
Microfinance Is Mostly a Scam (2015) - lowmemcpu
https://mathbabe.org/2015/10/13/microfinance-is-mostly-a-scam/
======
rayiner
Micro finance is definitely not “mostly a scam.” My dad is in the
international development field, and was an early fan of Mohammed Yunus, the
Bangladeshi economist who pioneered micro finance.

The article doesn’t do a good job proving its case. Looking at interest rates
in isolation is meaningless. Is there any evidence these micro finance banks
are achieving above-normal ROIs by exploiting people who need loans? Grameen
Bank, one of the original micro finance institutions in Bangladesh, has a
return on invested capital of around 6.5%. That’s not very high at all,
especially considering the risky nature of their portfolio.

Well-meaning people worries about the notion of profiting from poor people are
actually holding them back. Capital is what turns poor people into middle
class people. Capital is what turned Korea from a poor country into a rich
country. Foreign assistance, addressing healthcare, family planning, and
education, helps catalyze the process. But all of that is pointless without
capital. Foreign direct investment is one piece of that puzzle, and micro
finance can be another piece of that puzzle.

~~~
smt88
If you read and want to refute the article, how do you counter the accusation
that most of these loans are used for daily necessities and not for starting a
business?

Why would a desperately poor person use a loan to start a business when they
can't get enough for their children to eat?

Just in theory, a loan is only useful for someone who is _already stable
enough_ to think about long-term investments like starting a business. It
doesn't help the hundreds of millions of people who don't have daily
necessities.

> _Looking at interest rates in isolation is meaningless._

Untrue. No one claiming to benefit the poor should ever charge, for example,
50% interest.

You might argue that the risk profile of these loans demands 75% interest, and
50% is a big discount by a nonprofit. That may be true, but it's still
unbearable for people struggling to buy food and it still highlights the fact
that loans are not a solution to systemic poverty in mismanaged countries.

> _Capital is what turns poor people into middle class people._

Citation needed. Is capital fixing the poverty, or is capital arriving because
_something else_ has already started fixing the poverty?

The US and India have waged wars on poverty with success. These may have been
boosted by capital, but they were not initiated or driven by it. As in all
cases where poverty is alleviated, they were driven by grants and social
programs.

In fact, the political interests of the holders of capital have reversed some
of this progress.

~~~
neximo64
You got to live in a poor country to understand the simple difference. These
trivial sums are able to buy more capital goods than in a developed country.

A wheelbarrow is ~$2 vs ~$150. Microfinance is a game changer & its very
visibly so.

Comments like yours are just so obviously from a developed country/western
viewpoint because they basically assume the cost of life/goods/services is the
same between the local market you live in vs the developing country with
microfinance.

The basic refutation can come from a PPP basket of goods that goes even more
basic to things people use every day. Flour, Chicken, i.e not a Big Mac index
& not an equivalent goods-for goods comparison of the basket. There is no
McDonalds in Nigeria fyi - the items of consumption are different too. The
most expensive item in someone living in a developing country is typically
phone airtime & never rent/mortgage which is probably your biggest outgoing in
the developed world.

~~~
smt88
You seem to be arguing against a point I didn't make. I never said anything
about the absolute dollar value or buying power of the loans.

Regardless of the amount of the loans, most are being used for daily
necessities. Feeding your kids with a 30+% loan cannot alleviate poverty.

Knowingly making such loans is predatory.

~~~
neximo64
Actually you did make the point, which is why I alluded to it being an
assumption of your point of view. The entire notion of your argument breaks
down because of it.

If I was to translate it backward to something an exact equivalent - you get a
$250k loan for your business/startup in SF but you spend it on feeding
yourself/kids and paying rent because you absolutely have to do those things
and you're struggling to pay your bills/rent & SF is damn expensive.

You don't exactly do that though with your 250k loan/predatory startup bond,
though.

You're basically saying, albeit in a different frame of reference, the entity
giving you the 250k loan is predatory because you are incentivised to pay your
rent and you might be struggling to do so.

The assumption, once again, is the relative purchasing powers are different in
the developing world vs your frame of reference.

~~~
em-bee
now that i have read both of your arguments, i still do not understand what is
right.

are loans used for food?

how does one pay back a loan with a high interest rate?

maybe some concrete examples of how those loans work would help.

i have seen reports on the positive effects of microloans, so i am inclined to
believe that they work, but i still do not understand how.

------
oisino
10 years ago out of college I helped set up some microfinance banks in Coffee
producing communities in Honduras. At first your taken aback that people are
paying 40%+ annual interest rates on small loans for these banks. But when
your in the communities talking to people you realize their opportunity costs
are like 400%+. Example is in most coffee producing communities in Central
America farmers have to sell their products before they even grow them for
4-10x bellow the market rates if they just waited and banded together as co-
op. Their issue is no access to financial products and they are substance
farmers with no option but sell to coyotes to get money for food. In this
world micro finance is a game changer in their quality of lives for it creates
options

~~~
trophycase
"micro fiancé"

Sorry, hate to be reddit-esque here, but this auto correct was too funny.

~~~
dang
I've fixed the typo now.

------
jkraker
I personally think that this article is really just skimming the surface in
the area some people broadly refer to as development work. Helping people
toward sustainable, more independent situations is really difficult work, and
there are a multitude of examples where even people with the best intentions
did more harm than good, particularly when they blindly follow their own
designs without paying specific attention to the people they're helping and
the complex web of circumstances and history they live within. As the article
detailed in the area of microfinance, there are unfortunately many people who
shamefully further their own interests (money, reputation, etc.) in the guise
of charity.

I really do think that applied correctly, microfinance is one tool of many
that can be effectively applied for real good if it is not abused. The reason
I think that is that in contrast to just giving someone something,
microfinance can be more empowering in certain circumstances. In some
development work, empowerment is a key ingredient to moving toward lasting
change. I absolutely agree that there is potential for and are many examples
of microfinance being used in harmful ways, but I think the same is true for
just about every tool of development work. Even simply giving a person cash
can be bad in some circumstances. This comes from my personal struggles in
working a bit in the area of development as part of an organization that
attempts to help people in lasting ways by leveraging a very limited pool of
resources.

All that to say that I agree that microfinance is used to abuse people, but I
don't think its use as such disqualifies it as a potential development tool.

~~~
luckylion
Is it your experience that, when giving cash money as a donation/gift to a
person does not result in positive consequences, giving a microloan to that
same person produces different outcomes?

I assume that the people who use the (high interest) microloans for
consumption would also use cash the same way, while those who use it to create
a better future for themselves would do the same even when they don't have to
pay it back.

Basically: is it the way/circumstances you got the money that makes the
difference, or is the loan instrument just filtering out more of those that
would "waste" it, because paying interest isn't attractive to them (and it
wouldn't be 90% consumption credits, but 99.x% if there was no credit check
and no interest)?

~~~
jkraker
My experience does not include microloans, but I can clearly see the gap that
they could fill in some of the situations I work through.

In many circumstances I encounter, financial need is a symptom of a deeper
need that's harder to address and might even be exacerbated by financial gifts
that aren't paired with something else to address the deeper need. Don't
misunderstand. The financial needs in these cases are formidable with
compounding impacts to be sure, but the root problem cannot be solved just by
providing financial resources in the cases I'm describing. Satisfy a cash need
and you can be only providing a bridge to essentially the same situation in
the near future along with the despair of not being able to get out of the
cycle yet again. By deeper needs I mean things like habits that need to
change, mindsets that disadvantage, relational deficits, medical issues, etc.
I also don't want to imply it's always primarily the person that needs to
change. There are very real systemic issues in our society that need to be
addressed for all to flourish.

Poverty is debilitating. Hope is important. When we can in our help identify
real assets a person has (talents, passions, non financial resources, etc.)
and empower them to be a part of the solution, there's hope there--they can
act in a way that gets them to a better place. It might be assisted, but
they're doing it. This is very important in many cases. If I take that same
person and just impersonally satisfy their need, that can communicate they
have nothing to offer, and it may reinforce problematic mindsets that are
keeping them down.

Ultimately, microloans are just tools. All tools needs to be employed in the
right way to be effective.

------
api
I long ago developed the opinion that most "innovations" in money and finance
are scams whether intentional or not.

Money and finance are like power and water. They belong to a class of things
that should be unbelievably boring, things you forget exist when they are
working properly.

A related idea I developed from watching the cryptocurrency world is that it
is really hard to have a financial system that is anything but gambling,
Ponzis, and fraud. These are the paths of least resistance in finance, the
things money seems to "want" to do. The vast maze of regulations in
conventional finance are the outcome of a multi hundred year evolutionary
battle to maintain at least some level of actual productive activity in the
financial world.

The reason money "wants" to gamble and play Ponzi games is likely related to
how human dopamine reward loops work. We get dopamine hits from gambling and
are very prone to it, while productive investment is often too slow to deliver
regularly spaced Skinner box rewards.

~~~
Paperweight
Finance is _always_ gambling, ponzis, and fraud. But hey, that's not a bad
thing.

Gamblers add liquidity, which is better for society than them hiding in a
basement playing cards.

Stocks are essentially ponzi scheme financing. They have all the hallmarks.
Then often literally use the cash from sales of stock to pay dividends. Most
companies will never pay dividends, though, so the idea for a purchaser is to
hold on and cash out while it's big before everyone else does.

Fraud is the worst when people have an expectation of trust, assuming they're
protected by regulators. They never are. Madoff. Bre-X. Enron. Even highly
regulated markets are _always_ riddled with fraud. People should _expect_ the
market to be riddled with fraud and act accordingly - it keeps the populace
wise.

Regulations are an attempt to get something for nothing which always just ends
up with a bunch of friction, corruption, barriers to entry, and lawyers.

~~~
imtringued
Your characterization of stocks is just wrong. The definition of a ponzi
scheme is that the returns are paid by new investors but when a company is
buying back shares it is earning that money by providing a service or selling
a product. That product or service is purchased by a customer, not an
investor. Money is coming from outside the company.

What you are misunderstanding is that the difference between paying dividends
and a stock buyback isn't that great. Both mechanism distribute money owned by
the company to shareholders. With dividends you simply receive a payment. With
stock buybacks you get the ability to sell the stock back to the original
company instead of selling the stock to another investor.

Think about it this way. The company has a valuation of 50 billion dollar. It
is buying 1 billion dollar worth of stock back every year. After 50 years the
company owns itself and every investor has been paid back. Of course this is
an oversimplification but it shows that even if you hold onto your stock after
everyone else has "cashed out" you can still earn your money back by selling
the shares to the company.

~~~
Paperweight
Did you even read my comment?

------
addicted
The problem with micro finance is that it’s not scalable.

It takes effort and energy to setup in a certain location, and then will take
the same effort and energy to setup in another location (minus some minuscule
efficiencies), because what’s key in micro finance is understanding the needs
of each individual community and catering to that.

If micro finance was scaleable, that would imply the same strategies would be
broadly profitable across a range of communities. But at that point there is
no need for micro finance. Regular banking entities could, and would, have
stepped in and made money.

~~~
Someone
Not being scalable is much less of a problem when you want to make a living
and help people than when you want to make lots and lots of money.

Because of that and because labor is cheap in most places where micro-finance
makes sense, I would think not being scalable isn’t a huge problem for micro-
financing.

------
bretpiatt
Good micro lending options do exist, Kiva has a great track record[1].

My perspective, the exploitive micro lending options exist due to lack of
financial education in our K-12 primary schools globally.

Teaching the average student the fundamentals of accounting and finance would
be much more practical than trigonometry or pre-calculus. For base IRR, NPV,
DPP, etc. algebra 1 is plenty of a mathematics foundation to complete.

[1] [https://www.kiva.org/about/impact](https://www.kiva.org/about/impact)

~~~
skybrian
The marketing says they are good, but the point of the article is that the
marketing is often untrustworthy. What are Kiva's local partners hiding from
them and does Kiva watch over them closely enough to find out when something
is going wrong? It seems like we aren't in a position to know?

~~~
gravitas
Kiva indicates I have been using them for 8 years (2012); 75
countries/territories, 15 sectors, 163 activities and 258 field partners (the
company on the other side processing the loan in country is the field partner
to which you're referring). My lend focus is primarily agriculture,
infrastructure education and other back end type microloans as opposed to
finished goods and services typically for front end selling (a long time ago
there was another website just for education, they merged with Kiva many years
ago).

Stats as of today: Delinquency rate 29.40%, Defaulted rate 7.67%, Currency
loss rate 0.04% - the webUI indicates my Delinquency rate is higher than
average (20.70%), same with Default rate (1.76%) but Currency loss much lower
than average (0.33%). Results from folks who lend in the sectors I do not may
have wildly different results...

~~~
FabHK
My stats: Delinquency rate 101.44% (dunno how that's computed...), default
rate 2.41% (lucky - I've diversified a lot), and 86 of 75 countries (they've
dropped several countries).

~~~
gravitas
What we need is the ability to see this data by country, I think patterns
might develop. It doesn't appear to be possible in the current webUI that I
can find - probably an uncommon query for them.

------
pieno
> It’s a nice story, but of course it means, even in this best case, that the
> people around her who had previously done what she now does have been pushed
> out of business. They need to find a new job.

This is the lump of labour fallacy[0]. There’s a whole body of economic theory
but generally arguments against the fallacy are that lowering prices is likely
to increase demand (so competitors could make the same investment and compete
for the increased demand and be better off as a whole; productivity increases
may lead to new ancillary or similar products that were previously not cost
effective to produce, again increasing the pie; those increasing their income
have to invest or spend it, so those put out of business could start a new
business taking investment or spending from their previous competitor. Reality
is obviously much more complex and definitely in the short term it can lead to
real misery for those losing the competition and not having the time or
savings to wait for a new job or for an investment to start paying off. But
that doesn’t mean that we should just stop innovation and stop trying to
become more productive.

The rest of the arguments in the article against micro finance seem to be
issues with underperforming legal and governmental institutions that fail to
prevent and remedy fraud and abuse of people in precarious situations. In
these systems/countries, there will always be fraud and abuse no matter how
you try to help people (including charity, starting real companies and trying
to give people real jobs with reasonable pay).

That doesn’t mean you should stop these initiatives. Hopefully, improving
conditions for individual people will help improve systemic conditions and
vice versa.

[0]
[https://en.wikipedia.org/wiki/Lump_of_labour_fallacy](https://en.wikipedia.org/wiki/Lump_of_labour_fallacy)

~~~
glenstein
You have to be making some awfully specific assumptions about what the article
is claiming in a throwaway sentence to conclude that it's a lump of labor
fallacy. I don't see the article committing itself to a broad argument about
the theoretical fungibility (or lack thereof) of labor just because it was
noting that the workers need to find new jobs. There's a huge personal cost to
the workers.

>and definitely in the short term it can lead to real misery for those losing
the competition and not having the time or savings to wait for a new job or
for an investment to start paying off

Yes, exactly. That's a reasonable interpretation of what's being said.

>But that doesn’t mean that we should just stop innovation and stop trying to
become more productive.

But I don't think this is.

------
nordsieck
I think "Microfinance is a scam" oversells the claim.

The truth is much closer to "Microfinance is payday loans". To the extent that
you believe payday loans can help the poor in the developed world,
microfinance can also help the poor in the developing world.

~~~
ritchiea
Many if not most people believe payday loans are predatory practices that prey
on people without access to capital and/or financial literacy.

~~~
jfengel
That's certainly true in American cities, where they are made to desperate
people devoid of options for a whole host of reasons (systemic racism,
regulatory capture, supply-side economic, etc.) Those conditions don't
necessarily apply to impoverished countries where microfinance organizations
target. They've got other problems, so microfinance may or may not work, but
they're really not comparable to payday loans in the US.

Payday loans are also much shorter term. They're not intended as investments,
even when they're not actively fraudulent. They're supposed to stave off
literal starvation for people with unreliable income. Presenting them any
other way is fraudulent, and people are often trapped in them by people who
knew that they could not be paid back in time (and the compounding interest
would claim everything they own).

The US was working on regulation to limit fraud in payday lending while still
trying to keep the aspect of trying to even out inconsistent income. That was
in 2016, and I think the new administration killed that.

~~~
jeegsy
I'm not even sure I see the economic viability of payday loans/microfinance
even in the best case. Certainly not if you are running a private business
based on that. If unreliable income caused you to need a loan in the first
place, I'm not sure how a usually high interest loan helps in the long run. So
maybe they are not intentionally scams but the outcomes are very much the same

~~~
imtringued
The problem with payday loan companies is that they give access to loans to
people who cannot pay any type of loan back. If they had enough money to pay
e.g. their credit card bills then they wouldn't need a pay day loan in the
first place. Most payday loan companies have a smaller borrow limit most
credit cards or even regular bank accounts in europe.

Now imagine you are running a company that is making a profit by lending to
people who cannot pay their loans back. Isn't that impossible? Shouldn't your
company lose a lot of money because it's handing out money but never getting
it back? You are forced slap on all the lost money as extra fees on top of the
loan itself.

------
wegs
I think one of the questions is whether microfinance works as a bank, to make
a profit, or works in lieu of donations, where loans are subsidized and act as
a force multiplier on donor money.

If I had my druthers, I'd set up a VC firm in the developing world, which
funded businesses on reasonable terms, _knowing_ I'd lose money, but:

1) Generating a stream of occasional successful enterprises.

2) Even for failures, giving people an opportunity to go through the learning
experience of launching a startup.

~~~
sukilot
That sounds like GiveDirectly.org with extra steps for the donors ego.

The US just gave $1200 to each of millions of Americans, _all_ of whom have
already income plus other govt benefits totalling high above median income in
Nigeria. If you have money burning a hole in your pocket, why not give $1200
to a random Nigerian, average income $2500/yr? Or even $200?

~~~
wegs
Mostly, because all that would do is cause is random inflation and inequity.

When donating money, you are reallocating resources. That can lead to improved
economic growth, if for example you are allowing people to go to school, start
businesses, or otherwise helping build such bridges.

More times than not, donations cause long-term harm. Look at oil in Nigeria to
see how a massive simple influx of cash was not good for the population.

If you really want to help in Nigeria, you can help mentor a university
student there. Your time will count for a lot more than your money. Or if you
are willing to spend money too, hire a university student from there as an
intern (likely remotely). That helps align a lot of incentives.

------
aaron695
Having volunteered for a few years overseas educating in this industry this is
somewhat a true title but not a great write up.

Microfinance does includes banking, remittance and insurance and other things
microfinance. But most people think it's loans. So ok.

The scam is it's fully self sufficient now anyway and kinda always has been.
Doesn't need charity. Some Government oversight however helped I think. You
can study the numbers on a few experiments governments preformed.

I take issue with this bit "that the people around her who had previously done
what she now does have been pushed out of business"

This is exactly what you want. Innovation.

What I saw however was people just exactly copying local business. Another
market stall which just reduced everyone's wages.

The author also doesn't seem to get TVs make a big difference to the poor both
in happyness and reducing poverty. But perhaps microfinance doesn't help
getting TVs.

Lot more that could be said.

------
mleonhard
Many microfinance organizations [1] provide much more than loans. They provide
business training. They set up peer groups to provide mentoring and
accountability. They are essentially providing local versions of the US SBA
[2] and Y-Combinator, critical infrastructure for society. These organizations
have huge positive impact.

[1] [https://opportunity.org](https://opportunity.org)

[2] [https://www.sba.gov](https://www.sba.gov)

------
wodenokoto
I remember back when microfinance was winning Nobel prices and I had just
started studying economics I considered investing in it.

This was the true promise of capitalism - investing money will make everyone
better off.

However, the only microfinance organizations available would only take
donations not investments.

So I would have had to donate money to someone in order for them to lend it to
a poor farmer for outlandish 30% and above interest rates!

I’d rather donate it to an actual charity in that case.

~~~
lern_too_spel
A charity only gets to give part of the money away once and pay the rest to
administrative overhead. A lender is incentivized to get the money back more
than a charity and has to do more vetting and training of the people it lends
to. In order to be self-sustaining, it needs to charge interest.

~~~
jm_l
GiveDirectly ([https://www.givedirectly.org/](https://www.givedirectly.org/))
gives 88% of the money straight to recipients and offers a nice baseline for
charity work.

There's also better metrics than "how much money does the charity take off the
top" which you can learn about in Will McAskill's book "Doing Good Better,"
namely you can try to track things like "how much good are we doing for the
amount of money we get." The main idea is that if a charity can use more of
its donation money in order to have a better impact, then that's what it
should do.

~~~
lern_too_spel
The point is that the money can be used only once, so your money gets 88% of
its value. A lender uses the money more than once, so they can provide more
value from a donation.

~~~
zozbot234
A costly loan provides only a _tiny_ fraction of value, compared to an actual
transfer. You can't sustainably "loan" money to people in extreme poverty,
they can't possibly pay you back. And once these people have bought assets
with their transfer they can even access traditional loans.

~~~
heavenlyblue
You can’t sustainably give money to people and not end up with a huge amount
of fraud.

Then the 40% of inefficiency may turn our to be not as bad.

~~~
zozbot234
We're talking about people in truly extreme poverty here, which is trivial to
verify. Sure, you can and should make _some_ effort to direct your aid to the
very poorest, etc. but at this level, fraud just doesn't matter the way you
think it does.

------
simonebrunozzi
> It’s a nice story, but of course it means, even in this best case, that the
> people around her who had previously done what she now does have been pushed
> out of business. They need to find a new job.

So, let's undo the industrial revolution and get back to weaving cotton by
hand.

Seriously?

------
mtgp1000
The intentions are there, but if you only look for the good in people you will
be taken advantage of and swallowed by grifters. Some who are driven by
selfishness, some who are driven by lust for disruption and/or destruction.

The general trend in the west right now seems to be an overestimation of the
good in all of us, and society is increasingly paying for it. I know that many
are downtrodden for reasons outside of their control but that doesn't excuse
the fact that a lot of poor people are poor because they are shitty,
antisocial people, and no amount of mentoring or social programs will fix
them.

That's where redlining comes from. That's why poor people pay higher interest
for loans, if they can even get them. It's not just blind classism or
"systematic racism" without a cause. Social groups are an emergent phenomenon,
not a deliberate invention.

~~~
heavenlyblue
People in the west forget how many governmental institutions exist in their
countries to make sure that the good in people is efficiently enforced.

That’s why the overestimate the goodness of people in other countries. Also
don’t forget how many westerners happily go to these third-world countries to
do business in the not-so-well-regulated economies.

------
A4ET8a8uTh0
I genuinely want to believe in it, but as others have already mentioned,
charities seem to have a better track record in what they are trying to
accomplish ( my favorite example being a goat gift ).

~~~
zozbot234
That's a pretty bad example tbh. Gifting the cash equivalent to what the goat
would be worth is a way better deal than gifting a goat, because then the
recipient can buy some other asset instead.

~~~
imtringued
If you give people cash they might stop farming and import food instead. Once
the handouts are over people won't be able to feed themselves because their
country is not exporting enough to import food.

There is nothing wrong with importing food but it would have to be conditional
with a guarantee that e.g. USA is importing goods from Kenya for every dollar
Kenya spends on importing goods from USA. The trade imbalance would have to be
in favor of Kenya.

------
FabHK
Mods: (2015)

Not sure much has changed, but the article is nearly 5 years old.

------
asah
Um, this is just a random subset of the truism:

"Capitalism is mostly a scam"

(which is mathematically true but nonetheless it's the best system we got)

P.s. I've lent to dozens of people on kiva and tracked their stories - really
uplifting and highly recommended... but you have to be choosey...

------
macawfish
Those interest rates are extortionate. I don't care what nuance or anecdotal
hypothetical feel-good story you tell yourself. This stuff is exploitative
and, even worse, exploitative in the name of "doing good".

~~~
anon102010
What a clueless comment. Inflation rates in Zimbabwe and Venezuela are FAR
higher than these rates as a quick example to show context matters do real
rates may be negative. And these rates are lower than payday and can unlock 3x
returns for borrowers.

The west takes access to capital for granted.

~~~
sukilot
(1) Zimbabwe and Venezuela are two extreme examples.

(2) microfinance is not those currencies.

------
rectang
I agree with the author that under-regulated microfinance is prone to failure.

But the conclusion that I draw from that is not "microfinance is prone to
failure" but that _all under-regulated finance is prone to failure_.

~~~
valuearb
I took it to mean that excessive regulation reduces options, competition and
costs.

~~~
sukilot
What does "excessive" mean then?

------
apta
Any financing scheme that charges interest is a scam. We've known this for
thousands of years, but people don't learn.

------
waldito
No comments about the head proccessor who has a head grinder? WTF

~~~
jdpigeon
I know. Author should have mentioned the unused body parts came from livestock
because that is NOT the image that popped into my head at first.

~~~
tuckerp
My thought was "wow, well that's certainly a dark comedic way to illustrate
the author's point"

No clue it was on animals

