The “on the one hand” and “on the other hand” of microfinance lending

by Deborah Burand : Monday, April 27, 2009

Two of my fellow law professors here at the University of Michigan Law School recently asked me what I thought of online lending platforms dedicated to microfinance. In response, I heard myself saying things like “on the one hand” yet “on the other hand.” I am sure I confused my colleagues more than I might have clarified matters. All of which is a long way to say I am ambivalent about these platforms.

On the one hand, I am in awe of the power of online lending platforms to generate interest in the microfinance sector among the general population and to attract capital to the microfinance sector, especially in these difficult times of tightening credit markets worldwide. I also admire the people I know who either have founded online lending platforms or now work for online lending platforms. So why the ambivalence?

Well, that is the “other hand.” Every time I read a newspaper story about Mr. Madoff’s financial chicanery, I wonder if somewhere, some time in the future, we also might see an online lending or investment platform characterized as a Ponzi scheme. The nightmare headlines accompanying that story might go something like this… “Online Do-Gooders Cheated” or “Loans to Poor Rarely Delivered.” 

I am in awe of the power of online lending platforms to generate interest in the microfinance sector among the general population and to attract capital to the microfinance sector, especially in these difficult times of tightening credit markets worldwide.

Evidence to date is that today’s online lending and investment platforms are conscientiously working to fulfill the promises they make about where and how the funds they attract are delivered. But the number of these platforms is growing quickly, so it is not hard to imagine some less reputable actors entering the field in an attempt to get rich quick by appealing to the soft hearts of unsophisticated or ill-informed online lenders.

How might the good guys differentiate themselves from these potential bad guys? Here are a few ideas.
• There could be a transparency award for online lending platforms similar to that which we give to microfinance institutions.
• There could be a specialized code of conduct or best practices that all reputable online lending platforms could endorse (and be held accountable to).
• There could be a new cottage industry created (either conducted through or created separate from existing online lending platforms) aimed at educating the online lending community so that online lenders might make informed choices about which platforms they choose to use as the vehicle for their online loans.
• Online lending platforms could invite ratings by specialized microfinance rating agencies much like the ratings now aimed at microfinance institutions.
• Finally, and perhaps most powerful, the community of online lenders could self-police and share openly their “good” and their “bad” experiences with online lending platforms. Some microfinance stakeholders might even consider using “secret shoppers” to pose as online lenders and then openly compare experiences across platforms. 

Some of these ideas already are being advanced by online lending platforms or the online community that invests in these platforms. Others are perhaps just the wild ideas of a worrywart (me!). The concern, of course, is that the need for clear differentiations among “best practice” online lending platforms and the “others” will become pressing only if and when a bad actor does surface. But by then the damage will have been done, and the overall credibility of online platforms in particular and the microfinance sector more generally may be irreparably damaged.

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  1. April 28th, 2009 at 9:20 am, Ryan ()

    I wholeheartedly agree. Though I think the arguments apply to microfinance generally. Though there are internal standards (think of Grameen’s “Stars”) and some financial transparency initiatives, there is yet to be a regulatory regime. Undoubtedly some major MFI will turn out to be corrupt and all the great work of those operating squeaky clean will be tarnished as the whole industry takes a hit.

    Moreover, there is a need for distinguishing between those MFIs measuring social performance indicators and those that aren’t. Microfinance seems to be bifurcating across that divide, and it’s appropriate to market those two elements as distinct.

  • April 28th, 2009 at 8:52 pm, NIcolas Leupold ()

    This issue could not have had better timing. Transparency throughout the “value chain” of mainstream financial products and services is under severe questioning due to the crisis. Being MF a niche, the general concepts apply to it as well. It is a question of time a Maddoff or Ponzi scheme comes to light in a MFI or financing platform around the world. Credit rating agencies that analyse IMF´s just to avoid mishaps cannot do any better than S&P/Moody´s/Fitch did.

    Nevertheless, though scandals will not be avoided this should not stop the MF industry from creating new financing and distribution channels, governance procedures, efficiency metrics, etc.

    Every error or scandal should be taken good notice of, corrected, prosecuted and then move on. The net growth of honest money going to honest micro-entrepreneurs is what counts, not the headlines that will be forgotten in a week. Being stopped from lending by the errors that will inevitably happen will do more harm than a manageable PR issue.

  • April 29th, 2009 at 2:01 pm, Deborah Burand ()

    Ryan and Nicholas make a terrific point that this is an issue that applies to microfinance providers as well as to those online lending and investment platforms that fund microfinance. Much work is being done now to help differentiate among providers of microfinance. Much less work has been done to differentiate among retail-oriented funders of microfinance – online or more traditional platforms.

    For those who believe, as I do, in the power of socially-motivated microfinance and see online platforms as a relatively untapped source of fuel to generate that power, there is much to do. We have a valuable opportunity to be proactive, rather than reactive, in shaping how online lending and investing platforms develop.

  • April 30th, 2009 at 3:18 am, V.Rengarajan ()

    Dear all
    In the context of prevalence of unavoidable scandals (Nicolas) at provider (institutional) level ‘on the one hand’, and the significance of social values/ sensitivities (Ryan & Deborah) ultimately at client level ‘on the other hand’ in MF platform, it provokes me to raise a question “ Does MF sector warrant to go for ‘on line lending ‘ or feel it as an inescapable necessity in the process of attraction of capital?
    The rationale for the above inquiry
    In the first, as a by product of technology, on line lending helps the investors and the lenders (MFI) and there will be lack of transparency at all levels. It leads to more risk particularly in the regulation free environment in MFI arena.. (A lesson from the financial crisis in USA)
    Secondly if on line lending facilitates more attraction of capital to the providers without proportional to the actual demand from the target group (the poor) on the one hand, can we assume that all the capital so attracted, could be optimally or economically absorbed to create a tangible social impact eventually at client level ‘on the other hand’?
    Finally, in the context of the need for a gestation period for the candid process of positive social and economic change with the help of MF package (micro savings, micro credit, micro insurance, capacity building etc.,) at client level, does the MF environment warrant such a speedy transfer of micro credit only through on line to the providers? Otherwise will not result in increase in the level of indebtedness ultimately at the client level as the MFI/providers may likely rush to provide the capital (gained through on line) for realizing their due return without much botheration on social impact at their poor client level.
    As against the above portrayal in the MF arena, I am also equally in awe like Deborah little differently on the economic impact of power of on lending in the supply side (investors and the MFIs) ‘on the one hand’ and its social impact in the demand side ‘on the other hand’. Unfortunately, many occasions saw the said impact ‘on the one hand’ only and not yet ‘on the other hand’ equally

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