Transcapitalist

Today's NYT offers yet another set of indictments against microfinance. The charges are: 2) interest rates are unfair and exploitative, 2) banks are making profits off ventures originally meant to be charitable; and 3) loan pricing is not transparent enough to consumers.

As a lender myself, I too have questioned the high interest rates charged by the major lenders - at Compartamos, the average rate is 84% - but let's be honest, lending in micro-amounts to the poor is an expensive proposition. It's considerably more expensive to lend 10 loans of $100 than 1 loan of $1,000 especially if none of those people has any credit history, nor employment history, or even access to a bank. If I lend someone $100 for 1 monts divided into two payments at an 18% interest rate, I will make 75 cents and that probably doesn't cover my costs. I don't doubt there is abuse in the system - just as payday lenders and other loan sharks abuse financially illiterate American consumers, but interest rates that seem high by our American standards are not necessarily exploitative.

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Several organizations are making an impact in Haiti in innovative and powerful ways, notably CrisisCommons and Samasource. The latter's CEO Leila Chirayath Janah has a great blog profiling her training activities there and beyond to teach women and refugees how to perform dignified, digital work.

Add to the list zafen.org, a microfinance organization in Haiti aiming to provide support to small and mid-sized businesses.

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A friend points me to Angels in Action, an "ecosystem" and community for entrepreneurs and amateur investors. The idea seems simple enough: investors buy in at a minimum of $1/month and that money gets circulated to entrepreneurs who are part of the community. There is also an Angel Academy where investors get to network and resources for entrepreneurs to connect to funders, artists, and fellow nascent businessmen.
The concept is one that I like: a microfinance community for entrepreneurs and a mechanism for amateur investors to share in a new idea's success. Unfortunately, the promise of the site goes downhill fast. It begins here with AiA's "Social Compact":

1. Angels in Action is a social network of individuals with one common purpose: the long-term benefit of humanity and the planet.
2. Angels in Action is an inclusive community of people who seek to extend generosity and create sustainability.
3. Angels in Action reserves the right to restrict access to our network of affiliates, service groups, financing resources, and sources.
4. Angels in Action restricts access to pornographers, social and financial predators, gambling and gaming institutions, and any organization or person that seeks to bring injury or harm to others or the network as a whole.
5. Angels in Action's mission is to gather resources from a broad pool of Patron and Sponsor groups, and to lend to Angel Recipient Entrepreneurs.
6. Angels in Action forwards over 60% of the net proceeds within our system to Entrepreneurs.
7. Angels in Action establishes contracts and distribution agreements with like-minded companies and individuals to market, sell, and distribute their product sets via our social network.
8. Angels in Action is the micro-finance division of Angel Acquisition Corp, a Nevada Corporation that is fully licensed to do business in the state of California. Angel AC is a publicly traded company, trading under the symbol: AGEL.OB
9. Angels in Action accounts for and reports on all of its financial transactions on a quarterly and annual basis.
10. Angels in Action is based upon the simple premise of ONE TO MANY, MANY TO ONE.
11. Angel AC has retained the services of Randall Gruber & Associates, PCAOB as its external, independent audit firm.
12. Angel AC has retained the firm of Paulina Lippets as its general counsel.
13. For full terms & conditions, refer to our "Use Doctrine" that can be found on our web site.

Leaving aside the grand pronouncement of #1, I am most troubled by #6: for a microfinance community, why are only 60% of the funds going to entrepreneurs? Why isn't the number 100%? The site is not all transparent in explaining how your money gets distributed or what the repayment plan is. And a 40% overhead cost seems unacceptable.

Digging through the site deeper, things get more strange. The "Angel Academy" section for the angels is merely a series of bizarre videos on "secrets of the self-made millionaire" by Brian Tracy, a self-help author/guru/motivational speaker. Then the "AiA Store" section only sells books of the Through Gates of Fire series, here described on Amazon:

Dr. Flash Bastion is the cutting edge of Christianity. He is the poster-child of Christian success. Dr. Bastion is the senior pastor of the largest evangelical church in the world. The Harmony Heights Community Church is the epicenter of the Christian Faith. Dr. Bastion leads his congregation for twenty years. His congregation goes from "glory to glory," until . . .Through Gates of Fire: Wingless Flight is a story of paradise found, paradise lived, and paradise lost. Volume I: Wingless Flight introduces the character who imprints grace upon others. Have you ever wondered what happens when those who dispense grace become emptied of their giving energies? In Through Gates of Fire: Wingless Flight, author Steve Bonenberger leads the reader through the journey of faith found and faith misplaced and faith restored.

This all makes me question whether the company is even for real. Yet they proclaim Microsoft is their sponsor, and they are tweeting. Seems like the door is wide open for someone else to execute this idea much better.

40billion.com is trying to fix a problem: the $40B gap between the total funds aspiring entrepreneurs require and the total seed funding currently available to them. By tapping into the social networks of the entrepreneurs, the hope is that additional funders can be found.

This is essentially a crowdfunding platform. Their pitch is that if your business requires $40,000 then you just need to convince 40 friends to lend $40, each of whom in turn just needs to convince 40 of their friends to lend $40. The first step is certainly plausible (Kickstarter is a great example); while I'm less convinced of the feasibility of the second step, this network approach may help you bring new people into the fold. The site allows you to put together a private network of potential donors who have access to your business plan and other supporting documents to make the case for why they should lend to you (anywhere from $40 to $10,000). It also can set up webinars for you to make your pitch to the crowd.

Probably the greatest benefit is that it takes care of the dirty work of formalizing the loan process between you and your friends and family members. It also probably saves time -- you can invite everyone to view your information in a single e-mail -- but while this impersonal approach may score you $40 from your aunt, I doubt that it would land any major loans. And then you need to rely on the second ring of your social network, where the ties are considerably weaker. Maybe you have a brilliant business plan that your dad's colleague is willing to get behind, but then why would he loan to you on this site rather than say, make an investment?

Which leads to the major point which is that this idea is fun and a good way to raise from your friends and family in a more efficient way, but start ups are extremely risky and I would bet that someone with means would rather invest than make a traditional loan. 40billion makes no comment anywhere on the site about the terms of their loans, but they do make it clear that they do not facilitate equity investments.

The bigger gap to me is the inability of amateur investors to invest in, not loan to, startups. When someone figures out how to legally facilitate micro-investments, that will be a game-changer.

A savvy, young real estate investor of mine asked me recently about p2p lending:

"What is this peer-to-peer lending about? Is it true that anyone can lend to strangers on a website without anyone who actually knows anything about investing helping them? They must be getting screwed. Investing is hard. Not everyone should be doing it themselves.”

It's a similar argument to that made by many critics of microfinance recently: that the poor aren't knowledgeable enough to make use of access to financial services wisely. As with naive p2p lenders who far from earning a return, may end up holding useless paper of defaulted loans, naive microfinance borrowers  may end up far from improving their lives in the worse shape of over-indebtedness.

These concerns certainly are valid. Not everyone is a savvy lender with knowledge of investing principles and not everyone is a born entrepreneur or businessmen who can reasonably project future income based on new debt. But there are some common principles that both p2p lending companies and microfinance institutions can (and often do) embrace to alleviate these concerns and make them both accessible and fair.

• Simplicity. P2P lending is remarkably straightforward: You (the lender) select the return you want and the risk you can accept, choose borrowers that fit that profile, and agree to lend them money. You then collect a proportion of their monthly interest. This is a process that most people can understand without credentials as a finance genius and creator of synthetic CDOs. And because more people can understand it, more people can reasonably be expected to enter the market and make rational decisions. I’m a believer in not investing what you don’t understand, but a smart person can get p2p lending.

• Transparency. As a P2P lender, your money changes passes from you through one middleman (the lending institution) to the borrower. There are no mysterious detours. You won't be told that your loans will be repackaged into something newer and better that you no longer recognize. To the unsavvy investor, this is paramount -- I can track where my money is at all times. In microfinance, the transparency comes with clear terms and rates. Adjustable rates and balloon payments don’t exist in the legitimate microfinance world. First time borrowers can enter into these agreements with full knowledge of what their repayment commitment will be throughout the course of their loan.

• Quality. When markets are open and quality is poor, disaster awaits. Unsophisticated, early investors on Prosper lended money to very high risk borrowers and were soon burned. P2P lending companies learned quickly from this mess that they needed to focus on finding quality borrowers. In fact, Lending Club now claims that among their biggest challenges is finding enough good borrowers, not lenders. Similarly, many microfinance institutions have embraced a certification/rating mechanism to signal high quality partner institutions that embrace client protection. This is a market mechanism to determine quality (like Moody's, minus the conflict of interest) of the providers and minimize negative effects on the poor borrowers.

I agree that there are risks to democratizing finance. Cutting out expert financial advisors to investors and providing access to capital to poor borrowers can lead to dangerous outcomes if the opening comes without caution. My friend worries about what will happen to amateurs making investment decisions without the help of an expert. The Wall Street Journal and others worry about what will happen to the poor who become overindebted because of newfound access to financial markets. I argue that people can generally make good decisions for themselves if the right prerequisites and protections are in place. P2P lending companies and microfinance institutions offer that chance.

Lawrence Lessig's article "Against Transparency" in The New Republic has sparked a lot of debate about the perils of going down the road of "naked transparency".  Lessig fears open data for government may end in citizen cynicism and withdrawal from the political process. Rather than being actually against transparency, he makes clear in his follow-on article and this interview that his real concern is that people will see transparency as the sole answer rather than the necessary combination of transparency + meaningful campaign finance reform.

I agree that transparency is not a panacea, but I believe he overstates the "perils" of open data. Take a look at the Sunlight Foundation's display of health care lobbyist contributions to Senator Max Baucus, author of the current main health care reform bill being debated in Congress. Will citizens reach "unwarranted conclusions" upon seeing the nearly half a million dollars Senator Baucus received from these lobbyists while he was shaping health care reform? It's a scandal that such a revelation does not lead his career to "be destroyed".

Of course, Prof. Lessig is in support of such thoughtful analyses and he is right to bring up the broader reform issues.  I believe we need more of the kind of transparency and analysis that the Sunlight Foundation has fostered, but the cynicism question raises an important point. One can imagine a scenario in which people are participating in a process that is ultimately good while ignorant of some of its messier internal mechanics. Should that process be made transparent at the risk of alienating the participants or is ignorance really bliss?

Take the case of Kiva. Yesterday the Harvard Businesss Review pointed out that the peer-to-peer lending platform tells a story that is not entirely true. A large part of Kiva's appeal for lenders is the implicit promise that your money goes directly to the needy entrepreneur of your choosing. In reality, the $25 that you donate on Kiva to Ndidi Bienose, for example, is routed through his sponsoring NGO, Lift Above Poverty Organization (LAPO). LAPO collects all lender money and in turn distributes it to their entrepreneurs. This is one reason for the unexpectedly high repayment rates of Kiva (~98%) -- individual losses can be easily disguised within a group under an NGO. Microplace uses the same model, but has always been straightforward about it.  Kiva, however, has been vastly more successful because of their more appealing, albeit untrue, story.

This unplanned transparency could turn into an example of what Lessig fears: that the exposing of the behind the scenes action will turn previously happy do-good Kiva lenders into cynics who now see P2P micro-lending as just as corrupt/misleading as the more traditional forms of aid that it hoped to supplant. Due to the attention problem that Lessig identifies, lenders will not take the time to learn that the end result of Kiva's and Microplace's approach is actually more effective and more efficient than direct peer-to-peer lending.

It's too soon to tell whether some Kiva lenders will be turned off enough by the revelation to stop participating, but I'm optimistic that the real Kiva story can be told effectively.  There is a powerful fact that Kiva can stand behind : Lending through a field partner is more reliable than direct lending and smooths the process for the benefit of the entrepreneur that the lender is hoping to help. The bottom line of Kiva remains the same -- to alleviate poverty through microloans -- and in the end, your money still goes to Ndidi Bienose. In Seth Godin's parlance, the P2P story is still authentic, even if it is not entirely true.

So is the new transparency in Kiva a good thing? A few lenders may be lost, yes, but the ones who remain will have full knowledge of the process and will no longer be duped. The strongest and most engaged communities are built on honesty. The same is true of government.

Flickr credit: bgblogging via Creative Commons, where I get all my photos and a concept for which I thank Lawrence Lessig for pioneeering

Internet platforms are springing up to connect western lenders directly to developing world borrowers in the name of ending poverty, embracing different philosophies on how to achieve the same end. We've covered (here, here, here and here) Kiva and Microplace, who each embrace micro-entrepreneurship; Samasource who challenges you to "give work"; and Acumen Fund, who invests patient capital. The latest is Vittana Foundation, a non-profit startup specializing in education microfinance.

Vittana is seeking to bring change to the developing world by expanding access to student loans. On the site, you can lend to students though microfinance institutions (MFIs), helping them attend school and ostensibly opening up additional opportunities for social mobility:

Your student goes to school. He graduates and then gets a real, stable, salaried job. Congratulations! Your student has taken the first step towards a thriving, successful life. Real change has begun.

But I wonder whether an education necessarily means opportunity in many of these countries. Are the jobs there to provide gainful employment to new graduates? I embrace increased access to education as a step towards reducing poverty, but how does Vittana fit into the increasingly dense international p2p lending space?

Is it targeting a different population than the micro-entrepreneurs on Kiva? Kiva co-founder Jessica Jackley is on Vittana's advisory committee, so clearly she sees it as providing an important additional service. Could it be a complement to the job training and work focus of Samasource?

The Wall Street Journal asserts that “many of the problems in Indian microlending might sound familiar to students of the US mortgage crisis” leading The Economist to ask: "Are microfinance loans the new subprime mortgages?"

In this disappointing take on the microfinance industry (the magazine refers to the reputable Accion International as a "global network of microfinance schemes"), one crucial differentiating factor (among many) between microfinance and subprime is neglected. In the subprime market bankers were reliant upon asset speculation -- real estate -- that caused them to essentially ignore borrowers' ability to repay. There is no such underlying asset blubble in microfinance.

I'm also intrigued by comments made by Beth Rhyne, Director of the Center for Financial Inclusion at ACCION, in a talk for her book Microfinance for Bankers and Investors that I heard last week:

"Banks are not necessarily the key movers. The real game changers are retailers, telecoms companies and others with new and stronger connections to the underserved, low-income market. And technology companies that bring in lower cost business models, like VISA’s government-benefit distribution programs."

This ability to deliver financial services without banks is an important innovation in the developing world and one with interesting parallels to peer-to-peer banking in the United States, another innovation that cuts out the bank. Later in her talk, Rhyne suggested that p2p lending will not take off in the United States for small entrepreneurs because here the barrier to entry of starting a small business is so high that most people who pass that barrier can also qualify for a loan from a bank. The evidence may be there to support that; from what I can see, most borrowers on American p2p lending sites are seeking loans to consolidate credit card debt rather than begin/expand a small business. Looking at Lending Club borrowers, only about 15 of the 91 notes currently available relate to small business demands.

I'd be interested to know what the players in the p2p lending space think of Rhyne's assertion.

Flickr credit: Meanest Indian

Kiva's recent poll of its members shows that there remains a sharp divide among lenders regarding Kiva's recent pilot program for American borrowers: 48% are in favor, 44% are opposed, and 9% are unsure.

As we profiled earlier, upon the announcement that Kiva would open its doors to borrowers not only in the poorest countries but to those in the U.S., many Kiva forums exploded with cries that this decision was counter to the Kiva mission to alleviate poverty. We never quite understood that rallying cry, since lenders, after all, retain full freedom to choose the recipients of their funding and there are plenty of Americans living in poverty. A more serious complaint, perhaps, is that such a move would divert money from the neediest borrowers, where the poverty is more extreme.

Kiva's study proves that this is not the case: lending is up across the board. June was a record month for the peer-to-peer microfinance lending site:

• Excluding the U.S., more loans were made to the developing world than ever before -- $4,682,025
• 4.6% of the loans were made to U.S. borrowers

Regardless of whether you agree with Kiva's policy, you have to admire how much they are engaging their community around the issue. This is one reason why social lending will continue to be the way of the future -- communities on both sides of the transactions have a say in how it is evolving.