A Microfinance 'Heretic' on How to Fix the Industry

Sharda Bhandare cuts towels to make gloves at a workshop in the Dharavi slum of Mumbai, India Photograph by Adeel Halim/Bloomberg

The gloss surrounding microfinance has faded in recent years. Although everyone from Oprah to Bill and Hillary Clinton has touted the idea of using small loans to help developing-world entrepreneurs lift themselves out of poverty, reports of high interest rates driving impoverished borrowers in India to suicide and academics’ claims that the loans do little to impact poverty have tempered some of the enthusiasm.

In Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor (July 2012, Berrett-Koehler Publishers), British author Hugh Sinclair recounts what he calls the corruption of banks and ineffectiveness of loans he saw during his 10 years in the microfinance industry. A former investment banker, Sinclair went to work for microlenders in Mexico and Mozambique, among other places, starting in 2002. He says many of the problems he witnessed arose when profit-driven investors rushed into microfinance, driving up interest rates and pressuring borrowers to repay.

Sinclair, who still consults for microlenders, likens the pitfalls of microfinance to the seeds of the economic crisis in Europe and North America: too much borrowing, whether by individuals, banks, or governments. “If you give people way too much credit at very high interest rates in an unregulated environment, it ends in tears,” he says.

I recently spoke with Sinclair about the state of microfinance. Edited excerpts of our conversation follow.

When did you begin to see problems with microfinance?

We saw problems from the very beginning. In Mexico it was very clear that a lot of the clients weren’t engaging in entrepreneurial activity. Interest rates were pretty high, and poverty reduction was underwhelming. Money was rarely being used to help anyone. It was going to buying new TVs.

What’s so appealing about microfinance that celebrities endorse it as a way to alleviate poverty?

The fact that these celebrities celebrate microfinance has always been a little bit of a mystery to me. You’ve got Bono going around saying it’s the end of poverty. My question to him is, “On what basis do you make that claim?” Microfinance has the tendency to zero in on just a few success cases, put it on the website, and the money flows in.

If one of the problems is high interest rates, can for-profit microfinance institutions work at all?

It can work: There are plenty cases of microfinance making a modest profit, covering all its costs, and having a positive impact. The problem is that those cases are relatively few and far between.

The higher the interest rates, and the more aggressive you are with your clients when they don’t pay you, then the more profitable you will be. You have this continuum, and the question is where you want to be on that continuum. There is definitely a place for profitable, ethical, effective microfinance.

How do you work toward making this a more profitable and ethical model?

The first thing is that we have to be a bit more transparent. It’s a very murky field with a lot of myth. The other thing that is essential is regulation. When you take the same people, institutions, and underlying philosophy of the Wall Street players, and you put them in an unregulated environment in Africa, it shouldn’t come as much of a surprise that it doesn’t work out that well. It doesn’t work out that well in America.

How do you keep the criticisms raised in your book from just blowing over?

Everyone focuses on the exploitation of the poor, and I totally agree with that. I think that’s terrible. But very few people have said, “Isn’t it the Americans who are also being exploited? Isn’t it investors in Europe who are putting their pensions into these funds?” They’re not being told the truth either. What I’m trying to do is make people aware that this is not something that happens on the other side of the planet. This is happening to you, today, with your money in your Kiva account. And hopefully by raising some sort of public awareness of this, the public will vote with their wallets.