have three or four full time staff dedicated soley to Kiva lending (Cambodia is an example). XacBank is receiving the supposed “0% financing” in exchange for information. XacBank gets cheap financing and the Kiva lender gets a picture, short bio, and updates on how the loan has changed the borrowers life. Getting the information from the Mongolian countryside is not a cost free process. Loan officers need to take pictures and write in english about the borrowers. XacBank has built in an extra incentive program for staff that fill in the Kiva information otherwise they would not do it.

   I don’t want to make it sound like XacBank isn’t benefiting from the arrangement, they are. However, for a tier one MFI the “free money” available through Kiva is a drop in the bucket relative to their total capital needs.

3. David Friedman Says:
   April 30th, 2010 at 2:00 pm

   I think a larger question that Milford Bateman brings up is:

   When is a particular party telling the truth, when is it hedging or distorting, and and when is it lieing?

   I think this question can be legitamately applied to Kiva, the microfinance institute, or the borrower.

   Bateman raises the issue of dishonesty or self-interest on the part of the MFI, but another part of the chain is the borrower.

   In how many cases is the borrower not using the money for what he or she says it is being used for? Zero? Only a few? Some? Most?

   Consider one real loan, and two hypothetical loans.

   Real loan:

   http://www.kiva.org/lend/183580

   Is Raul going to using the money for cockfighting or is he going to use it to fix his taxi? If he is not going to use it for cockfighting why mention it at all? As it is illegal in the United States and Europe and offensive to many people who lend on Kiva.

   Hypothetical loans:

   John, who owns a small farm gets a loan, which is supposedly for the purpose of the purchase of seed. In reality he uses the loan to purchase a weapon which he uses for armed robbery.

   Melinda who owns a small shop is induced by an official, crime boss, or source of power to get a loan from a local microfinance institute.

   Her references and her requirements check out fine, and she is awarded the loan for her business.

   She gives the entire quantity of the loan to the source of power who uses it for his or her purposes. These may include the drug business, bribery, corruption, prostitution, extortion, armed robbery, etcetera.

   The source of power gives the money with interest back to Melinda when the loan comes due and she gives the money back to the microfinance institution.

   What steps are taken to prevent that? Does that happen?

   Maybe the second hypothetical case is less likely that the first as it seems improbable that a criminal organization would accept the high interest rate charged by the microfinance institutions if they already have cash available.

   Roodman mentions in his blog post that often the poor use the money provided for food, or school.

   http://blogs.cgdev.org/open_bo.....-seems.php

   I think many lenders feel this is a legitimate use of provided funds, or if a borrower used the money for a similar business (i.e. instead of purchasing seeds of one crop they purchase seeds of another crop).

   However, it seems to me that the first hypothetical case is more likely. Especially if it is high crime area where crime of one kind of another may be the most lucrative and among the least risky financial enterprises.

   Raul lives in Bolivia which is rated 120 out of 180 on a corruption index scale:

   http://www.transparency.org/po.....2009_table

   The State Department, CIA, and Lonely Planet all have more information on Bolivia:

   http://travel.state.gov/travel....._1069.html

   https://www.cia.gov/library/pu.....os/bl.html

   http://www.lonelyplanet.com/bolivia

   including the fact that the drug trade is occurring there, and there are frequent protests and demonstrations in the streets.

   It was interesting to me to compare the State Department’s page with that of Lonely Planet. One gets the impression from the State Department that it is a crime ridden dangerous place to visit. However, reading the travel guide Lonely Planet one gets the sense that it is not that risky.

   Raul lives in Santa Cruz which I believe is more affluent and has a lower crime rate than La Paz.

   What he is going to use the money for is something I do not know.

   The first real loan was brought to my attention by someone who posted on a Kiva list discussing the issue of cockfighting as an inhumane and cruel blood sport. The fact that it may be used for cockfighting has disturbed me, and other people who are interested in the welfare of animals, and we’ve expressed our disapproval of that. I have pointed out that in the U.S. where it is illegal it is associated with other crimes:

   http://www.americanhumane.org/.....hting.html

   I do not know whether the other two hypothetical cases occur or not. But the fact that people have not dismissed Bateman’s conjecture about the microfinance institute brings up in my mind logically the issue of the borrower. In what countries it is more likely to occur, or how often or how infrequent it may occur are things I do not know.

   David

   P.S. In the interest of full disclosure I’d like to mention that I was surprised to find that Kiva was competing for a grant from Wal-Mart. I have not had a good experience working for that company, and remain skeptical about its motives, but this is not the right forum for that discussion.