“Some microfinance is extremely beneficial to the poor, but it is not the miracle cure that its publicists would have you believe. Microfinance has been hijacked by profiteers, and we need to reclaim it for the poor. The problem is not with a few rogue operators, alas, but with systemic flaws that permeate the sector.” H Sinclair

Just finished reading the explosive and insightful Confessions of a Microfinance Heretic, by Hugh Sinclair. Sinclair is ten-year veteran of the microfinance industry, having worked with dozens of microfinance institutions around the world and in several microfinance funds, concluding that the sector on the whole isn’t helping the poor but has been “hijacked by profiteers”, entwined in financial greed and exploitation. His attempts at exposing wrongdoing would result in death threats, aggressive and personal retaliations, and legal action. Part expose, part memoir, the book accounts how the industry turned him from believer to heretic. Bono once said “Give a man a fish, he’ll eat for a day. Give a woman microcredit, she, her husband, her children and her extended family will eat for a lifetime.” Sinclair says the quote should be rephrased to “Give a woman a microcredit loan to buy a fishing boat and the CEOs of the MFI and the microfinance funds will eat for a lifetime.”

In the book, Sinclair focuses most of his attention on one large MFI, the Lift Above Poverty Organisation (LAPO), operating in Nigeria. Sinclair was working for a Amsterdam-based microfinance investor called Triple Jump at the time and was dispatched to Nigeria to sort out a problem with LAPO’s IT systems. He describes how, during his time there, he discovered high interest charges, unusual lending operations and vast profits. Sinclair alleges that LAPO claimed to be charging interest of 3% per month for eight months but after fees, taxes, commissions, forced deposit etc this translated to over 144% per annum. In addition, LAPO used clients’ deposits to lend money to other clients – a practice only allowed with a banking license. He subsequently raised the alarm with some of LAPO’s large institutional investors, expecting them to put pressure on the MFI or withdraw their funding altogether. However, he claims he was ignored and eventually fired from his job at Triple Jump. Godwin Ehigiamusoe, Managing Director of LAPO has recently told The Sunday Telegraph that interest rates at the MFI are 2.5% a month with a 1% management fee – or a total of 42% a year – and that Sinclair failed to appreciated the high costs of operating in Nigeria.

Godwin also added “we have not put our finger on his motive” but concluded Sinclair was angry over losing his job. However, rather than being a bitter address on his former employees (although there is inevitably some element of this), Sinclair’s claims are detailed and comprehensive, with a vast amount of data collected from various sources and personal experience.

There is actually surprisingly little solid evidence supporting microfinance as a practical tool of poverty reductionthe poor repay loans and this is all the proof the sector requires.” However Sinclair admits the real “debate is not whether microfinance works, but how the inherent conflicts of interest can be managed.” As such, I have drawn out the five main systematic flaws addressed in the book:

1. High interest rates on loans

The interest rates charged on some microloans are prohibitively high. Hugh alleges that in some cases institutions are charging up to 200% interest and profiteering from the subsequent returns. Often the loan often comes with hidden charges on top of the hefty rates such as fees, taxes, and compulsory deposits. Rates vary widely across the globe, but are particularly high in Nigeria and Mexico where the demand for small loans from a large population cannot be met by existing lenders. Although there are genuinely high operating costs in microfinance, this excuse is often abused and used as a catch-all.

Damian von Stauffenberg, founder of Microrate, said that local conditions had to be taken into account, but that any firm charging 20 to 30% above the market was “unconscionable” and that profit rates above 30% should be considered high. Yunus himself has said interest rates should be 10 to 15% above the cost of raising the money, with anything beyond a “red zone” of loan sharking. “We need to draw a line between genuine and abuse,” he said. “You will never see the situation of poor people if you look at it through the glasses of profit-making.”

2. Lack of regulation and client protection

In countries where local laws and a lack of regulation or government oversight give free rein to the MFIs, competition has run wild and sometimes led to credit crises. In India’s Andhra Pradesh, “There were more microloans than poor people.” And in Nicaragua “total lending by MFIs was estimated at $420 million in 2008, in a country of about 5.5 million, not all of whom were poor (and MFIs generally don’t lend to children)…One particularly ambitious client in Jalapa had managed to rack up $600,000 in micro-loans.”

3. Majority of loans are for current consumption

There is little effort to check what the loans are for – a majority goes not to help poor people launch or sustain micro-businesses to supplement family income but rather for current consumption, which are difficult to then repay. Cash is sometimes taken and spent on a TV or repaying other loans. Estimates for consumption loans range from 50% – 90% of all microfinance loans depending on the study. As Sinclair points out, the proportion of entrepreneurs among the poor is no bigger than it is among the rich. It’s naive of us to expect that every poor person is an entrepreneur waiting to be discovered.

4. Intermediaries and investors fuelling the crises

Investors such as banks and MIVs are blamed by Sinclair for fuelling the crisis and turning a blind eye to the problems of dubious lending practices, such as high interest charges, of MFIs on the ground. Partly this has been due to a lack of proper due diligence, however even worse, there is evidence that they have not stopped funding projects even after dubious practices have come to light. As Sinclair writes, “Which is worse – to invest in such an MFI with full knowledge or to admit investing without bothering to obtain full knowledge? Best left unanswered”. Microfinance funds, often acting as private equity funds, have been perceived to be merely profit driven in cases where their longstanding investments are in some of the most egregiously exploitive MFIs. Like the subprime lending crisis, Hugh believes that predatory practices are unavoidable where the motivations of the lenders aren’t aligned with the motivations of the borrowers.

5. Lack of business growth

The amounts of money loaned by MFIs are often far too small to permit businesses to grow to scale. Even when many reach the size to employ other family members, Sinclair reveals in an exchange with one Mongolian woman: “we asked her about her future plans for the business, and whether she thought it could be built up further and be a useful business for her children to take over. ‘You misunderstand me. I don’t do this job because I like it or want to grow it into a big business. I do it so my children will never have to do work like this.’”

Yunus himself has recognized the downfall in the sector in recent years – criticising at a gathering of financial officials at the UN, “We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks… Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.”

This all sounds rather depressing! However, Sinclair is careful not to condemn the whole industry and insists there are funds that are faithful to the original ideals. Sinclair himself still works in microfinance in South America and movingly describes his past experiences with ethical and effective organisations throughout the book. Rather than be a critic of the principles behind microfinance, he hopes this will be a “call to action”, even laying out the conditions necessary for its success and suggesting fundamental reforms to be actioned.

And the situation has been improving. In recent months, the Indian parliament has introduced The Microfinance Institutions (Development and Regulation) Bill following anger about the Andhra Pradesh crisis and the collapse of the country’s only listed fund, SKS Microfinance. MIX market has done much to improve the availability of data on the industry as has Microfinance Transparency to promote transparent pricing of MFIs. Furthermore, the introduction of client protection principles such as the SMART campaign and the UN PRI Principles for Inclusive Investment will also go a long way to strengthen the sector.

I therefore believe Confessions of a Microfinance Heretic is an important book to read for anyone not only involved in microfinance but also for all who seek an end to global poverty and injustice. Sinclair has a strong sense of justice and is quick to ‘whistle blow’ on the industry without always giving a bigger picture, but on the whole provides valuable insight. The book brought up many personal questions for me regarding my foray into microfinance – yes, there are aspects of it which both disappoint and discourage and even anger me, but on the other hand it’s made me even more determined to ensure those MFIs working in a responsible way succeed, to invest in the ‘right’ way, and do my best to ensure the industry develops in a more transparent and accountable manner. Sometimes it’s about understanding the bad, recognising the flaws, in order to build a better future.

Further reading:

The books website with additional data and reviews here

Dave Roodmans review here