2010

SPEA Honors Thesis Jennifer Lindsay

[An Evaluation on the Effectiveness of Micro Finance Institutions]

Mentored by Senior Judge David L Welch

Table of Contents
Introduction .................................................................................................................................... 3 Objective ......................................................................................................................................... 4 Thesis .............................................................................................................................................. 4 The History of Micro Finance .......................................................................................................... 4 Types of Micro Finance Institutions ............................................................................................... 6 How Micro Finance Works .......................................................................................................... 12 Criticism of Micro Finance ........................................................................................................... 13 Measurements of Effectiveness ................................................................................................... 16 Figure 1 ......................................................................................................................................... 19 Conclusion and Analysis .............................................................................................................. 20 Suggestions ................................................................................................................................... 22 Bibliography .................................................................................................................................. 25

Introduction Living in the United States, a country of excess, it is sometimes easy to forget that in other places in the world people are suffering from a severe lack of basic needs. Not to say that poverty does not exist in America, but we are fortunate that it does not exist to such an extreme extent as it does in other nations. People talk about the need to reduce poverty, but the argument behind micro finance is that the way to bring people out of poverty and into a better standard of living is to focus on creating wealth; not just reducing poverty. Because the poor will always be with you, it is more attainable and measurable to enable the poorest people access to basic needs like shelter, food and water than to simply make a goal of reducing poverty. This paper will evaluate the ways that micro finance attempts try to create wealth in underdeveloped countries. Micro finance developed from banking systems dating back to the early 1700s, but it wasnt until the 1970s that it began to branch into the three forms of micro finance institutions used today. Micro Finance Institutions (MFIs) are classified into commercial, quasi-commercial, and nonprofit micro finance institutions. Each types characteristics equip it to serve its members differently. As micro finance institutions are developing, they are becoming overwhelmingly commercialized. Though commercial MFIs have the most financial support, their desire to profit prohibits them from being as effective as nonprofit organizations that only seek to help the poor. On the other hand, nonprofit micro finance institutions only seek social return, but do not have as much capital to execute their goals as commercialized MFIs. This evaluation will seek to determine which type of microfinance institution best serves the poor in terms of wealth creation.

4 Objective This thesis will evaluate the effectiveness of different types of micro finance institutions; differentiated by their motivation to or not to profit from their services. After identifying the types of micro finance institutions and determining their differences, the effectiveness of each one will be compared. This thesis will evaluate the effectiveness of micro finance institutions in measurable terms like loan repayment rates and number of people served. Evaluating the strengths and weaknesses of each type of micro finance institution will expose which institution type should be used to create wealth in impoverished nations today and in the future. Thesis The structure of nonprofit organizations is best suited to help the most number of poor people get and stay out of poverty and help others do the same. The History of Micro Finance The history of micro credit is traced back to the early 1700s when Jonathan Swift, an Irishmen, had the idea to create a banking system that would reach the poor. He created the Irish Loan Fund, which gave small short term loans to the poorest people in Ireland who were not being served by commercial banks, in hopes of creating wealth in the rural areas of Ireland. This idea took years to catch on, but then grew quickly and expanded globally. By the 1800s, the Irish Loan Fund had over 300 banks for the poor and was serving over 20% of the Irish population. In the 1800s similar banking systems showed up all across Europe targeting the rural and urban poor. Friedrich Wilhelm Raiffeisen of Germany realized that the poor farmers were being taken advantage of by loan sharks. He acknowledged that under the current lending system, the poor would never be able to create wealth; they would be stuck in a cycle of

borrowing and repaying without ever making personal economic development. He founded the first rural credit union in 1864 to break this trend. This system was different than previous banks because it was owned by its members, provided reasonable lending rates and was created to be a sustainable means of community economic development. The idea of credit unions spread globally and by the end of the 1800s, these micro credit systems had spread all the way from Ireland to Indonesia. At the turn of the century similar systems were opening in Latin America. Whereas in Europe the credit unions were owned by its members, in Latin America the institutions were owned by the government or private banks and were not as efficient as they were in Europe. In the 1950s donors and government subsidies were used to fund loans primarily for agricultural workers to stimulate economic growth but these efforts were short lived. The loans were not reaching the poorest farmers; they were often ending up in the hands of the farmers who were better off and didnt need the loans as critically as others. Funds were being lent out with an interest rate much below the market rate and there were not enough funds to make this viable long term. These loans were rarely being repaid, so the banks capital was depleting quickly and when the subsidized funds ran out, there was no more money to pump into the agricultural economy in the form of micro credit. In the 1970s the biggest developments in micro finance occurred. Grameen Bank in Bangladesh started off as an action based research project by a professor who conducted an experiment credit program. This nonprofit program dispersed and recovered thousands of loans in hundreds of villages. The professor tried to extend this idea to other bankers in Bangladesh, but they were afraid that it was too risky as a business and turned down the offer. Grameen Bank is now one of the worlds largest micro finance institutions with over 4 million lenders. By the 1990s lenders had learned how to increase loan repayment rates enough to make micro finance

institutions sustainable. They targeted women as borrowers and gave them money to invest in businesses that would increase their income and charged very low interest rates so the borrowers could pay back their loans and still have money, i.e. create wealth, for themselves. This is when the term micro finance was coined to replace micro credit, because the new institutions were doing more than making loans; they were offering other financial services to the poor like savings accounts, insurance and money transfers. Aforementioned, banks are increasingly becoming commercialized. The first commercial microfinance institution was founded in Bolivia in 1992. The founders of this commercial MFI were originally the founders of a nonprofit MFI in 1986 called PRODEM. PRODEM grew so rapidly that after 2 years, it had more people desiring loans than they could support. They then created BancoSol to meet the growing needs of the borrowers in Bolivia and became the first ever MFI to issue dividends. Nonprofit micro finance institutions are successful, but reach a capacity of lending when they run out of donations. There are currently over 10,000 micro finance institutions serving 16 million people. The trend now in 2010 is shifting away from donating to nonprofits and towards investing in commercial micro finance institutions. Types of Micro Finance Institutions The original type of micro finance organization was the nonprofit MFI. The source of funding for nonprofit MFIs is the publics money; mainly donations from philanthropists who are not seeking a return on their money. Nonprofit micro finance institutions have been critical in the experimental phases of micro finance development. These organizations are able to take more risks because they are not trying to make money to pay back their investors (in this case donors); they are merely trying to make enough money to continue operating their organization.

Nonprofits primarily rely on donations and subsidies to operate their organization, but this money eventually runs out especially now that there is an option to invest in commercial MFIs and get a return on investment. Loans from nonprofit MFIs are unsecured, which means they are lent out without collateral. This makes lending very risky because in the chance that the loan isnt repaid, the MFI has no means of collecting the money they lost on the loan. The nonprofit MFIs simply lose the money. The repayment structures of loans from nonprofits are generally very simple and lent with interest rates below market price. Grameen Bank was a very successful nonprofit MFI, however it has not been able to be mimicked on such a large scale. An example of a typical nonprofit micro finance institution is Jamii Bora which began in 1999 in Nairobi, Kenya. In the mission statement of Jamii Bora (which in Swahili means Good Families) it is expressed that their goal is not to profit, but rather to assist members in getting out of poverty and making a better life for themselves and their families. Ingrid Munro began this organization by loaning money to 50 beggars and in 11 years it has grown to have over 60 branches and serves 130,000 people. Though the people who borrow from them dont always pay back their loans quickly, they always pay them back eventually. The fast climbers as Munro calls them, climb out of poverty in a year to a year, but some of the slower climbers take 5 or 6 years to pay back their loans. The average loan that Jamii Bora lends out is $95 and 85% of the loans they give out are for less than $100. Munro explained that the institution loses money on the small loans, but has so much confidence in its programs impact that it is willing to take the loss because they know everyone will eventually climb out of poverty. Though this is admirable, an organization cannot sustain itself on this type of mentality. Administration costs are high for micro finance institutions, but Jamii Bora has been very innovative in trying to keep administrative costs low.

They continue to provide services and help people who have climbed out of poverty stay there and help others do the same. Jamii Bora seeks social return rather than monetary return which is exemplified in its structure that is set up to benefit the poor in every way possible. Aside from Munro, the founder, every worker in Jamii Bora was a former beggar from the slums of Nairobi who climbed out of poverty from a loan from the institution. Munro believes that a person who has lived in poverty and made an effort to get out has much more knowledge in how to help others do the same than any MBA she could hire. The organization survives because it is employed by its own members. Jamii Bora only hires its own members because they believe money isnt the only way to assist people to create wealth; they believe treating someone with dignity and giving them responsibilities to help others is just as critical to the process. Jamii Bora is clearly more concerned with the personal development of each of its members than it is to profit from their services. They offer counseling for poor people struggling with alcoholism, medical insurance for people with AIDS who cannot get coverage and is currently working on getting its members clean water and a place to live. Their most recent project is creating a town for the poor made by the poor. Not only does this provide shelter for the people in Nairobi; it creates jobs for its people too. To get a loan, a person must become a member of Jamii Bora and save money in their bank until they have saved half the amount of the loan they wish to borrow. Before taking out a small loan, Jamii Bora employees help the borrower find a way to turn their specialties into a profitable business. When the loan has been repaid and the borrower has started making money, they can purchase a home with plumbing, two bedrooms, a kitchen, a gathering room and a room for storage for a very low price. The poor people are building these homes, and many of the jobs are paid in terms of shillings for a roof or

bricks for the foundation of their home. Jamii Bora is committed to the social and economic development of all its members, which exemplifies the nonprofit MFIs goal of social return. Though Jamii Bora is the largest nonprofit micro finance institution in Kenya, parts of their system are seriously flawed. One benefit of commercialized banking is that they are required to be transparent and are accountable for their lending decisions. Nonprofits dont have these requirements. Jamii Boras website is the main way people learn about the MFI, but it is not kept up to date with information on loans being lent out and when they are being repaid. Their most beneficial information is a few years old. Another flaw in their structure is that they are constantly losing money on the loans they give out. Since they are a nonprofit institution, they do not give loans based on whether a borrower has collateral, so they dont have any way to guarantee they will be repaid. Loaning in good faith is admirable, but cannot sustain itself long term. KIVA is another nonprofit organization whose goal is to connect people who are investing and people who are borrowing all across the world via the internet. KIVA resembles a quasi-commercial institution because although it is a nonprofit organization, it gets funding from private investors and decides loan size on the borrowers collateral. Lending is done online to connect the most number of people possible, and there are currently lenders and borrowers in 195 countries connected through the website. Potential borrowers go to KIVA representatives and give them a brief history of themselves, an amount they would like to borrow and an explanation of their plan for the money, and set up a repayment schedule. This information is translated into English and posted with their picture on the website. Lenders can search the website for a person they want to sponsor and can pay as little as $25 to sponsor an entrepreneur. Lenders are given updates on the person they sponsored so they can see how their money is

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being used every time they log onto their account. Lenders and borrowers are able to email each other to share how the loan is helping the borrower. When a lender gets their money back they can either take it to sponsor another person or donate that money to KIVA to cover operational costs. KIVA requires high interest rates (around 11%) because they need to secure that they will get their initial investment back. Some interest rates in KIVA are as high as 36% because they need to cover the transaction cost of the loan. These rates are low compared to the loan sharks in poor African villages who charge up to 300% interest. Interest rates are highes (36%) for small loans. Unique to quasi- commercialized institutions and commercialized banking, investors in KIVA can get a return on their money. KIVAs average return on assets in 5.5% which is appealing to investors. The negative side of an attractive rate of return is that it can affect the people who are lenders select online. Investors in micro finance want to get the most back on their investment as possible, so they are more likely to select someone who wants to borrow a large sum of money because they are likely to have a higher return than on a loan of the minimum $25. To ask for a large loan you need to have more collateral, which means the people who are asking for higher loans are already better off than those needing small loans. This causes the poorest people to receive less help even though they are in more critical need of the loans. Though KIVA itself is a nonprofit organization, its average rate of return of 5.5% is similar to rates of return in commercialized banking. Investors realized they could get a financial return on micro finance in the 1990s. This meant growth for the bank, therefore a higher capacity to lend. Commercialized micro finance institutions take deposits and offer opportunities for investments which enables them to lend more than nonprofits. In many countries, nonprofits cannot accept deposits; it is only a

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characteristic of banks which means commercialized banks have more opportunity to collect capital for loans. Investors provide financial stability for the bank; however the motive of investing for a financial return often jeopardizes the banks social mission. Commercialized banks as micro finance institutions are more transparent than nonprofits. Investors want to know the risk of their investment, the probability of their financial return as well as how the banks are operating. Though commercial micro finance institutions often lack the staff skills and knowledge in micro finance that nonprofits have, they offer greater transparency and less risk than nonprofits. Just like investing in anything by spreading out their investments, investors are able to diversify their risks when it comes to commercial banks. Loans from commercialized banks are secured, and though they are given out less frequently than loans in nonprofits, they are able to be given in higher amounts. Commercialized banks have the unique opportunity to mobilize general public deposits as loans, which is risky but gives them more capital for lending. They have more options for financial support but consider potential borrowers with scrutiny and assess them based on their riskiness and probability of paying back their loan. Blue Orchard is one of the worlds leading commercialized banks. It is a Swiss bank that started in 1998, right around the time when micro finance institutions were transforming into commercialized banks. Commercial banks have to be extremely transparent so their investors can analyze the riskiness of their investment. Each year, Blue orchard produces an annual report of about 20 pages of charts, graphs and analysis of their previous years investments. Blue Orchard believes that social returns happen naturally when you give micro loans; that it is an automatic byproduct of micro lending. Because commercialized banks have more capital, and know that money is lost on smaller loans, loans are generally only given out in larger amounts.

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Commercial micro finance institutions intend to profit so they are more likely to loan to people with large amounts of collateral who want large loans because they offer greater chances for profiting. Though loan amounts are larger through commercialized micro finance, it is concluded that the people who need loans most are least likely to receive them because they lack the collateral to make them a desirable loan candidate. Micro finance institutions were deliberately created as nonprofits to correct for the people who werent being served by the commercialized banks at the time, and original founders of MFIs believed nonprofits served the poor better. The issue of the poorest people being overlooked is nonexistent in nonprofits because anyone who wants a loan can get one. How Micro Finance Works What makes micro finance an effective way to create wealth? People living in poverty struggle to find the money for basic needs from week to week. They often trade for things they need rather than purchase them with currency. If they even have any money they arent likely to have much excess after paying for things they absolutely need to survive. Without any extra money, there is no possibility to save and accumulate wealth. Poor people arent always served by banks either because they are not desirable candidates or because they have no money to put into the bank in the first place. If they are able to take a loan from a local bank, they are mandated to pay an interest rate of around 300%. At a rate this high, they cant take out much money and are stuck repaying the interest on the loan rather than using the money they make for economic development. Micro credit was created to combat this issue. First time loans are generally very small, no more than $20 or $30. They are usually short term loans to be paid back in 3 to 6 months at an interest rate that varies by institution types. When smaller loans are repaid in a timely manner, the borrower builds credit which allows them to take out larger loans to

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expand their business. Many micro finance institutions require their members to save very small amounts of money in their bank before they are allowed to take out a loan. This isnt so they have money to claim as an asset, rather it is to teach them how to save. Loans are used to buy materials at whole sale to sell for a profit, to buy materials to expand their business, or to purchase land to raise animals. Many borrowers are entrepreneurs trying to expand the communitys production possibility by following Adam Smiths concept of specialization and division of labor. Rather than all members of the village making their own clothes, finding their own food and manufacturing their own goods, these entrepreneurs are using their skills to provide a good or service for the whole community. When these entrepreneurs specialize in something, they allow other members of the community to stop making that good for themselves and specialize in different things. As this happens, the community grows and has more potential for production compared to everyone providing for themselves. When a loan and its interest are paid back, the micro finance institution has expanded its capital and is able to make larger loans to the community. Often, the same people come back and take larger loans to further their business i.e. creating wealth. Criticism of Micro Finance Despite the statistics and success stories, there are critics of micro finance as a means of wealth creation. There are currently some 10,000 micro finance institutions serving about 16 million people; however this is only estimated to be only 4% of the people who actually need micro finance assistance. Micro finance is therefore one of the worlds largest untapped profit sources. Since the 1990s, the goals of micro finance for investors have turned from donating to help the poor to investing to help their own financial returns. This ability to profit has been

14 corrupted in some areas; like Mexicos micro finance commercialized Azteca Bank. Azteca Bank has no legal limits on interest rates and little if any government oversight. Interest rates at this bank are between 50%-120% which is much higher than the average micro finance loan interest rate of 31%. These exorbitant rates are not stimulating economic development and creating wealth. Borrowers who want to build good credit pay back their loans no matter how much their family needs it at the time and they end up worse off. The loans are creating a debt trap that prohibits the poor from ever getting out of poverty because borrowers cannot afford their interest rates. Other critics of micro finance suggest borrowers are being taken advantage of because they are not educated enough to know what to do with the money they borrow. When micro loans become available in an area, many people borrow just to pay for something to purchase, rather than to invest in something that creates wealth. The possibility to turn a profit is attracting all sorts of investors and bankers. Wal-Mart recently purchased a banking license in Mexico to jump on the profit-from-the-poor bandwagon and began offering loans at their stores in Mexico. These loans are given not to encourage wealth creation, rather to encourage spending money on things the borrowers cannot afford at time of purchase. Wal-Mart will graciously offer anyone a one year loan on a $957 television at an 86% interest rate to bring the television cost to almost $1,500. Micro finance was intended to be a way to create wealth while teaching people how to manage their money, but with big corporations jumping in on lending it is turning into a glamorized form of price-gauging. Wal-Mart capitalized on the idea of lending to the poor to help their economic situation by giving loans to people who will help them profit twice; once from the purchase of the TV or good and again from the 86% interest they collect on the loan.

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One of the biggest abuses of the micro credit system is using loans to make personal purchase rather than investing in a sustainable project that will allow the borrower to repay their debts and create wealth in the long term. One of the main reason women are targeted by microfinance institutions is that they have proved to be more likely to use their loans for their intended purpose than men. It is speculated that this is because men are generally egocentric and concerned with perception of wealth rather than actual wealth. This leads to men using their loans to purchase expensive items rather than using their money to invest and create a sustainable steady income. As micro finance becomes commercialized, there are fewer people helping borrowers use their loans wisely and more people enforcing loan repayment deadlines and charging heavy penalties for delinquency. A final criticism on micro finance is that the claims of how effective micro finance systems are is measured by the number of repeat borrowers. Micro finance institutions tend to prove their effectiveness by saying they have the same people coming back to their institution over and over again, assuming there is a correlation between number of loans needed per person and helpfulness of their services. This high demand for loans does not necessarily represent an effective micro finance institution. Because interest rates are so high, many times people need to take out multiple loans at a time to pay off their previous loans. Even worse when there are multiple micro finance institutions in an area, sometimes borrowers take out loans from more than one institution at a time thinking they are benefiting from having more money. They dont realize they have taken out more than they were able to repay (exemplified by the fact that the original bank wouldnt let them borrow the amount of the two loans combined in the first place) and end up drowning in their loan payments.

16 Measurements of Effectiveness In 2005, the Ford Foundation created a task force to ensure that micro finance institutions were promoting social returns for borrowers and not just financial returns for investors. The Social Performance Task Force has created a network for MFIs to assess the ways they are promoting social returns and implement ways to better their efforts. This network currently includes over 100 MFIs, but this number is small compared to the 10,000 MFIs in existence today. The Social Performance Task Force has defined social performance as sustainably serving increasing numbers of poor and excluded people, improving the quality and appropriateness of financial services, improving the economic and social conditions of clients, and ensuring social responsibility to clients, employees and the community they serve. These criteria are general, but offer a measurable way to gauge the effectiveness of the institution. Every institution in the network evaluates their organizations attempts to improve social performance using the same criteria. The Social Performance Assessment (SPA) tool is a scorecard for micro finance institutions that compares 6 different components of micro finance. The first factor is breadth. This is measured by the number of borrowers an institution has as well as what percent of those borrowers start saving after their loan is repaid. The second criterion is depth which is measured by the average loan size, the percentage of borrowers who are women and the percentage of borrowers who live in rural areas. The third thing MFIs evaluate is the average length of loan and length of repayment. Fourthly they are measured on scope which is the amount of financial services their institution offers aside from lending. The fifth thing they report is the cost of their operations. Finally, they have to evaluate the worth of outreach to clients and the community. This final category is measured in percentage of repaid loans that are reinvested into the community and transparency of the agency.

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The six criteria are a good way for organizations to evaluate if they are on track with promoting social returns, but the system itself is ineffective. First, this is not a mandated evaluation that every micro finance institution must report. Micro finance institutions join this network and report their progress on a voluntary basis. They are already more likely to want to promote social returns because they are holding themselves to those standards. There is also no suggested level to reach for each criteria, they are just given 6 things to evaluate themselves on so they can compare themselves to others in the network. Effectiveness of micro finance institution will be hereby measured on 7 criteria. The criteria are total amount loaned, amount loaned per year, number of countries represented by organization, number of loans funded, average loan size, repayment rate and interest rate. (See Figure 1) Jamii Bora, KIVA and Blue Orchard have been analyzed for nonprofit, quasi, and commercial MFIs respectively because they are leaders in their institution distinctions type. In terms of total amount loaned and amount loaned per year, Commercial micro finance institutions clearly have the advantage. Blue Orchard has loaned $714 million to date, an average of $131 million a year. The quasi MFI is the second strongest having loaned $130 million to date and an average of $26 million per year. Nonprofit MFIs loan the least amount per year; around $3.5 million which also puts them last for total amount loaned. This distinct advantage of commercial banks to loan out the most amount of money is explained by their ability to mobilize deposits into loans. They also have higher capital than the other two institutions because they have more financial support from investors. In the mid 1990s, turning a profit from micro finance was developing, which encouraged investors to put their money in commercialized banks because they could help alleviate poverty and expect a 6% return on their

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investment; a win-win situation. Nonprofits had nothing to encourage people to donate their money to them over commercialized or quasi commercial institutions. In terms of countries represented, KIVA the quasi institution has the clear advantage. This is primarily due to its organization being completely operated online. KIVA has used to internet to connect borrowers and lenders from 197 different countries. Blue Orchard has spread to 35 countries, which is quite impressive for any micro finance institution. It is expected that Jamii Bora is only in one country because it is a smaller organization that was created just to help the poor in 7 regions of Kenya. In terms of the number of loans given out, KIVA leads over the other two institutions but not by much. KIVA has funded over 180,000 loans to date, while Jamii Bora has funded 145,000. Blue Orchard, the commercial bank has only given 800 loans to date. Aforementioned, commercial banks generally give loans out less frequently, but do so in larger amounts. The average loan size for Blue Orchard is more than $1,600 while the average loan size for Jamii Bora is $95. This exemplifies the distinction of microfinance institutions that says nonprofit and quasi institutions give out many loans (often without a collateral requirement) in smaller amounts. These definitions also expressed that commercial banks generally gave out few loans but in large secured amounts. There is no doubt that commercial banks would have the best repayment rate of the three micro finance institutions. They select loan candidates based on the belief that they can pay back their loan which is backed by collateral. Blue Orchards repayment rate is 97%, KIVAs is 82% and Jamii Boras is 69%. Interestingly enough, there is a direct relationship between loan repayment rates and loan interest rates. It would be presumed that an interest rate of .5% per

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week (Jammi Bora) would have a much higher repayment rate than an institution that charged an average of 31% interest. (The exact number for loan interest rate for Blue Orchard is NA, but assumed by the average interest rate for commercial banks.)

Effectiveness of Micro Finance Institutions

Type of MFI Name of MFI Non Profit Jamii Bora Quasi KIVA
$130 Million $26 Million 197 181,432 $395 82.29% 11% per year

Commercial Blue Orchard

Total Amount Loaned ($) Amount Loaned Per Year ($) Countries Represented Number of Loans Funded Average Loan Size Repayment Rate Interest Rate

$21 Million $3.5 Million 1 144,760 $95 68.8% .5% per week

$714 Million $131 Million 37 800 $1,653 97% 31% average

Figure 1

The highlighted number shows the institution with the best ranking for each criterion.

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Conclusion and Analysis The most effective type of micro finance institution cannot be determined based on numbers alone. It is apparent that commercial banks have the upper hand over nonprofit and quasi institutions in the amount of money they can raise, but is money the only factor? Blue Orchard invests an average of $131 million per year in micro finance. It would take a nonprofit like Jamii Bora 37 years of operation to invest as much money as Blue Orchard can in one year. If amount of money lent was the only criteria of determining an effective micro finance institution, there would be no need for nonprofits to exist. Nonprofit organizations like Jamii Bora offer value in services that cannot be measured, but are critical to the economic development of individuals and communities. Micro loans by commercial banks reduce poverty by loaning and recovering the most amounts of money, but poverty reductions is not enough to help the poor. Giving and recovering a loan only shows that a person was able to make enough money to pay back their loan and interest. It shows nothing about their personal economic development or long term income. Nonprofit institutions dont measure their effectiveness in the amount of money they have given out or the percent of loans they have been repaid. To them it is more important to assess that each person they help can afford food, water, clothing and shelter. Even if they lose money on a borrower, they arent concerned because they know they have helped them. Nonprofits like Jamii Bora offer more than just a loan and a payment schedule. They teach their members to be wise with their money by teaching them to save before they can borrow. They make sure their members make wise decisions with their loans by finding out what they can specialize in and make a profit in their community. This not only benefits the borrower, but benefits everyone around them because when people specialize and divide up labor, their

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community is able to produce more as a whole and everyone is better off. They treat the poorest people with dignity and respect, which empowers them more than money can alone. They encourage people to become sober through counseling and support. Jamii Bora also helps their members teach their neighbors how to use their loans wisely. All the workers at Jamii Bora are former members who were once struggling to afford basic needs. They are using their personal experience to help and encourage others to do the same. Though they do not have the same funding as commercial banks, and probably never will, they are effective at producing communities that are better off as a whole. Jamii Bora doesnt just create wealth for one person, it creates wealth and a stronger economy for the whole community. Quasi micro finance institutions are able to obtain large amounts of funding and help larger numbers of people and are still nonprofits. They are well equipped to serve a lot of people, particularly in KIVAs case where 197 countries are brought together in one place to borrow and lend. KIVA allows personal attention between lenders and borrowers which encourages accountability from the borrower. Through this website, borrowers can be in constant communication with their investors to tell them exactly how they are using their money and inform them on their progress. KIVA encourages relationship between the borrower and lender, to increase accountability and investor assurance that their money is going to a good cause. Though borrowers are given personal attention, it is not the same attention that a nonprofit like Jamii Bora can provide. Their connection is through a computer screen and only insures financial progress, not that they are better off in other areas of their lives as well. Commercial banks clearly reach the most people, but that doesnt mean they reach the people most in need of financial assistance. The average commercial micro loan from Blue Orchard is 17 times larger than the average nonprofit loan of Jamii Bora. Micro finance

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institutions lose money on smaller loans, so it is logical that commercial banks who are concerned with making a profit would have larger loan amounts. A larger loan does not necessarily mean a person is getting more help. It does however tell what type of person is getting the help. Commercial banks decide who they are going to loan money to based on collateral to secure their loans. A person with who is receiving a large loan must already have a fair amount of collateral to make them a desirable loan candidate. Larger average loan amount from commercial banks means people with little or no collateral, those who need wealth creation the most, are ignored because they are too much of a liability. Further, there is no connection between borrower and lender other than transfer of money, so there is no guarantee that a person is better off after they have repaid their loan. The only think the loan repayment shows is that the borrower made enough money to cover the cost of their loan and interest. Suggestions There are over 10,000 micro finance institutions, but it is estimated that only 4% of the people who need micro finance services are currently being reached. Micro finance is a fairly new field that has only been around for 30 years. The last 20 years of micro finance has shifted from nonprofit institutions to commercialized institutions. As micro finance grows to reach the 96% of people in need of assistance that arent being reached, knowing which type is most effective will benefit the poorest people tremendously. When looking at the goals of each type of micro finance institution it is clear to see it is a comparison of apples and oranges. There is no mathematical equation to which institution is most effective, because the definition of effectiveness varies with perspective. A businessman will say the most effective bank is one that loans and recovers the most amount of money and a nonprofit worker will say the most effective institution is the kind that changes people in ways that cannot be measured.

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One must look at the original intent of micro credit to be able to determine which type of micro finance institution is best fulfilling the purpose of micro finance. Micro credit initially began to reach the poorest of the poor, the people who couldnt get loans from commercial banks. In this case, the answer is obvious. The most effective type of micro finance institution, in terms of what micro credit was intended to do, is the nonprofit institutions. It would be foolish however to discredit quasi and commercialized micro credit institutions because their size is certainly evidence of their effectiveness in terms of expansiveness. Therefore, the type of institution that best helps the poorest people create wealth and develop socially may not currently exist. Upon analysis of the functions, benefits and disadvantages of the three types of micro finance institutions, the ideal micro finance institution has yet to be created. Just as micro credit developed from the early 1700s to today, micro finance will have to keep evolving to create a micro finance institution that has aspects of each type of institution presented above. The ideal future micro finance institution would have the financial capabilities, such as investor support and ability to mobilize deposits as loans, as commercial MFIs have. It should be able to use these funds to reach the most amount of people, like KIVA does with an online interactive connection between lender and borrower. Its interest rate should be similar to KIVAs quasi institution rate which is large enough to cover administrative costs and make some return, but not so large that it takes advantage of the poor and keeps them in a debt trap. Loan sizes would be similar to those of nonprofits and quasi institutions because they are small enough to make a difference and not so large that they require large amounts (if any) collateral to secure them. The goal of this would be to make sure the poorest of the poor were not being ignored because they did not have anything to offer the loan agency. After all, that is

24 the idea behind micro finance; loaning money to people who need it most and who arent able to get loans from local banks without paying exorbitant interest rates, as high as 300% in some villages today. Finally, and most importantly, the future of micro finance institutions should be specifically focused on social development, not just loan repayment. Nonprofits do this by offering services like health care to people with AIDS who cannot be covered without incredibly expensive premiums, and programs to help the depressed poor get sober and invest the money they were spending on alcohol on something that will create wealth. The ideal micro finance institution would also strive to see economic development for the whole community, not just individuals. Though they are small compared to Blue Orchard and KIVA, Jamii Bora is a very effective organization because they follow Adam Smiths Wealth of Nations. They teach that when people use their skills to specialize in something, the whole community benefits. When labor is divided piece by piece, and everyone in the community is doing a certain task that benefits others; the entire community is able to produce more goods collectively than each person could produce for themselves. This is a measurable impact on Jamii Boras effectiveness. A micro finance institution that reaches as many people as a quasi institutions, has the investment capabilities of a commercialized bank and provides the services of a nonprofit will best serve the 96% of poor still in need of micro finance assistance. As for the most effective micro finance institution for the 4% of the poor who are currently being served, nonprofits are most effective option available because they are concerned with economic and personal growth of their members.

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Bibliography
Compassion in Politics. (2009). World Press . Epstein, K. (2007). The Ugly Side of Micro Lending. Business Week . Greuning, H. v. (1998). Framework for Regulating Micro Finance Institutions . The World Bank . Hyshemi, S. (2006). Beyond Good Intentions. Micro Credit Summit . Matthaus-Maier, I. (2006). Micro Finance Investment Funds. Frankfurt: Springer.