Thursday 10 December 2009

Burning Thoughts at Fahrenheit 451

Busy days in Buenos Aires follow busy days in Sao Paolo and my life is a blur of new information that I commit to processing and adding to without really knowing how. In between I worry about what do with all this information. Today I met with Mei Ling who has written a book and is writing another, through Vanessa who pointed out that in books lie the legitimacy and permanence of big thinkers. More immediate than books lie articles; 2000 word ones that Neal will pay me to write for and I haven’t even got there yet.

Maybe its because sometimes I feel like my mind has a mind of its own and I'm merely an observer taking photographs of my imagination. If that sounds like a poor attempt at wordplay, rest assured that its utterly literal...

Course Ecosystem Acumen Brand Recommendations v0.2

Bang Restructure 2009 Development Plan the wiki organisation

Brand and Web Goals and Topic Categories DSCF6013

PositiveTV-FocusPoints Revenue Streams For Ashoka Mexico v0.2

Corporate and ASN Breakdown IMG_0232

I don’t really know where it comes from, or why I’m able to do it. I don’t really see myself as a writer or a big thinker. The world is overloaded with words, and big thinkers rarely create anything the person on the ground can use. But then today I read Fahrenheit 451, which is just stunning. A book about the power of books, and the dangers of simplification and the simplification of simplification, until the point where richness and complexity of thought become anathema. A pain to be avoided and destroyed. And then I started thinking about thinking and wondering what do with the stuff I create.

Hopefully at some point my mind will make up its mind and I’ll figure out what to write, and how I’m going to do it!

Friday 4 December 2009

Microfinance in Pictures

While in Mexico I had the fantastic opportunity of spending time with Frida Ruiz Fernandez who worked in regulation for microfinance and banking for Peruvian Government for 4yrs, and Juan Ahedo who works with Fin Comun, a microfinance organisation based in Mexico. From Frida I learnt a bit more about Microfinance, much of which is summarised below, and through Juan I was able to accompany a couple of branch managers on their site visits around the city.

Fascinatingly for me, I learnt that microfinance is not just about lending to rural populations, but also a support system for tiny shops, restaurants and stalls all over low-income areas in cities too. The most fascinating thing was being transported back to a world of notebooks and hand-written accounts.

Microfinance in the City – Typical Clients

P1000590 P1000591 P1000593 P1000596 P1000597 P1000601 

Introducing Microfinance

Traditional Banking

The mechanisms of traditional banking essentially function around monetising (investing/re-lending for financial return) deposits that people store with the bank; and on providing interest based credit that is offset either by collateral, or risk managed through the use of standardised credit rating systems for medium to high income populations.

Why Low Income Populations Can’t Use Traditional Banks

Low income populations typically have neither the collateral nor ratings needed to access credit, because their wealth base is too small for collateral and standardised credit rating systems are not designed to assess their circumstances. Traditional banks therefore have to invest in completely new mechanisms for managing these demographics, which isn’t worth their effort so they ignore the space altogether.

Finally, where low income populations do have savings, they generally don’t deposit their money in normal banks because
  1. There is a lack of accessible infrastructure. i.e. no branches in their areas since it is not profitable for traditional banks to provide these.
  2. Low income populations are not used to going into big banks. They feel out of place and intimidated by the experience.
The Critical Problem

Since low income populations often have greater immediate needs around borrowing money, the lending space has traditionally been covered by loan sharks, where exorbitant interest rates mean that people can end up paying many multiples of the money they borrowed, under threat of personal violence. This simply exacerbates their poverty.

The second problem is that without access to mechanisms of depositing, managing and growing money, these populations are typically excluded from opportunities to create the longer term wealth that can help them to escape the poverty cycle.


So microfinance is really just a fancy name for the mechanism of providing safe small (typically high interest) loans to people, groups or enterprises who’s incomes are too small to provide collateral or credit ratings, and are therefore risky and highly cost intensive to manage.

Microfinance organisations make it cheaper and profitable to provide these services by basing themselves and working in the same areas as these populations, and they have adapted their credit methodologies to lend to low income sectors in 3 ways
  1. Their assessment model is very human intensive in terms of finding entrepreneurs, getting to know them personally, helping them with paperwork etc, typically by having branch managers which personally go out to meet clients rather than have them come into a branch, which means a much higher cost base than traditional banking.
  2. They provide loans without collateral, and manage the risk by replacing collateral with information about the people they are lending to. Hence they are significantly more diligent than traditional banks about each individual being lent to. Branch managers establish close relationships with borrowers and work to understand their networks and personal circumstances.
  3. They charge higher interest rates than traditional banks – anywhere between 25% and 40% annually, which although high is still less than loan sharks. Commercial microfinance entities lend at even higher rates of 40%-140%.
The Goal

Enable people to exit poverty through profits from assets or activities enabled by small loans.

The Gap and Issues

Microfinance organisations however are typically not banks, which means that they still do not address the issue of saving and wealth accumulation. One reason for this is that lending entities (like store finance) operate without much scrutiny, but taking deposits makes you a bank, which requires compliance with a whole new range of costly financial regulations that can otherwise be avoided.

Since these organisations fall outside traditional banking mechanisms, in many countries they often exist without any regulation. This means they often grow too quickly and operate at very high risks of bankruptcy.

Another issue that is also now being recognised is that the mechanism of micro-finance still struggles to bring people out of poverty. The reason is to do with the focus on funding entrepreneurs rather than stable business models or even helping create enteprise for people who don't have any income streams, and because of the lack of education and understanding of money management in low income populations.

Finally, microfinance is a profit model, and many of the players are not in it for the social goal. They don’t always operate ethically, and are not necessarily interested in mobilising communities out of poverty. Education and health components added to the financing model, can cynically be seen as mechanisms to reduce the risk of default, but the really good ones invest significantly in the development and mobilisation of the communities they work with.

The exorbitant interest rates can often be equivalent to loan sharks, and more importantly, as the sector matures and costs of managing clients and risk reduces, these rates don't drop (see lack of regulation and monitoring). This means that after a while commercial microfinance entities typically just mint money and will continue to do so. This is one of the reasons for the huge financing boom for these organisations, but goes entirely against the ethics that the public associates with social enterprise.

The real trouble in the end is that any development model whose sustainability/profitability is based on offering debt, and which has financers as the primary stakeholder, is likely to result in exploitation unless it is ethically run or strongly regulated. At some point any commercial lending entity will end up having to convince (manipulate) people to take loans regardless of whether they need it, just to keep its business model and profit margins going. As the market booms, more entrants seeing easy money are rushing in under the radar of public goodwill.

Solution 1: Regulation

Peru recently won an award for the creation of regulated environments for successful growth and scaling of microfinance. They minimise the risk of failure of microfinance orgs by enforcing a step by step system of growth by modules. Every step in scaling operations requires governmental approval, using a risk based approach covering 4 areas:
  1. Credit
  2. Market
  3. Liquidity and Operations
  4. Capital adequacy (i.e. having enough capital to support operations).
This approach prevents microfinance organisations from growing too fast or taking risky decisions, and unregulated Microfinance organisations are not allowed to take deposits.

Benefits of regulation
  1. Access to ratings and ranking makes these organisations open to investment
  2. They get feedback that helps them grow and get better
  3. Regulation means they are better run, so they have access to better human resources
  4. Access to guarantee funds up to a certain amount of deposit to help offset risk.
  5. Protect against and reduce risk of exploitation of vulnerable low income populations.
Solution 2: Education & Community Investment

Microfinance organisations are now beginning to provide financial and health education, in order to offset risk (well educated and healthy populations are better placed to repay loans), but the really good ones also invest in education and community programs to transform civil society in low-income areas. Education must focus on savings and wealth management and not be used to encourage take up of more debt.

Solution 3: Microfranchising

Entrepreneurs are great at finding opportunities to set up ventures, but not necessarily so good at scaling or creating stable and repeatable business models. Since microfinance typically lends to small entrepreneurs in low income populations, the quality of enterprise is typically not suited to scale or growth. Your average tiny corner shop isn’t very likely to become 10 large corner shops. Results are starting to show that while microfinance has benefits, it isn’t necessarily mobilising communities out of poverty in the long term.

The solution may involve offering finance for proven micro-scale business models that can be scaled by franchising. Local product reseller models for example. The value here lies in the creation of new jobs as it does not involve funding existing enterprises. It would also open up economic possibilities for people who don't already have stable incomes.

Solution 4: Debt and Wealth Management

For any microfinance entity seriously interested in driving economic development for low income populations, there absolutely must be a focus on debt management and reduction, followed by support for creating and growing wealth. Cash in hand is not wealth. Assets are. A savings account with interest for example. It not only grows money, but also safeguards it. Another example is ownership of housing. A lot of poor people have historical debt that keeps them locked in poverty. Debt reduction systems are not necessarily profitable, but could be justified in the longer term of creating a base of clients whose wealth can be monetised without fear of exploitation. The key here is replacing short-term profit maximisation with long term profitability and social impact.

Wednesday 2 December 2009

Adventures in Sao Paolo Part 4: Searching for Marcelo Lima

It’s another month gone and I’m at the airport in Sao Paolo, waiting for my flight to Buenos Aires. The taxi ride was expensive (80 Reais) but very fast and I’ve now got an extra hour to kill and time to reflect on another whirlwind few weeks of vibrant people, new problems, passionate conversations, beers, and days so full that I haven’t even had time for blogging.

In truth I’ve been meaning to post more often, but I’m finding that I just don’t think in actively reflective ways, so I don’t have much to say on a daily basis. My notes would be all be repetitive… “I met some great people, had interesting conversations about social development, offered some new perspectives, ate well and had a few beers!” Can’t imagine how any of you would find that interesting after about the 5th time :) Churning out emotive descriptors of daily experiences is therefore not proving to be an option with the time I have. But I find if I carry on absorbing things in my usual go with the flow type way, then things aggregate and crystallise and the writing occasionally just happens. Like today.

I’m sad to be leaving Brazil. I’ve met as many lovely people as I did in Mexico City, which is pretty amazing. I’ve been looked after and entertained and included, to the point that I’ve never had a single day with time to occupy by myself. In my short time in Rio, I caught up with Iris, Theresa included me in the amazing things she’s doing and Gilberto showed me around. In Sao Paolo, the Ashoka crew took me for beers, Elenice showed me around the city, the Wikimedia guys made me feel part of the movement, and others from my hostel hung out with me in the few moments there was time to spare.

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