On Nov. 4, Pierre Omidyar and his wife, Pamela, announced that they're donating $100 million to Tufts University to create a new fund for microfinance lending initiatives. The eBay chairman and his wife are no strangers to the world of microfinance, business loans made in tiny amounts to people who are far too poor to qualify for normal-size loans. Their philanthropic organization, the Omidyar Network, has made some $15 million in microfinance investments to date. But this initiative is intended for lending institutions and to help stoke the development of new investment products attractive to traditional investors. BusinessWeek Silicon Valley Bureau Manager Robert D. Hof talked with Pierre Omidyar about his goals for the new fund. Here are excerpts from the conversation:
How did you get interested in microfinance?
When I stepped back about two years ago and took a look at what we were doing with the Omidyar Foundation, I looked at eBay and the social impact that eBay was having. I asked myself, well, if we're trying to have a social impact, especially around helping individuals discover their power, how can we do that by ignoring the business sector? That was the realization that led to the Omidyar Network (see BW Online, 11/4/05, "Tiny Investments, Big Changes").
As part of that process I came across the microfinance model. As I started looking into it, and looking beyond the clear impact on borrowers' lives, what I realized pretty quickly was that there's actually a business model here as well. A well-functioning microfinance bank can actually be a profitable business as well. So it became a perfect proof point that, through business, you can provide an experience that leads to individual self-empowerment.
So lifting people out of poverty isn't the key thing for you?
Among the practitioners of microfinance, it's a story about alleviating poverty. We look at it as being about individual self-empowerment. But that's just the first step. It leads very quickly to social self-empowerment -- the status of women in society has been elevated in Bangladesh -- and it leads very quickly to political self-empowerment, as they organize, pool their votes, and have an impact.
Why are you creating a separate fund, given that Omidyar Network has already invested in microfinance initiatives?
We've invested about $15 million in different microfinance-related institutions, including Grameen Foundation USA, Unitus, and some private funds. The idea here is to try to accelerate the growth in this sector. The business side of it -- that you can create a sustainable, scalable, long-term business in microfinance and have this impact on people's lives, but do it in a way that's profitable -- that's really very early. We haven't seen it scale yet.
What we're trying to do with this fund is, first of all, provide capital to this really great sector that's constantly in need of capital to make loans. We'd like to unleash $1 billion in microloans through this fund. But at the same time, by connecting with an institutional investor like a university, we'd like to increase the level of professional investor involvement in this sector to try to stimulate more commercially viable investment products.
Why is the involvement of institutional investors so important?
If you want to reach global scale -- and we're talking about hundreds of millions of people who need this -- you can't do it with philanthropy capital. There's not enough charity capital out there. In order to reach 500 million people, you have to access the private capital markets. In order to access private capital, you have to provide competitive return on investment. In order to give competitive returns to investors, you've got to operate on a profitable basis and be thinking of yourself as a business.
So you think microfinance investments can be competitive with traditional investments?
We have early evidence of that, but not on a large enough scale to be able to say, everyone join in, there's plenty of capital and you'll get competitive returns. We're really hoping that the existence and size of this fund will motivate people in this sector to figure out how to provide those kinds of returns.
Do you intend the loans ultimately to go to different kinds of projects and people than where microfinance loans are going today?
There's not a significant difference in the financial performance of microfinance institutions based on the type of borrower. There are cultural differences and regulatory differences, but this is a great model whether you're making very small loans to larger loans over $500. Investors' return expectations should be the same.
There shouldn't be an expectation that, in order to create a financial return, you have to move to larger loans and get closer to consumer lending models, and therefore leave some people out. Grameen Bank, for instance, hasn't taken outside capital for the last seven or eight years, and they continually try to push to smaller and smaller loans. This year, they've focused on beggars, to try to get them to become borrowers. And they seem to be financially self-sustaining.
Are too many small microfinance initiatives out there for the sector to be efficient?
By some estimates, there are 10,000 microfinance institutions (MFIs) in the world. Anytime you have a fragmented industry, whether it's the nonprofit sector or microfinance, there are inefficiencies built in. Each MFI has to invest in the same startup costs that the other one did, instead of benefit from economies of scale.
What should be happening over time is that as the microfinance teams figure out how to most effectively pursue their mission and access capital to do it, those teams will attract more capital and thereby scale more rapidly, and you should see consolidation in the sector.
Out of the 10,000, there are very tiny institutions that have maybe thousands of borrowers, and they're really driven primarily by their social mission. They're not really run as businesses. We're not going to get to 500 million borrowers 10,000 at a time with a separate organization and management team for each small block of customers.
What are the obstacles in microfinance that you're trying to overcome besides the general scarcity of capital?
Microfinance initiatives are very high-touch models. The loan officer meets with local groups of borrowers every week, they share tips and techniques. There's a lot of training and learning that goes on, which adds to the cost of the model. But it's a very important piece of it, because it increases the level at which these loans are repaid. And these loans tend to be repaid at a much higher rate than typical consumer lending. You're talking about 98% repayment rates generally.
So that high-cost model leads to a better financial model. But it's a balance. If you want to reach scale, you need to spread those costs among larger numbers of borrowers. There is room to improve the effectiveness of everything on the cost side of the microfinance equation -- everything from greater use of information technology to better record-keeping to the physical and legal infrastructure of the country.
What else is needed on the financial side, besides the capital itself?
There need to be more financial products developed, basically. You need to be able to do securitization of these loans [to package bundles of loans for sale to investors]. In order to do securitization, you need good data. In order to have good data, you've got to have trusted third-party ratings agencies, like Standard & Poors for stocks and bonds, in microfinance.
How did you decide on the $100 million amount?
I wanted something that was substantial enough to get us to the billions of dollars in actual loans. If you're trying to a billion dollars in microloans, having a 10th of that available in equity capital is a good way to do it as loans get repaid and the money gets recycled.
It's sort of a drop in the bucket in the overall microfinance sector, where there are $15 billion worth of loans outstanding. But if you focus it the way we have, looking for investment returns, I think it'll have an impact.
Why Tufts, besides the fact that it's your alma mater?
We look at Tufts as an institutional investor. These universities that have large endowments are large investors, and they have to manage them for financial returns so that they can operate the universities. Also, two of Tufts's key areas of focus are internationalism and active citizenship.
Do you see any role for eBay or PayPal in participating in microfinance initiatives?
At this point, it's pretty early. There's no official focus on this at eBay or PayPal. But as I talk at eBay about what I'm doing outside of eBay, there are a lot of receptive ears about how business can be a force for good.
Do you anticipate that the projects ultimately funded through the loans this new fund enables will be largely in the developing world?
Yes. The most effective microfinance programs seem to be in the developing world. The microfinance programs in more developed countries tend to have lower repayment rates. The more of a social safety net there is, the less impact these microfinance initiatives will have, and the less financial performance they will have.