In December 2006, Muhammad Yunus, a Bangladeshi national, was awarded the Nobel Peace Prize.1 His work on structuring financing in Bangladesh revolutionized the thinking on how to lend to the poorest, and most rural, segments of countries; that is, the communities in which the majority of poor people are employed in the agricultural sector, often buffeted by unpredictable events, and live in villages which lack physical infrastructure (roads or power supplies), making the costs of establishing a formal banking network prohibitive.
Professor Yunus’s innovation was to find a way to lend to the poorest of the poor who have no collateral – no house, no car, no tangible asset against which to borrow. People whose only nominal personal wealth would probably be in the form of land, where the collateral is undocumented and legally unenforceable.
Looking across Bangladesh, Yunus realized that although many villages had no obvious visible asset, they all shared one thing – a community of interdependence and trust. The genius behind Yunus’s Grameen Bank (literally translated from Bengali as ‘Bank of the Village’) was in converting that trust into collateral.2
The mechanics of Grameen Bank’s solidarity lending are pretty straightforward. Take a small village with five traders for a basic illustration. Through its micro-lending programme, the Grameen Bank lends the group US$100. Within the group the US$100 is passed on to trader A for a pre-specified period (a loan period currently runs for about one year). At the end of this time, she (97 per cent of Grameen’s loans are made to women) has to pay back to Grameen Bank the loan amount plus interest (which can be between 8 and 12 per cent). Trader A is solely responsible for repaying her loan. When the loan is repaid, the next US$100 loan is made to the group, which is then passed on to trader B. But if trader A does not repay, the group is extended no further loans.
Although, technically speaking, there is no group joint liability (the group as a whole is not responsible for the loan when one member defaults), the group is implicitly liable in the sense that the behaviour of each individual member affects the group as a whole. So very often when difficulties in repayment do arise, the group members contribute the defaulted amount (with an intention of collecting the money from the defaulted member at a later time), thus keeping the loan-cycle turning. In this sense microfinance in poor countries works much like credit cards in rich countries – borrowers repay their loans because they know that if they don’t pay the loans they have today, their lender will blacklist them, and they won’t be able to borrow more tomorrow. The bonds of trust extend not only between the members of the group, but also between the group and the bank – there is no legal instrument between Grameen Bank and its borrowers.
The Grameen model has met with resounding success. At least forty-three countries around the world have adopted some version of it. Grameen Bank initially offered micro-finance to 36,000 members with a portfolio of US$3.1 million when it became a bank in 1983. By 1997, it had 2.3 million members and a portfolio of US$230 million. Perhaps most impressively, its default rates are at less than 2 per cent and, with its success, the bank now provides a host of other financial services (beyond also insurance and pension schemes) to the poor – micro-enterprise, scholarships and housing programmes.
According to Grameen Bank estimates from March 2008, over 1.3 million members took micro-enterprise loans (mainly for power-tillers, irrigation pumps, motor vehicles, and river craft for transportation and fishing), for a total of over US$450 million. On the education side, scholarships amounting to US$950,000 have been awarded to over 50,000 children, and by March 2008 nearly 23,000 students received higher-education loans, many for medicine, engineering and professional certificates. Finally, in the twelve months to February 2008, Grameen housing loans alone have reached US$1.19 million with some 8,300 houses having been built. Since the housing programme’s inception in 1984, over 650,000 houses have been constructed.
The most truly extraordinary aspect of this extraordinary tale is their ‘No Donor Money, No Loans’ policy. In 1995, Grameen Bank decided not to receive any more donor funds, and today funds itself 100 per cent through its deposits. Although recognized as the grandfather of micro-credit and micro-lending, Grameen Bank has spawned numerous variations all over the world, all targeting the segment of the population that has fallen through the high-street banking cracks. The BKI in Indonesia, Acción in Latin America, BRAC in Bangladesh and K-REP in Kenya are just a sample of the growing and expansive list.
In Africa, Zambia offers an interesting case study of how microfinance has developed. Traditionally, conservative banking institutions have generally targeted large and established companies (for example, those in the mining sector) and shown little appetite for small businesses and individuals (save a few high-income salaried earners). In a population of around 10 million people, where only about 500,000 are formally employed, some 9.5 million (although this includes children) remained ignored by the banking sector. Enter micro-finance. The many thousands of would-be Zambian entrepreneurs finally had a way to secure capital to fund their businesses.
In practice, like many other poor countries, the Zambian micro-finance market can be split into three tiers. The first two target salaried workers, who pay different rates of interest depending on their employer. In the first tier are civil servants (doctors, teachers and military personnel), who by virtue of working for the government are charged relatively low interest rates. Second come salaried professionals, not employed by government (lawyers and bankers) and who, because they work in the private sector and do not have the security of the government behind them, are charged a higher rate of interest. In each of these two cases, the micro-loan lender uses the salary as collateral – using the individuals’ wage to directly secure the loan.
The third category, which encompasses the vast majority of Zambia’s poor, and for which the Grameen Bank structure was originally intended, are the unsalaried, often rural poor, with variable incomes, and generally no access to loan capital – think of a woman selling tomatoes on a side street. Yet this group – the real entrepreneurs, the backbone of Zambia’s economic future – need capital just as much as the mining company to see their businesses established and grow.
In Zambia, as in other African countries where micro-finance has started to blossom, the risk of lending to the most risky is often reduced through joint liability – the notion that members of a group of borrowers are all liable for any loans that a micro-finance lender makes to them.
Consider again a group of borrowers in a small rural village, where the lender has virtually no information on the individual borrowers. Joint liability gets around this information asymmetry in a number of ways. When forming their groups, borrowers have an incentive at the onset to match themselves with other good borrowers, and exclude those known to be high-risk. Naturally, this self-selection mechanism helps the lender screen the borrowers and reduce the risk of default. Joint liability also addresses the moral hazard lenders typically face – that is, the risk that once a loan is made, once the borrower has secured the cash, she defaults. Under joint liability, other members of the group have a vested interest to ensure their partners do not cheat, to see the loan repaid, so that they too can access funds.
Having seen the explosion and success in micro-finance (micro-finance default rates in Zambia are less than 5 per cent), traditional banks have woken up to the opportunity that hitherto they have left untapped. Since 2000, there has been a rapid growth in international investment in micro-lending by various agencies and funds that tend to be more commercially oriented. By mid-2004, this group had invested a total of nearly US$23 billion in about 450 micro-finance institutions.
But micro-finance is not without its naysayers. This type of lending to the poor is criticized as loan-sharking (charging punitive and exorbitant rates), as fuelling Ponzi schemes (borrowing from one lender to pay off another) and as simply supporting reckless consumption. However, with ever-increasing numbers of micro-lenders, and growing participation in this type of lending, the interest rates charged inevitably become lower and, in this sense, more competitive. As to the Ponzi scheme criticism, the objection merely points to the need for more information concerning borrowers – who’s good and who’s bad (which, by the way, is exactly the information asymmetry that the Grameen model mitigates). And on the issue of consumption versus investment, this applies to any loan, any time, anywhere.
The important point, not to be overlooked, is that the previously unbankable and excluded poor are now part of a functioning financial dynamic. With this comes a culture of borrowing and repayment crucial for financial development in a well-oiled successful economy. Small-scale banking to poor people has the capacity to create enterprise and growth in developing countries.
Lending to the poor is also no longer constrained by national boundaries, or by financial institutions. With the advent of Kiva, a California-based interface, pretty much anyone sitting anywhere with a keyboard can lend money to anyone across the planet.3 This is how it works: a woman in Cameroon goes on line seeking a US$200 loan towards her tailoring business. She makes her case, as best she can, and a man in Des Moines, Iowa, lends her US$25 of it, someone in Sweden lends another US$25, and the balance is covered by someone in Japan. The loan is made for a set period, for a pre-agreed interest rate, and she regularly updates her lenders on her progress. In the week – just one week – leading into 19 April 2008, over US$625,000 was lent by almost 3,000 new lenders.
Like the Grameen model (and unlike aid) the default rates have been minimal. Thus far, since Kiva’s inception in 2005, some US$30 million has been lent, 45,000 loans made to people in forty-two countries. A wonderful innovation – get involved.
Remember the mosquito net manufacturer who, thanks to aid, is now out of business? And remember the 176 people (one owner, ten workers and their 165 dependants) now with no stable income, dependent on handouts?
How much better would it have been if just half of the million-dollar donation had been invested as micro-lending in the country instead? Within five years, our mosquito net manufacturer could have expanded production to meet growing demand, doubled his workforce (and by default provided support for another 150 of their dependants), and his product would be there to replace the nets as they fell into disrepair.
Of course, other entrepreneurs, seeing how his business has flourished and recognizing the ever-present demand for mosquito nets, would venture into the market, thereby lowering the cost of the nets over time, and of course improving quality.
What should Dongo do?
The extension of financial services to people who otherwise have no access to banks dates as far back as when municipal savings banks began in Europe in the eighteenth century, and when German groups based on the self-help principle and called savings and credit cooperatives were first organized by Herman Schulze-Delitzsch and Friedrich Raiffeisen in the middle of the nineteenth century.
In more recent times, micro-credit organizations were developed in the 1960s to serve Africa and Asia’s needs for agricultural support, yet most Africans today still have very limited access to financial markets. In Ghana and Tanzania, for example, only about 5–6 per cent of the population has access to the banking sector, although some 80 per cent of households in Tanzania would be prepared to save if they had access to appropriate products and saving mechanisms.
The oldest private, worldwide, fully commercial micro-finance investment fund is the Dexia Micro-Credit Fund. It is managed by Blue Orchard Finance, a micro-finance investment consultancy, and finances some fifty micro-finance institutions in twenty-four countries. It has investments of US$77 million. However, it was really not until Grameen Bank’s success that micro-finance really took off.
Today, micro-finance brings groups of people into the economy for the first time, by offering the poor a range of saving tools. Beyond the direct capital injection it puts into a borrower’s pockets, it can also be a powerful development tool. Even small loans can boost business productivity gains and contribute to job creation and raise family living standards (better nutrition, better health and housing, more education).
By some estimates some 10,000 organizations (from nongovernmental organizations to registered banks) today offer over US$1 billion worth of micro-finance loans annually to many millions of customers around the world; projections are that this amount will have to grow twenty-fold (to US$20 billion) over the next five years to meet projected demand. But in more extreme forecasts, some predict even more exponential growth. Vijay Mahajan, a micro-finance practitioner, puts potential annual micro-credit demand in India alone at US$30 billion, 10 per cent of the estimated global US$300 billion.4 According to an April 2006 survey by McKinsey Consulting, India has the potential to become a US$500 billion market by the year 2020.
Growth in most emerging-market regions has been meteoric: For example, the Bangladeshi organization BRAC signed up 5,000 customers in Afghanistan, just six months after setting up there; two Cambodian organizations (Acleda and EMT) each have over 80,000 customers; Banco do Nordeste in Brazil has become the second-largest micro-finance operation in Latin America, with 110,000 clients in just a few years; and Compartamos, in Mexico, has nearly doubled the number of its clients in the past year to become the largest Latin American programme, with over 150,000 clients.
Despite all this expansion, the industry has yet to reach 5 per cent of the customers among the world poor. Even according to the Grameen Foundation USA’s more optimistic estimates that 10 per cent of a potential US$300 billion micro-finance market has been penetrated, there is plenty of scope for development financing through micro-lending. It’s about time Dongo, and the rest of Africa, got involved.
Remittances
The UN estimates that there are around 33 million Africans living outside their country of origin. Nigerians and Ghanaians principally move to the United States, Malians and Senegalese settle in France, and the majority of Congolese make their home in the Netherlands. Some 30 per cent of Mali’s population lives elsewhere. In total, emigrants represent almost 5 per cent of Africa’s total population, and they are yet another source of money to help fuel Africa’s development.
Remittances – the money Africans abroad sent home to their families – totalled around US$20 billion in 2006 (remittances were US$68 billion and US$113 billion in Latin America and Asia, respectively). According to a United Nations report entitled Resource Flows to Africa: An Update on Statistical Trends, between 2000 and 2003 Africans sent home about US$17 billion each year, a figure that even tops FDI, which averaged US$15 billion, during this period. What is more, according to the World Bank, the figures on Africa’s remittances are most likely grossly under-valued, as a lot of money makes its way to the continent through unrecorded channels (Freund and Spatafora estimate informal remittances are 35–75 per cent of the official flows); so much so that remittances may possibly be the largest source of external funding in many poor countries. At US$5 billion, Nigeria receives the greatest amount of remittances in Africa, followed by South Africa (US$1.5 billion) and Angola (US$1 billion). They accounted for roughly 40 per cent of Somalia’s 2006 GDP, the same year that six out of fifty-three countries received remittances in excess of US$1 billion. Quite clearly remittances are (and increasingly should be) a significant piece of many African countries’ financing puzzle.
In July 2006, the UK’s Department of International Development published a report, The Black and Minority Ethnic Remittance Survey, which revealed that within black communities 34 per cent of Africans send money home to relatives. Perhaps more startlingwas the fact that of the almost 10,000 minority households interviewed across the UK, Black Africans were found to remit money (an average of around £910 annually, or almost US$1,800; the global average per capita is around US$200 per month) more frequently than any other group.
Like the other forms of private capital flows already discussed, the benefits of remittances are far-reaching.
Although the actual remittance sums taken individually are relatively small, taken collectively the remittance amounts flowing into African nations’ coffers (banks, building societies, etc.) are enormous. The US$565 million that flowed into Mozambique and the US$642 million that went to Uganda in 2006 most certainly contributed to bolstering their economies.
Remittances can play an important part in financing a country’s external balances, by helping to pay for imports and repay external debt. As remittances tend to be more stable than other capital flows, in some countries banks have used them to securitize loans from the international capital markets – that is, to raise overseas financing using future remittances as collateral, thereby lowering borrowing costs. Banco do Brasil raised US$250 million in 2002 by using future dollar- or yen-denominated worker remittances as collateral.
An April 2008 World Bank publication entitled ‘Beyond Aid: New Sources and Innovative Mechanisms for Financing Development in Sub-Saharan Africa’, estimated that sub-Saharan African countries can potentially raise as much as US$1–3 billion by reducing the cost of international migrant remittances, US$5–10 billion by issuing diaspora bonds (a bond issued by a country (or even a private company) to raise financing from its overseas diaspora), and US$17 billion by securitizing future remittances – not small change. Incidentally, India and Israel have raised as much as US$11 billion and US$25 billion, respectively, from their diaspora abroad, showing that these schemes can work, and work very well if executed efficiently.5
On a household level, remittances are used to finance basic consumption needs: housing, children’s education, healthcare, and even capital for small businesses and entrepreneurial activities – the heart of an economy. More fundamentally, more remittances mean more money deposited in the bank, which means more cash that the banks have to lend. In Latin America, deposits-to-GDP ratios (a key indicator of a country’s financial development) markedly improved as a result of high remittances. Naturally, the most direct channel through which remittances have an impact on GDP is by increased spending by the recipient households.
Remittances make an important and growing contribution to relieving poverty. According to a paper by World Bank economists, evidence shows that a 10 per cent increase in per capita remittances leads to a 3.5 per cent decline in the proportion of poor people. Household surveys in the Philippines indicate that a 10 per cent increase in remittances reduced the poverty rate by 2.8 per cent by increasing the income level of the receiving family but also via spillovers to the overall economy. Moreover, this 10 per cent increase led to a 1.7 per cent increase in school attendance, a 0.35-hour decline in child labour per household per week, and a 2 per cent increase in new entrepreneurial activities.6
All of this is good news, but there is a price to be paid – and one that potentially constrains the growth of remittances to the continent. For every US$100 sent to Africa, only US$80 gets there – the middleman takes the rest – while from the US to Mexico US$85 gets home (that is, a 15 per cent charge), and from the UK to India as much as US$96 (just a 4 per cent tax) reaches its destination.
This form of higher ‘taxation’ on monies sent to Africa throws up a double-whammy: it encourages those abroad to send money secretly and can ultimately discourage them from sending any money at all. In a survey, remitters said that they would send 10 per cent more money if costs were 50 per cent cheaper.
The bulk of the transfer cost for remitting money from the sender abroad to the recipient at home is determined in the private markets. Therefore, the high remittance costs can really only be reduced by increasing access to banking and strengthening competition in the remittance industry.
However, there is scope for African governments to encourage greater remittance flows by offering cheaper ways for money to be sent home. In Latin America, for example, the International Remittance Network facilitates remittance flows from the United States to Latin America. Similar initiatives in Africa would undoubtedly do the same. It is encouraging to note that innovative mobile phone technology is making it both cheaper and quicker for people to send and receive money. In April 2007, a money transfer system called M-Pesa was launched in Kenya enabling subscribers to send large sums of money in an instant transaction. Within just two weeks of the launch over 10,000 account holders were registered and more than US$100,000 had been transferred. At the moment the M-Pesa programme only facilitates money transfers within the country’s borders, usually from richer urban dwellers to their poorer rural relations. However, there are plans underway to roll the scheme out on an international basis, not only tapping the billions of international remittances Kenyans regularly send home, but doing it in the most competitive way – that is, getting more cash into the recipient’s pocket.
Remittances are, of course, in some sense a form of aid (the recipient is essentially getting something for nothing). And like other forms of aid, there is the inherent risk that remittances encourage reckless consumption and laziness. In 2006, Jamaica’s finance minister, Dr Omar Davies, expressed concern that the multimillion-dollar flows of remittances to Jamaicans were instilling a culture of dependency over achievement.
Perhaps this is true, but at least some part of the money is reaching the indigent and making its way to productive uses. And unlike aid it does not increase corruption. Indeed, Giuliano and Ruiz-Arranz, and Toxopeus and Lensink, conclude that remittances do have a positive impact on growth.
Savings
In April 2005, two young boys stumbled upon US$6,000 while playing football in Maiduguri, in north-east Nigeria. Maiduguri is not Nigeria’s bustling capital city of Abuja or its largest commercial city of Lagos; nor, for that matter, is it Nigeria’s third, fourth or fifth business hubs (those honours go to Port Harcourt, Kano and Ibadan). Yet it was here, in Maiduguri, that the US$6,000 was found.7
This money hadn’t been lost. As it turns out, in the absence of a credible, formalized banking system the owner of the cash had opted to neatly wrap his savings in a black plastic bag and hide his stash near a rubbish dump.
This incident raises a fundamental question: does Africa lack capital? Or might it be that there is a lot of cash in these poor countries – unseen, dormant cash, which simply needs to be woken? Could it actually be that the countless development agents and agencies and innumerable man-hours deployed to send cash to Africa have been for naught – attempting to address a problem that simply does not exist? That, in fact, the core problem with Africa is not an absence of cash, but rather that its financial markets are acutely inefficient – borrowers cannot borrow, and lenders do not lend, despite the billions washing about.
In The Mystery of Capital, the Peruvian economist Hernando de Soto suggests that the value of savings among the poor of Asia, the Middle East and Africa is as much as forty times all the foreign aid received throughout the world since 1945. He argues that were the United States to hike its foreign-aid allocations to the 0.7 per cent of national income (as prescribed by the United Nations at Monterrey), it would take the richest country more than 150 years to transfer to the world’s poor resources equal to those that they already have.
Evidence from India would seem to add weight to this theory. By some estimates, as much as US$200 billion worth of untapped investment potential is privately held in gold in India.8 In 2005, India introduced a policy which allowed Indians to exchange their physical gold holdings (often held in jewellery and coins) into ‘paper’ gold in denominations as low as US$2. Estimates suggest that this policy unlocked as much as US$200 billion worth of untapped investment potential privately held. The initiative promised to bring the poorest 700 million villagers, who purchase about two thirds of India’s gold, into the more formalized banking system. Moreover, this gold policy injected more money into the economy than the total FDI India received in 2004 – in that year Indians poured about twice as much money into gold (around US$10 billion) as the country received from foreign investors. With more than half of India’s savings tied up in physical assets, such strategies can bring millions of poor into the banking system, offering credit access to many Indians, and inject capital into the economy.
The Indian experience is an example of how a government has successfully unlocked latent resources. Africa should take note and look for ways to bring the hidden money into the financial stream. Of course, Africans might not hoard gold to the same extent as Indians, but many of them do have access to (and nominal ownership of) the land they till. And this is de Soto’s main argument, that the inability of people across the developing world to secure their property rights is what prevents them from unlocking their vast capital. What is needed is a functioning and transparent legal framework so that Africans can convert that land into collateral against which they can borrow and invest.
It is not the case that African countries do not have legal frameworks (many inherited from their colonial past); it is, however, the case that in environments of rampant corruption the legal systems are often impotent.
Savings are a hugely important part of a country’s growth, and a country’s financial development. Domestic saving is the most important source of financing investment and thus boosting growth. Looking back at the Grameen Bank model, it too includes a component to encourage saving amongst its borrowers – in fact, they are required to save and invest. Customers must save US$0.02 per week, and new members are required to buy a share of stock in Grameen for US$2; localized financial development at its best.
What Africa desperately needs is more innovation in the financial sector. We can put a man on the moon, so we can most certainly crack Africa’s financing puzzle, jump-start economic growth and drastically reduce poverty. But herein lies the key – innovation. Innovation means breaking out of the mould, and finding more-applicable ways for Africa to finance its development. There is a history of financial innovation to draw from: the Soft Banks of America’s Wild West and the Scottish Banks of the eighteenth century. Both catered to the unsecured and traditionally unbankable.
At the time of the gold rush in 1800s California, for example, one would have expected the well-established East Coast American banks to have simply migrated westwards, opening branches and setting up their lending shops on the West Coast to cater to the demand from those in search of yellow (and black) gold. Instead, what happened was that there emerged hybrid banking structures – a combination of venture capital, where the lenders would lend money with the prospect of a portion of the spoils when the borrower struck gold, and standard lending practices, where the borrower would have to pay back the principal plus some interest (in this case the lender got no share in the project). To illustrate, under a venture capital (VC) arrangement, the lender would give the collateral-less gold-seeker US$1,000 to invest in exploration and hiring all the staff he needed, and in return the lender would get 20 per cent of the gold project or all future profits emanating from the project. Naturally, this structure was very different to the standard banking practices which would have lent out the US$1,000 with an interest rate attached. But, of course, under standard banking practices most of the borrowers without collateral would have been excluded. In essence, as is the case in many places in Africa today, the gold-rushers of America’s Wild West had a good idea, but no collateral which standard bankers would feel happy to lend against.
The financing revolution of eighteenth-century Scotland was not much different in its innovative thinking. By essentially becoming a fully fledged, all-service financial supermarket (providing all elements of banking – venture capital, standard commercial banking, investment banking, merchant banking, etc.), Scottish banks could customize the cash and liquidity needs of a whole range of businesses and individual entrepreneurs. Banking and finance are about risk – risk assessment, risk mitigation and risk estimation. Scottish financial engineers had figured it out. Even if a potential borrower did not meet a bank’s standard, prescribed risk profile (that is, had no collateral, no guarantees, no obvious ability to repay), rather than turn them away the bank would tailor a lending instrument to meet the risk profile of the borrower. Certainly, it might have meant infinite permutations to get the right structure, but there was never any doubt that a financing structure could be found.
There is a story, for example, of how two independent farm owners each applied for financing to invest in their individual farms. The lender could not see how to lend to each farm individually, but somehow if the two farms were merged, their risks pooled, and therefore mitigated, a loan arrangement could be struck.
It is this type of innovation, providing micro-loans as well offering hybrid venture capital structures (in addition to standard banking fare), that Africa should look to replicate in order to bring its masses into the global fold. No country has economically succeeded without finding a way to funnel the risk capital to finance its small and medium-sized enterprises. For Africa, this is an imperative that must be heeded.