Speeding along on the back of a hired bicycle with tall stalks of maize on either side of me, I traveled from one African village to the next, working to convince men and women to join a small microfinance bank. On arriving in a village or trading center, the bank accountant and I would be your typical honored guests. People stopped what they were doing to gather around us. I followed the "accountant"--Wamela Sam, my boss, guide, and translator--over to the villagers, where we would take out our prepared notes and promote the National Urban and Rural Savings and Credit Cooperative (NARU SACCO). I spent the summer of 2005 working for that organization all over rural Uganda.
Microfinance has enjoyed a recent boom throughout Africa and especially in countries on the upswing, such as Uganda. But is it as effective as it can be? Poor loan management and lack of critical innovation have limited the reach of microfinance.
In principle, microfinance helps individuals in the developing world because it allows them to save and take out loans. It operates independently from sometimes corrupt governments. In cash economies, poor people benefit simply from having the option to store their money in a bank, if only so it cannot be lost or stolen. Furthermore, savings open up a whole new world, in which individuals get help to reach goals such as paying a child's school fees. The benefit of taking out these small loans is often the selling point of membership. The loans, often between US$25 and US$200, help small businessmen gain advantages by expanding, investing in new capital, or cutting out middlemen.
According to the World Bank, microfinance reaches 30 million people worldwide, which is estimated to be only four percent of the possible market. The people to whom I gave loans over the summer were few in number, and we often had trouble securing loan repayment, making it difficult for the bank to achieve stability. While microfinance is fulfilling a crucial role in the developing economy, the industry must improve in several ways to reach its potential.
One way microfinance could improve in the long run is to gain self-sustainability in the market. According to the UN Capital Development Fund, only one percent of microfinance institutions worldwide are financially stable. To augment this figure, interest rates must be kept high enough to maintain sustainable organizations. At the same time, interest rates must not be so high as to exclude too many would-be recipients from receiving loans.
For example, the organization I worked for operated solely on its own devices. That meant all the operating expenses of the bank--the building, the small safe, the wages of employees--had to come from small profits we took on the loans. How much interest to charge is therefore a tricky question, one compounded by relatively low rates of loan return, a problem that banks supported by non-governmental organizations (NGOs) in the West rarely face. Our bank, for example, charged a 2.5 percent interest rate per month, which may seem high by US standards but was just enough to cover our operating costs. There is, then, a tenuous balance between the sustainability of these organizations and the need to help people on low incomes. Attempting to help people can cause problems, especially if they do not have the means to pay back those loans and the interest attached to them.
The best (or only) solution is to give loans only to people who can pay them back. A loan for children's school fees is a loan that will not bring back returns. Microfinance works, but it can be sustainable in the long term only if it brings back more than it puts in, and that means ensuring effective repayment rates. While the stereotypical recipient of microfinance is a rural woman borrowing money to buy a sewing machine to start her own business, risk must be carefully measured and loans must be given to people with track records of business acumen and successful enterprise, an ideal not always achieved. …