The National Monday, December 13, 2010
By RAGHURAM RAJAN
THE new catchphrase in business seems to be “do well by doing good”.
In other words, undertaking socially responsible activities boosts profits.
For example, Pepsi bolsters its bottom line by shifting to more nutritious, healthier food.
Yet, in much of the world, doing well still implies that you must be up to no good, especially if you are dealing with the poor.
A recent case in point is the imbroglio in Andhra Pradesh in India, where the administration has moved to curb microfinance.
Microfinance has become the darling of development enthusiasts.
After all, who could be against an activity that produces uplifting stories like the cell phone ladies of Bangladesh, who lift themselves out of poverty by obtaining loans to buy phones and then selling minutes to others in the village.
The benefits of microfinance are in danger of being over-hyped – there are not that many successful micro-businesses that the poor can start solely with the help of loans, because skills and management abilities are also often necessary.
Nevertheless, the benefits are real.
While there is little evidence that microfinance sets substantial numbers of poor people on the path to riches, it does help the poor save, smooth consumption, deal with emergencies, and expand existing businesses.
These are not trivial benefits.
One problem the poor often have in accumulating savings is lack of easy access to savings accounts where they can deposit money.
The money is kept in a tin at home, and is easily spent when a neighbour is in difficulty, or the ne’er-do-well cousin comes calling.
By taking a loan from a micro-financier to buy a needed asset, and then making regular mandatory weekly payments out of her income, the housewife borrows to save – she no longer has spare cash lying around for others to fritter away.
The “asset” that is purchased need not be a physical asset.
In India, a big portion of college dues is paid at the beginning of the year.
Households whose members have steady jobs borrow from micro-financiers to pay the fees, and then spend the rest of the year repaying the loan.
That way, they do not have to cut spending substantially in the months before the fee is due, but can instead smooth spending over the year.
This is helpful when people live at the margin – where cutting spending means foregoing food or medicines.
Emergency loans are equally important.
When children fall sick, parents do not have the time to apply for a loan from a state-owned bank (perhaps, the only alternative source of loans for the poor other than the moneylender).
Usually, the bank takes months to process the application, and may demand a bribe even in the unlikely event it is willing to take on the credit risk.
The micro-financier, confident of being repaid, is willing to extend the emergency loan quickly and with little bureaucracy.
Finally, while I am skeptical that microfinance alone can promote a lot of successful entrepreneurship, it certainly can be helpful in allowing a farmer to buy more cattle or a tractor, or allowing a village shopkeeper to expand inventory.
Thus, it also helps expand incomes.
But, despite all these benefits, politicians are generally unwilling to accept that money can be earned honestly from those at the bottom of the income pyramid.
If micro-financiers are making profits off the poor, it must be because they are bilking them.
Suspicions are further reinforced by politicians’ underlying paternalism – the poor do not know what is good for them and are easily fooled.
Of course, the fact that micro-financiers charge the very poor relatively high interest rates exacerbates the perception that they are gouging society’s most vulnerable members.
But micro-financiers may have no choice: given the small size of the loans, the costs of processing them and collecting payments are relatively large, driving up the break-even interest rate.
Matters came to a head in August this year, when an initial public offering in India of SKS, a microfinance institution started by Vikram Akula, a graduate of the University of Chicago’s Booth school of business, raised roughly US$350 million.
The IPO valued the company at US$1.6 billion.
Such a high valuation can be justified if SKS provides a better service than the competition, but darker interpretations are possible.
If SKS is doing so well, the official thinking went, it must be up to no good. So, the authorities acted.
The Andhra Pradesh administration accused the industry of charging usurious interest rates, urging the gullible poor to over-borrow, and then driving some delinquent borrowers to commit suicide.
It imposed severe curbs on the industry in October.
The widespread belief among micro-financiers is that the curbs were imposed not because the industry was exploitative, but because it offered an alternative to political patronage.
Politicians gained influence and popular support by directing state-owned banks to make loans to favoured constituencies.
By threatening this source of power, the microfinance industry created a powerful opponent, who found an opportune moment to strike.
The truth probably lies somewhere in the middle – the microfinance sector has made some mistakes, which politicians have exaggerated in an effort to destroy an industry that undermines them by making the poor more independent.
There is a lesson to draw from all this.
There is money to be made at the bottom of the income pyramid, and businesses can do immense good while making that money by giving the poor choices that they have never had.
Skepticism that money can be made off the poor extends well beyond the politician.
It is incumbent on industries that deal with the poor to be transparent about how they earn their money – and to make the case for their activities strongly and publicly.
Like Caesar’s wife, microfinance has to be above suspicion. – Project Syndicate
*Raghuram Rajan is professor of finance at the Booth School of Business, University of Chicago, and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy, which was recently awarded The Financial Times/Goldman Sachs Business Book of the Year Award.