Bridging the digital divide has to be a bottom-up effort. It has to be powered by innovative entrepreneurs – of whom there is no shortage in the world’s emerging markets. What these entrepreneurs need is, among other things, some capital to help bootstrap or grow their business. Bank loans can be onerous and time-consuming, besides being out-of-reach of small entrepreneurs who have no collateral. This is where MicroFinance comes in.
Organisations like Bangladesh’s Grameen Bank and Bolivia’s Banco Solidario have helped provide finance to millions of entrepreneurs. Writes Professor Robert Kennedy in a Harvard Business School case study on Banco Solidario (February 18, 2002):
The term microfinance (also microcredit) is used to refer to the provision of financial services to low-income people and entrepreneurs, many of whom work in the informal sector. Informal sector workers have traditionally been cut off banks for both social and economic reasons. They generally have no formal employment status or documented salary, lack formal title to property for use as collateral, and have small credit needs and low savings generation.
These factors make serving the informal sector expensive and lead to the perception that the risk of doing so is high. Informal workers do, however, have financing needs, which are often met by informal lenders (either vendors or loan sharks) who make short-term loans at high weekly rates. Microfinance institutions aim to provide a more effective and institutionalized solution for the informal sector.
Here’s an example of how it works (Alkman Granitsas and Deidre Sheehan writing in the Far Eastern Economic Review,
in an article on MicroCredit entitled “Grassroots Capitalism”, July 12, 2001):
Grameen-style banks demand a sort of “social collateral”–in effect, peer pressure. It works like this: Each of the women (most microloans are only made to women) is tied to four others in her lending circle. The first loan is made to one woman, but all five members of the group are collectively responsible for repaying the loan. Until the first borrower has paid back at least half of the loan, the second in line won’t get a cent, and so on. Each week, all new loans, all loan repayments and all family financial problems have to be aired at the weekly centre meetings in full view of a roomful of gossipy village women. Peer pressure and potential loss of “face” keeps repayments high.
But ironically, keeping up the peer pressure is costly. Each loan officer is responsible for visiting just 200 to 300 clients every week. But some of those clients are miles apart down rutted dirt roads and where travel between villages can take the better part of a day. And with no mechanical aids, each and every transaction must be laboriously copied and recopied by hand in ledger books.
With loans of just $150 a piece on average and interest earnings of just a few cents a week, administrative costs can eat up as much as one third of the total value of the loan. In effect, microlenders are operating with a cost structure more closely related to private banking than general retail banking. So although the loans are profitable, the incremental profits are so small that it usually takes over 10 years for the microlender to grow to sufficient critical mass and break even.
Perhaps, some of the innovative tech solutions we have discussed here can help MicroFinance by connecting borrowers and lenders.