This interview was undertaken in Cape Town, South Africa between the co-founders of The MiFi Report.

Nick: Could you describe Microfinance in one sentence?

James: Microfinance is the practice of providing the financial tools that you and I take for granted every day, such as credit, savings, insurance, etc., to those affected by extreme poverty.

Nick: Can you describe the tools you referred to for providing microfinance in a bit more detail?

James: We have seen in recent years that microfinance institutions have been popping up all around the world, providing loans to low income entrepreneurs that may have a good business venture but lack the access to funds that you or I would find at any bank on any street corner.

Nick: What is the history of microfinance?

James: Well, the history of microfinance isn’t a very long one. Many attribute the beginning of the formal practice to a man out of Bangladesh named Mohammad Yunus. Though others around the world had been using microfinance on a less formal scale, he began giving agricultural loans in the 1970’s and grew his “experiment” into one of the largest microfinance institutions in the world, the Grameen Bank. In fact, you may have heard that he won the Nobel Peace prize in 2006 for his work in the field of microfinance.

Nick: Wow, so it is that recent?

James: Actually, yes. The field is very young, and it has only been in the past few years that people around the world have started to become aware of the incredible potential that microfinance has in assisting the poor. Though it isn’t a panacea for the issues of the developing world, not by a long shot, many have pinpointed it as becoming the most efficient and effective tool in poverty alleviation. Of course, this is only the case when microfinance institutions around the world, known as MFIs, behave responsibly and remain socially aware of their economic impact.

Nick: How much is the typical interest rate that the client has to pay back?

James: These loans are quite costly for an institution to undertake, considering the logistics of loan disbursement, marketing in rural areas, and loan collecting. Also, as you can guess, microfinance institutions must deal with perceived risk when the access funding. The interest, as you can assume can be quite high due to these factors, with banks and funds, in many cases, requiring 25-45% interest back.

Nick: Wow, I guess I see why, but that is really high, don’t you think?

James: Well before working in the sector, like you, I thought it was highway robbery, but the truth is that just the overhead fees for making a $10,000 loan is the same for making a $200 loan. You still need the same amount of staff to make each loan. You still need the same technology and resource capacity to keep track of either loan and to transfer the funds. So lending a lot of small loans out, without even taking into account the risk involved, is expensive.

With regards to risk, the initial risk may be high as individuals may be unfamiliar with the practice and some do not understand the importance of not “killing the golden goose” by taking out a $500 loan that they never pay back, only to later realize that if they had paid it back, their venture could have had an infinite stream of credit.

So the most established and efficiently run MFIs are able to educate their clientele base and iron out the details of their operational costs in order to lower their interest rates significantly.

And here is the kicker… the well-run MFIs around the world have been able to post repayments rates between 95-97%! That rate is higher than credit card payments or student loans in the U.S.!!

Nick: That’s incredible! And to think, microfinance wasn’t even around 30 years ago!

James: I know. I think about how it has taken us so long to see the bottom rungs of society as a viable market, and I’m just glad we have stopped ignoring them.

The truth is economists have only recently started to widely recognize that one of the most integral factors in creating wealth is access to credit. It is now no secret that the “trans-generational” aspect of extreme poverty has existed because the poorest of the poor previously had no access to reasonable credit; meaning that the poor stayed poor because they never made enough money to save any of it for future investments. So, the risk of opening up a business was quadrupled by the fact that to do so, the person had to take out a loan from the ruthless loan shark up the block.

Nick: Well, you mentioned donations and aid… wouldn’t donations still be better than loans that the poor have to struggle to pay back?

James: That’s a very common question. Two things come to mind though. First, some estimates say that 4 billion people, out of a total of 6 billion total, live on less than $2 a day. That’s “billion” with a “b”! These people live in extreme poverty, and donations will never meet this immense demand.

The fact that donations or aid will never meet that demand, is not an entirely negative thing. Through working in microfinance here in South Africa and in Nicaragua, I have seen firsthand, that loans for revenue generating businesses are often more effective than donations because they encourage financial responsibility and the loan comes with market-driven incentives to invest the money in their business instead of using it for consumptive purposes.

Furthermore, the loan, if used to generate income through some venture or another, will be worth more than the immediate value. Meaning that a $100 loan that is used to buy a toaster for a sandwich shop in Chiapas, Mexico, will add value to the client’s products, since now they are toasted, and in turn may generate, say $500, of extra income for that year.

Nick: I think I understand, but can you explain that a little more?

James: So, when I say that with a loan comes responsibility and added incentive, I mean that Juanita in Chiapas will use the money more responsibly if she knows that she will need to pay that loan back; that is, if she ever wants a loan from that microfinance bank in Chiapas again. She will be less likely to spend it on immediate consumption if she knows that she will need to start making installment payments on her outstanding loan soon. Also, there will be added incentive for her to really put that money to work because she understands that if she doesn’t pay that loan back, then the MFI servicing her village in Chiapas will not give her the next loan she is already planning on getting to get a second toaster in order to satisfy the masses that have already heard about how good “Juanita’s Toasted Sandwiches” are.

Nick: I wish Juanita’s Sandwich Shop was around here. I’m getting pretty hungry…

James: You see, the beauty is that there is woman or man in a village or township only so far away from us, just like Juanita, that will soon realize that their neighborhood could use a good sandwich shop like the one that he or she does not even know about in Chiapas. And you know what he or she is going to do in order to get the funds to buy a toaster?

Nick: Ah… Go get a loan from an Microfinance InstitutionI!

James: Precisely. And to think, it wasn’t long ago when he or she would be forced to take out a loan with a loan shark for an interest rate that he or she would spend years paying back.

Nick: Thanks, James. Hearing about it makes me think microfinance is going to be revolutionary, and when it becomes as big as I think it will be, I will be glad I invested in this site with you, haha!

James: Hah, I’m glad you think so, Nick, and readers, if you enjoy our site, please support us by supporting our sponsors. Thanks!

Nick: How can I get involved with microfinance?

James: Well, the easiest and most effective way I know possible is a website that a friend of mine is busy building called Dvelo.org. It isn’t completed yet, but when it is launched in the coming months, I will be sure to let the world know because it is truly an amazing idea! So keep an eye out for Dvelo.org.