In a cash-strapped age, are microloans the answer?

When Typhoon Haiyan laid waste the central Philippines in 2013, Bernadeth Cabusog was one of the many people whose lives were turned upside down. Her smallholding was wrecked and with it, her family’s main means of provision. “It was the hardest time of our lives,” she recalls. “All our vegetables were destroyed. We really needed some help.”

Cabusog took the advice of a neighbour in her village in rural Cebu province and approached Lamac, a local agricultural co-operative. Lamac lent her around $450 to replant her crops of lettuce, cucumbers and tomatoes, allowing her to defer half of its repayment until she was back on her feet again. “I was just so thankful that they were there to help me. I felt like God had a purpose for me after all,” she says.

Seven years later, Cabusog has just repaid her fifth loan of $1,900, which went towards fertiliser and other farm equipment, to Lamac. She sells her produce through the co-operative and employs two people. Some of the money will help fund the wages of more workers she plans to hire this year.

While her loan was administered by Lamac, the funds came from Lendwithcare, one of several nonprofit microfinance sites where small investors can help entrepreneurs in developing countries by crowdfunding loans.

Millions of people in developing countries depend on microloans to raise the funds to grow a business or just stay afloat in hard times. And thanks to digital platforms, smartphones and free-moving global capital, growing numbers of people in the rich world are using their money to lift others out of poverty.

In the decade or so they have been around, nonprofit microlenders have become big business. Kiva, the Silicon Valley-based market leader, has around $158m (£120m) invested by 639,000 lenders to more than 400,000 borrowers, according to its 2018 figures.

More modestly but no less impressively, Lendwithcare has lent £27m in total to 127,000 borrowers. Its recent funding targets include a baker in Ecuador looking to replace a mixer, an embroiderer in Pakistan seeking to stock up on cloth, and a taxi rider in Rwanda hoping to purchase a new moped – the kind of small individual ventures that can make a big difference in poor communities.

Critically with Kiva and Lendwithcare investors cannot make a profit – so once funding targets are met, the sites can forward on the microloan interest-free. When (and occasionally if) the loan is paid back, lenders are free to withdraw their initial investment – but most end up returning it to a new project.

Microfinance was conceived as a solution to world poverty by offering people in developing countries reliable access to loans and other financial products. But, 15 years since the idea caught hold, the question that perpetually dogs the sector is whether it actually works.

By some measures, extreme poverty appears to be falling. According to the most recent UN estimates, in 2015 10% of the world’s population lived at or below the World Bank’s extreme poverty line of $1.90 a day – down from 16% in 2010 and 36% in 1990. But how much of this trend can be attributed to the effects of microfinance? The microfinance sector has grown into a financial behemoth, with overall loans in 2018 estimated by the World Bank at $112bn to 120 million borrowers.

But Dr Philip Mader, a research fellow at the Institute of Development Studies who has looked at the sector extensively, says that, while microfinance has created more financial products in developing countries and encouraged generosity from the rich world, there is no clear evidence that microloans do, on average, lift people out of poverty.

“There are always going to be exceptional individuals for whom a loan was a single breakthrough factor, but most people just aren’t natural entrepreneurs,” says Mader. “They’re doing this to get by, and at the end of next year, they’re going to be where they were before. Some people are going to be worse off as well. Loans are risky. That’s important to consider.”

It’s a point acknowledged by Ajaz Ahmed Khan, the senior microfinance adviser at Care International, Lendwithcare’s umbrella organisation. “I’ve been involved in this sort of world for 30 years, but I’ve never been convinced that any one thing is a panacea,” he says. “Poverty is far too complicated for one simple intervention to remedy everything.”

Kiva is the slickest of the microfunding websites, offering a mind-bogglingly glossy catalogue of projects sorted into different categories, countries and attributes, all illustrated with backstories and pictures. It’s clear that this sense of connection between lender and borrower is a big part of the urge to invest.

But the reality is often a lot messier – something that may not initially be obvious to the lender. In fact, like Cabusog and Lendwithcare, borrowers and crowdfunding sites connect via local partner microfinance institutions (MFIs) who do the essential work of assessing creditworthiness and administering loans. To pay for that, most MFIs charge interest to borrowers, often at wildly varying rates.

Furthermore, many lenders have been surprised to find the money being crowdfunded on Lendwithcare or Kiva is often already in the borrower’s pocket, lent by a local MFI long before the loan target has been met. There are good practical reasons for this, explains Kathy Guis, Kiva’s director of partner investments. “Often borrowers have urgent financial needs, for example, to purchase perishable goods for resale,” she says. “So for entrepreneurs to wait two or three months for Kiva to send that money to the [MFI] partner just wouldn’t actually be useful.”

Still, the reality is that in many cases a lender’s individual investment is simply going towards a partner MFI’s general portfolio, rather than directly to the loanee. Both Kiva and Lendwithcare do spell this out in the small print on their sites, Kiva in particular having been accused of not being clear enough about this in the past. It’s just not quite as straightforward as you might first think.

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In the end, though, does this really matter? Goldie Chow, Kiva’s director of impact, says that a sense of connection is key to the urge to lend. “Kiva is a platform to democratise impact investing,” Chow says. “When you come on the website, it looks very simple, it looks very clean and very easy. But the fact of the matter is that to manage the $150m of loans that we do every year, we have to have really onerous systems and levers and monitoring processes in place.”

While the work carried out by local MFIs is generally necessary and cost-consuming, the malpractice of some operators has also cast a shadow over the industry. A recent Guardian investigation into a microfinance programme run in Sierra Leone by Brac, the world’s largest NGO, found its staff were failing to fully explain loans to borrowers, or ensuring they could afford the payments.

Separately, a report last year by Licadho, one of Cambodia’s leading human rights organisations, highlighted numerous cases of MFIs preying on borrowers. It detailed widespread reckless lending practices from local credit officers in offering loans to clients who were clearly unable to repay them, and who were then pressured to sell land to clear debt. It also revealed that at least a million Cambodian borrowers had been forced to offer their land or homes as security to MFIs.

Kiva and Lendwithcare both say they take stringent measures to avoid exposure to such bad practice. Khan says that Lendwithcare’s MFI partners tend to be NGOs and co-operatives and its due diligence visits typically last seven to 10 days, including full policy and procedure reviews. “Sometimes, despite all the research and country visits, we decide not to proceed,” he says, highlighting recent visits to Tanzania, Guatemala and Egypt as examples.

On its website, Kiva says it will not partner with organisations that charge unreasonable interest rates, and that it requires field partners to fully disclose their rates. “Kiva only partners with organisations and microfinance institutions that have a social mission to serve the poor, unbanked and underserved,” it says.

If rogue MFIs are often perceived as the problem, would it be possible to do without them? Around 2006, Julia Kurnia had that very thought while working for a small NGO in Senegal, when she saw first-hand how expensive microloans could be for borrowers.

“We had started a microfinance bank and hired a loan officer,” she recalls. “He would have to travel to the villages and collect money. That was very expensive relative to the small size of loans. But even though we tried to be as frugal as we could – I was there as a volunteer – we could never get the operating cost below about a third of the value of the loans.”

The result was that Kurnia founded Zidisha, a peer-to-peer lending service that cuts out the middleman altogether by utilising cheap mobile phone money transfer services to connect borrower to lender directly. Borrowers pay a 5% fee to Zidisha to cover its operating costs, but that’s it. Since it was founded in 2009, it has lent around $16.7m to more than 380,000 members.

Zidisha uses algorithms to assess potential borrowers for default risk and for possible fraud: “That’s the main problem we have to solve as an internet service that doesn’t have people on the ground,” says Kurnia. She admits the absence of an MFI to mediate could result in a higher risk of default, though she says Zidisha offers a guarantee to lenders of up to $1,000.

The traditional microlenders think that harnessing big data will be the key to lowering the cost of borrowing in the developing world. Kiva is using blockchain technology in Sierra Leone to create an online ID database so that loan applicants outside the formal banking system can prove their credit history, and it hopes to extend the system to other countries if successful.

“From the outside looking in, many people assume there’s minimal economic activity in the unbanked world,” says Kiva’s chief strategy officer, Matthew Davie. “In fact, there’s a very active financial sector. The problem is all the activity in that sector never gives you credit when you move on to formal financial services.”

Still, the question remains: does microfinance really achieve the objective of lifting people out of poverty? As with the differing models of loan disbursement, the answer is complicated. “Broadly speaking, I’d agree that it’s hard to prove,” says Khan. He points out that Lendwithcare tries to supplement its loans with a range of other financial services including savings and training, so that the impact is not just focused on loans.

Over the past five years, Lendwithcare has tried to measure the impact of its work in collaboration with the University of Portsmouth. It has found that in Pakistan, for example, household income for the low-income families it supports has risen by 30.7% since 2015. The results look encouraging – but even here, Khan says they should be treated with caution as Akhuwat, its MFI partner in Pakistan, charges no interest on its loans in accordance with Islamic practice. “The results in Zimbabwe, where the economic situation is difficult, were very mixed,” he admits.

In the end, philanthropic investing in this form is only one in a range of options open to people wanting to help alleviate poverty – and that includes just giving money to needy individuals or to good causes.

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“There is no one thing that will help everyone living in poverty find a way out,” says Kiva’s Guis. “Cash transfers are right for some people, loans are right for others. Where I find the argument for Kiva’s approach strongest is that we’re tapping into money that is not earmarked for charitable giving.”

As Mader points out, people need to consider what they want to achieve. “If people want to give directly to someone, there’s a website called givedirectly.org. If they want to make sure that somebody is working hard to have a chance at poverty reduction and development, but only after having repaid interest to an intermediary lender, then yes, use Kiva.

“I don’t want to fault anyone for giving a loan. But I’m fascinated by how well Kiva and others have managed to sell the idea that the best way to do this is by funding individual entrepreneurs via loans, rather than working for broader community-based change.”

In the Philippines, Bernadeth Cabusog is already planning for her next loan. She hopes to use it to concrete a track on her land, and to buy a motorcycle which would considerably reduce the time she spends travelling to and from the credit office in town.

“Every day I see the difference,” she says. “Before the loans, everything was so hard. Now, we have a comfortable life.”

• Graham Snowdon is deputy editor of Guardian Weekly

This article is part of a series on possible solutions to some of the world’s most stubborn problems. What else should we cover? Email us at theupside@theguardian.com