Micro-Finance and Kiva, a primer

Let’s say you live in Nicaragua and run a business from your home creating bricks for building houses. You want to buy a machine that will help you lay bricks faster but you don’t have the cash. You need a loan.

One day you make a journey to the nearest city to visit the local bank. The bank doesn’t want to give you a loan. Their minimum loan size is nearly $15,000! You only need $2,000 and can’t afford the monthly payments required to borrow more. Moreover, you don’t have the collateral needed to back the loan. You go back home empty handed and your business continues on as it always was, barely feeding your family of six.

Enter micro-finance and Kiva.

Micro-finance is a lot like regular finance, the kind you may have used to pay for school or buy a car, except at a scale much more accessible to the poor. Like our Nicaraguan brick layer, most impoverished people could greatly benefit from an affordable loan but are limited by an inflexible banking system. If more loans were available at more affordable rates, more people could use them to expand their small business and, ultimately, rise out of poverty.

Unfortunately, managing these small loans is expensive and risky. Not only is the interest earned on the micro-loans very small, but the people that need them most live in remote areas of countries with unstable governments.¹ Often, a loan officer has to mount his motorcycle and drive hours on rugged terrain to collect on a payment so small it might not even cover the cost of gas.² To survive, self-sustaining Micro-Finance Institutes, or MFIs, have to rely on innovations (like village banking or mobile payments) and alternate funding sources. Like Kiva.

The Internet’s first peer to peer lending website, kiva.org.

Founded in 2006 by Matt and Jessica Flannery, Kiva is the world’s first peer to peer lending service. The website kiva.org allows anybody with an Internet connection to browse a portfolio of entrepreneurs seeking micro-loans (say our Nicaraguan brick layer) and lend as little as $25 to their business. The novel idea has attracted a steady stream of press, including PBS Frontline, Time Magazine, and even Oprah.³

From a user’s perspective Kiva is deceptively simple. Make a loan and you will be regularly alerted when repayments are made to your account. It feels so automatic that it's easy to forget the complexity of the situation: these loans are being distributed in a foreign currency halfway around the world by someone who probably has a very limited idea of what the internet even is. Behind the scenes, Kiva has developed an innovative business model to ensure this loan cycle flows seemlessly.

Often before your loan ever gets funded, Kiva extends a zero percent interest line of credit to its 119 partner MFIs in 53 countries around the world. These partners use this money to manage the end relationship with the borrowers. In exchange for the nearly free funding, the MFI agrees to terms that are quite unusual for a normal bank. For one, they must follow up on ended loans to write an account of how the loan impacted the life of the entrepreneur and their family. These stories are posted to the original Kiva funders in lieu of interest.

As our brick layer in Nicaragua expands his business using your loan, he makes regular payments to his local MFI, who pays Kiva, who pays you through Kiva’s website. Through this cycle, the brick layer receives access to credit otherwise unavailable, you get your money back along with a few heart-warming stories, and the MFIs make enough profits to continue providing their service. Proponents argue that this model of loans, as opposed to donations, has proven very effective at bringing people out of subsistence poverty to become full contributors to their local economies.

A store owner in Costa Rica proudly shows off his well stocked shelves. (by Gabriel Francis).

Of course, things don’t always go as planned. On occasion, like a teenager with a new credit card, the already impoverished borrower enters into a cycle of debt that she is never able to escape. Critics are quick to point out these scenarios as evidence that micro-finance doesn’t work, and recent lucrative stock offerings by SKS and Compartamos⁴ leave some pointing fingers that micro-finance banks are profiting at the expense of the poor. Even some economists are beginning to question the micro-economic benefit of the model.⁵

While these critiques should be acknowledged, proponents can safely point out a slew of individual cases where lives have been changed, sustainable economies stimulated, and social impact verified. To combat criticism, proponents have begun to construct a new measure of impact, called social performance indicators. These new economic models attempt to establish a standardized, cross culture measure that supplements dollars for more delicate indicators, like improved health, child education, and access to food. While social performance measures are new and may take years to fully develop, the current quantitative measures aren’t too shabby.

Kiva claims a healthy loan repayment rate of over 98% by its borrowers, 82% of which are women. And Grameen Bank, considered the father of micro-finance banks, claims 68% of those who have used its micro-credit services have moved out of poverty.⁶

That, despite the critics, is a powerful figure.

Posted by Gabriel Francis, BRUTE Guest Blogger

As a Kiva Fellow, Gabriel Francis currently works with Kiva’s partners in southern Costa Rica to document the stories of micro-entrepreneurs and advance Kiva’s mission of connecting people through lending to alleviate poverty. You can follow his personal blog at www.gabrielfrancis.com and sponsor his adventures. Apply today to become a Kiva Fellow.

Gabriel with Matt Flannery (co-founder and CEO) and Premal Shah (President) of Kiva.

1. A popular way for new governments in Central America to win approval of voters in the past couple years is blanket forgiveness of all private and public loans. Called “no pago” movements. Great for the individual, potentially devastating for the economy.
2. For example, 8% simple interest on a loan of 10,000 yields $800. The same 8% on $1000 yields only $80. Less than it costs to fill a 4x4 vehicle to collect the loan at today’s oil prices. To be able to afford the costs, micro-credit organizations charge what might otherwise be considered usurious rates of 25% to, in some cases, upwards of 80%.
3. There resulting surge of traffic from the PBS Frontline episode crashed the website for nearly three days. After the Oprah episode Kiva “sells out” of loans for weeks. http://www.kivapedia.org/index.php/Kiva_Timeline#2006
4. http://www.nytimes.com/2008/04/05/business/worldbusiness/05micro.html
5. Source, quotes from Banker to the Poor by Mohammed Yunus
6. http://india.mit.edu/~varun_ag/readinggroup/images/9/90/Grameen.pdf