Confessions of a Microfinance Heretic: How Microlending Lost Its Way and Betrayed the Poor

by Hugh Sinclair

Very little solid evidence exists that microloans make a dent in long-term poverty. Sadly, evidence does exist for negligence, corruption, and methods that border on extortion. Part exposé, part memoir, and part financial detective story, this is the account of a one-time true believer whose decade in the industry turned him into a heretic.

Hugh Sinclair worked with several microfinance institutions around the world. He couldn’t help but notice that even with a booming $70 billion industry on their side, the poor didn’t seem any better off. Exorbitant interest rates led borrowers into never-ending debt spirals, and aggressive collection practices resulted in cases of forced prostitution, child labor, suicide, and nationwide revolts against the microfinance community.

Sinclair weaves a shocking tale of a system increasingly focused on maximizing profits—particularly once large banks got involved. He details his discovery of several scandals, one of the most disturbing involving a large African microfinance institution of questionable legality that charged interest rates in excess of 100 percent per year, and whose investors and supporters included some of the most celebrated leaders of the microfinance sector. Sinclair’s objections were first met with silence, then threats, attempted bribery, and a court case, and eventually led him to become a principle whistleblower in a sector that had lost its soul.

Microfinance can work—Sinclair describes moving experiences with several ethical and effective organizations and explains what made them different. But without the fundamental reforms that Sinclair recommends here, microfinance will remain an “investment opportunity” that will leave the poor with hollow promises and empty pockets.

Genres: Economics, Nonfiction, Finance

264 pages, Hardcover

First published July 9, 2012

Reviews

[Mike · Rating 3 out of 5]

This book, “Confessions of a Microfinance Heretic” offers a look into the actual workings of the Microfinance community. It’s not a comprehensive investigation into every player or even every country. Instead, it is a personal view of the problems that afflict the sector.

The author has worked in the industry for about a decade. He spent some time working for “normal” corporate finance, but then went on to get a Masters in Finance and later an MBA. So, he has a firm grasp of economics and financing as would many other people involved in financing of any kind – including microfinance.

In this book, Mr. Sinclair describes working in several countries for and with local Microfinance Institutions (“MFIs”) he also worked for at least one investment agency that invests (lends) money to MFIs. During his tenure in Microfinance he seems to have stumbled into situations that involve deception, greed, hypocrisy, misfeasance, malfeasance, and deliberate falsehood.

Was he just unlucky and stumbled onto a few “bad eggs”? Did he seek out places that had the worst reputation to accumulate adverse facts about MFIs? No, if you accept his larger premise. Although a small portion of the global finance industry, the same kinds of issues are seen here as was evident in corporate banking.

“What!” you say, “What about the morality of micro-lending to the poor so they can be better off? Didn’t what’s-his-name win a Nobel Prize a few years ago for creating the concept back in the 70s? Wasn’t there some PBS program by uber-capitalism-promoter Niall Ferguson who showed us a woman that built a drinks cart business with a micro loan? So, it must be working – right?”

Not so fast, bunky. Yes I saw that too. And, I’ve been writing letters of recommendation for a former co-worker who believes in microfinance and is trying to enter an MBA program. But let’s think about this for a second.

*** Start of a conceptual digression ***

During roughly the same decade, the world lurched from the US Fed flooding the monetary system because of Y2K fears, to doing the same after the dot-com implosion, the growth of unregulated markets that leveraged the underlying actual assets (money, stocks, bonds, etc.) at sometimes 40:1 or more. Setting up a domino effect (or “chain reaction” if you prefer the nuclear analogy) that we still haven’t dug ourselves out of.

And the people that created this were the financial wizards who saw opportunity in esoteric products that no-one, including themselves truly understood. And why did they do it? The chance to reap huge rewards in the form of bonuses, profits, and above all, equity in ventures going public.

Now, look at the microfinance industry. At the top you have funds and organizations that raise cash to invest in intermediaries. Supposedly they rely on due diligence, ratings reports, and experience to invest in good institutions that uphold appropriate standards and act ethically. (Remember the sub-prime mortgage fiasco? It should be easy – it was only 20 years after the Savings and Loan crisis which was also a housing/property-based scam.) In some cases they collect donations from individuals who expect no return of principal or interest.

In the middle you have organizations, investment companies that may get public or private funds to direct into specific lowest-level entities. They, too, are supposed to use oversight, diligence, and ethics to ensure that the monies raised are directed to clients (the poor) in an efficient and helpful manner. But what are they getting out if it? They expect to get paid for these loans – and that means interest income. They also expect to have low risk of default (i.e. capital preservation).

At the lowest end you have the in-country microfinance institutions (MFIs). They are the ones making the actual loans and having the burden of tracking all of these transactions in poor and rural areas, where there is minimal infrastructure. As the author correctly points out, even for a good organization, it is very hard to handle the volume of transactions when clients may be borrowing and making payments weekly. (He was often involved in the IT side of these organizations.) Even when there may be laws regulating the activities and interest rates that MFIs can charge, these may be easily ignored since there is little opportunity for enforcement. Since they are unregulated they can operate in a way that benefits the mangers and owners of the MFIs. This isn’t something limited to microfinance: the higher-ups in anti-poverty and medicine that I’ve seen do pretty well for themselves, also.

Of course, beneath even the MFIs, you have the individual borrowers. Are they all wizards of entrepreneurship? That’s not true in developed countries, so why should it be true in undeveloped ones. What do most people use “loans” for (and I extend this to plastic in the form of credit cards and debit cards with overdraft ability)? They purchase something and, so too those getting microloans. Is there proof? No, there isn’t the kind of data collected that can prove the argument either way, but just think of human nature.

Let’s revisit those middle-layer entities. They make money from interest payments and perhaps also by providing consulting and technical skills to the MFIs. But that’s a small payout for a lot of work. (Remember their peers were the ones getting 6- & 7- figure payouts for selling derivatives to the world.) Once, in Mexico, an MFI went public and those who were insiders got a massive windfall (that’s the name of the game in equity.) Now, having that lucrative example in front of them, less passionate believers might wish to replicate that success and reward themselves, also. (The phrase I use is, “Retire in the style to which they’d like to become accustomed”.)

So, to summarize: microfinance is led by the same type of people (perhaps some of the same individuals) that conned a planet into creating wealth from nothing, all the while siphoning off massive renumeration for themselves. Under the "best" scrutiny of the industrial world. But in a mostly unregulated and decentralized environment they are destined to act in a more ethical manner?

*** End of digression ***

But getting back to the specifics of this book, I found it to be fairly well organized and written. There was a bit too much repetition for my tastes, but overall it is a solid book with solid facts. In addition to footnotes, there is a nice introduction to economics at the end. Although it was not germane to the central theme of the book, I would have liked to know more about the good MFI that the author experienced in Mongolia. But that’s just my own wish.

The writing is mostly clear with humor thrown in to good effect. One of the best passages was about a woman selling bottles of water. Every day she attempted to both overcharge and then shortchange the author. After the first week when he asked her why she continued to try the trick on someone who clearly wasn’t letting it go by, she replied, “You’re right, sir and every day you discover the trick. But if I do this every day for 100 days, one day you might forget, and then I get N$5 extra.” Another nice touch was noticing an Internet Cafe named for the section of the penal code that spammers would be violating. The cafe and the woman were both in that bastion of superficial honesty and internet scams, Nigeria.

If you are a believer in Kiva or Grameen or just micro-lending as a principle, then you should read this book. Chapter 13 has some tips on how to protect you from being hoodwinked. (The same could be said for donors to many charity organizations that offer to save children by sponsorship: Caveat Emptor.) A “3” star rating.

[Mal Warwick · Rating 5 out of 5]

The Sorry Record of Microcredit Laid Bare by an Industry Veteran

“Some microfinance is extremely beneficial to the poor, but it is not the miracle cure that its publicists would have you believe. Microfinance has been hijacked by profiteers, and we need to reclaim it for the poor. The problem is not with a few rogue operators, alas, but with systemic flaws that permeate the sector.”

Thus does Hugh Sinclair lay out the thesis he pursues in Confessions of a Microfinance Heretic. If you skip over this statement in the opening pages of the book, you could easily conclude that Sinclair can see no good at all in the $70 billion industry that has grown up under the impetus of Muhammad Yunus’ 2006 Nobel Peace Prize. After all, Sinclair writes — at least twice — that he wouldn’t invest a single dollar in microfinance today. Nonetheless, he insists that the “debate is not whether microfinance works, but how the inherent conflicts of interest can be managed.”

The systemic flaws Sinclair perceives are eye-opening:

■ A majority of the money loaned to poor people goes not to help them launch or sustain microbusinesses to supplement family income but rather for current consumption, sometimes to buy food during a time when there’s not enough money coming in, sometimes just to buy TV sets.”Estimates for consumption loans range from 50 percent to 90 percent of all microfinance loans,” depending on the study. As Sinclair points out, citing numerous sources, the proportion of entrepreneurs among the poor is no bigger than it is among the rich. It’s naive of us to expect otherwise.

■ The interest rates charged for microloans are, far too often, prohibitively high. Muhammad Yunus’ benchmark — 10 to 15 percent above the cost of money — is rarely observed. Though there are indeed many, mostly small, nonprofit MFIs (Microfinance Institutions, generally microloan lenders) that charge no more than 25 or 30 percent, the bigger institutions, and most of the for-profit banks in the industry, typically charge far more. In one notorious case, the effective interest rate runs as high as 195 percent, but there are many other instances in which the rate exceeds 100 percent.

■ The amounts of money loaned by MFIs are far too small to permit businesses to grow to a size where they may employ workers outside the family. In fact, to the extent that businesses remain family-run, they frequently employ even the youngest children, sometimes withdrawn from school to work in the business. However, there’s another side to this question, as Sinclair reveals in an exchange with one businesswoman: “[W]e asked her about her future plans for the business, and whether she thought it could be built up further and be a useful business for her children to take over. ‘You misunderstand me. I don’t do this job because I like it or want to grow it into a big business. I do it so my children will never have to do work like this.’”

■ In countries where local laws and a lack of government oversight give free rein to the MFIs, competition run wild among them has sometimes led to credit crises. In India’s Andhra Pradesh state, for example, “There were more microloans than poor people.” And in Nicaragua “total lending by MFIs was estimated at $420 million in 2008, in a country of about 5.5 million, not all of whom were poor (and MFIs generally don’t lend to children).” Microloan customers frequently borrowed from several of the country’s 19 MFIs — the nationwide average was four — often to be able to pay back loans to other MFIs. “One particularly ambitious client in Jalapa had managed to rack up $600,000 in micro-loans.” As Sinclair disclosed in a talk he gave in Berkeley a few weeks ago, Nicaragua was only the first of several countries where the microcredit bubble is likely to burst. Stay tuned, he said.

■ The profit motive appears to have become the central preoccupation of the microfinance funds, which function like private equity funds, gathering together investment dollars and placing them in selected MFIs. Even some of the biggest and most prestigious of these funds — including the Grameen Foundation (USA), Calvert Foundation, Kiva.org, and BlueOrchard (the world’s largest) — have been tainted by longstanding investments in some of the most egregiously exploitive MFIs, brushing aside mountains of evidence that their investments were helping victimize poor people in Nigeria, Mexico, and other countries.

Despite all this, there is NO documented evidence that microfinance has achieved any reduction at all in the level of poverty. As a 2007 article in the Harvard Business Review stated, “In 1991, for example, Bangladesh ranked 136th on the UN Development Programme’s Human Development Index (a measure of societal well-being); 15 years later it ranked 137th.” And Sinclair writes, “In 2001, Nicaragua was the 106th poorest country in the world . . . Microfinance was almost unheard of in Nicaragua at this point, and there were no large microfinance funds throwing money around. By 2009, when the full Nicaraguan microfinance meltdown occurred, Nicaragua had slipped to 124th place.”

Hugh Sinclair is no cranky, slapdash journalist taking on a controversial subject for the sake of selling books. He is a ten-year veteran of the microfinance industry and has been involved as either an employee or a consultant in dozens of MFIs around the world and in several microfinance funds. He clearly knows whereof he writes, his citation of sources is extensive, and his publisher, Berrett-Koehler, is a highly respected source of books on business and current affairs.

Confessions of a Microfinance Heretic is an important book that should be must reading for anyone involved in international development.

(From www.malwarwickonbooks.com)

[Marsha Altman · Rating 4 out of 5]

I'll say straight up that I'm no economist, and I don't understand much about banking or lending or how non-profits are supposed to work, so I had a little trouble with the nitty-gritty of the book, but I kept reading because it was otherwise fantastic. Basically, microlending is a thing where charities give incredibly poor people micro-loans (say, $100) to start their own businesses, and this is supposed to lift people out of poverty. In reality, since there's almost no regulation and the poor have no other means of securing loans, they can charge ridiculous interest rates and start a loan cycle that the poor can never get out of. Also, not every person in poverty has a great idea to start a small business and even if they do, most of the small businesses fail. The author argues that in places where the industry is heavily regulated (like Mongolia) and interest rates are capped, the programs can be really successful, though never as successful as advertised. Otherwise, it's a giant scam started by well-meaning people who got greedy.

[Edwin Setiadi · Rating 5 out of 5]

Hugh Sinclair is a former quant trader in London, a heterodox economist, and he once driven a motorcycle from the tip of Alaska down to the edge of Argentina and landed in the Guinness Book of Records. An interesting guy. When he switched to microfinance (first in Mexico, then Mozambique, then 51 other countries) he experienced, saw first hand, and questioned the greed, corruption, manipulation and all the dark side of the industry, which made him ended up in a Dutch court battle, and eventually prompted him to write this book. And what a huge eye opener.

Like many other people, I first learned about the existence of microfinance when Muhammad Yunus won the Nobel Peace Prize. And when I read Muhammad Yunus' book "Banker to the Poor" I thought, what a great concept! Instead of giving the poor fish, help them to provide the means to buy their own fishing tools, then they'll eat for a lifetime. I even opened a Kiva account, though I have deleted it ever since I read this book.

It didn't cross my mind that 90% of loans actually used for consumption and thus trapped the poor in debt spiral. Nor did I realise that microfinance can be treated as some kind of ponzi scheme, or used as yet another financial tool to generate lucrative profit for the investors but screwing the poor through charging murderous interest rates. It never occurred to me that Muhammad Yunus is just a pawn, a PR icon groomed for the sector, though Sinclair had kept it ambiguous throughout the book. But even Muhammad Yunus himself once commented "I never imagined that one day microcredit would give rise to its own breed of loan sharks."

The result of this plunder can be seen in the Human Development Index that is mentioned in the book, and it does makes me wonder. If Nicaragua's and Bangladesh's rankings slipped down after the introduction of microfinance why do we have the microfinance sector at all? It led to suicides, abductions and forced prostitutions in India, while the microfinance institutions and microfinance funds keep on reaping profits. Moreover, the book sometimes give the impression that the big microfinance players such as BlueOrchard, responsAbility, Triple Jump, Deutsche Bank, Calvert Foundation, and Kiva closely resemble the untouchable too-big-to-fail investment banks. And their silence or cover up over their investment in Nigerian microfinance institution called LAPO (the central focus of the book) represent only the tip of the iceberg.

But perhaps asking why do we have the microfinance sector at all is like asking why do we have the global financial market at all, after the too-big-to-fail Wall Street banks have spectacularly damaged the world economy. Just because a lot of bad apples are corrupting the sector, doesn't mean the sector itself is a bad concept. And to his credit Sinclair does provide the best-case scenario on how the microfinance sector should operate, and even give examples of those who do work out very well such as the ones he encountered in Mongolia.

All in all, in this very well-researched book Sinclair managed to explain every single functionality of the microfinance sector within the amazing stories he has to tell, making it a well-rounded book to learn all about the real microfinance sector. 5 stars!

[Rusty Tobin · Rating 4 out of 5]

The book answered many of the questions I had regarding the efficacy of micro finance. His goal of critiquing micro finance for the general population was partially achieved although his focus is on the ins and outs of the financial profit making that many institutions have turned to and this made for rather dry reading.

[Thomas · Rating 4 out of 5]

A very interesting and eye opening book for those interested in the topic.

The chapter on Mozambique was awesome, it could be a movie script

[Ebonique Boyd · Rating 4 out of 5]

All the other micro finance books seemed like lies after reading this book.

[Deepanker Kaul · Rating 4 out of 5]

"Confessions of a Microfinance Heretic" is an insiders tell all into the world of Microfinance. Growing up I remember reading about Microfinance and how it was a miraculous cure of poverty. A few years later, Mohammad Yunus won the Nobel Peace Prize and it felt like Microfinance was THE SOLUTION to end global poverty. Alas.

This book covers Hugh's journey from a microfinance enthusiast, jumping at every opportunity to contribute, being let down and moving on to next till he realised the sector has become irredemable.

Microfinance was supposed to be a market friendly model of helping the poor, but instead poor were left behind and markets and profits took the front seat. Confessions of a Microfinance heretic is also a study of incentives. Badly crafted incentives can render the best of intensions and structures moot.

Hugh shows us the Good, bad and Horrible facets of Microfinance and in the process gives us a checklist of how to imagine social good and impact. This book is a mandatory read for anyone working in the sector or even if just interested about it. Lessons are documented and they're documented well. Unless we learn them, they shall repeat themselves.

[Sparsh · Rating 4 out of 5]

A very well written book which generally revolves around the subject of micro finance. Micro finance is subject which was projected as something which would diminish poverty and it will be a thing of past. It was further championed by Mohammed Yunus who can be considered as the ambassador of Microfinance.

One rule of microfinance industry is it can never be criticised which was broken again and again by author.
Overall author gives us a great insight into working of microfinance sector which is shiny vehicle outside with a crippled engine working to exploit the poor.

[Charles Eliot · Rating 4 out of 5]

Microfinance is an idea with much promise, but in practice it's often just another form of loan-sharking. Worse, the idea of microfinance is held in such reverence that it's hard to get people on the inside to address the systemic corruption, profiteering, and incompetence that could sink the entire enterprise.

This, in a nutshell, is Hugh Sinclair's thesis. His might be an extremely jaded voice, but it's an important voice to hear.

[Wochner Mike · Rating 5 out of 5]

Given the personal history of the author in the industry, I found it fair account and a great revelation that not all that glitters is gold. Was an eye opener to me back then.

[I · Rating 4 out of 5]

Author worked in Microfinance for over a decade and is an expert on inner workings of the sector. According to him, when you are charging around 30% to 150% interest rates on micro-loans, it is very hard for the borrower to generate a return that leaves something after paying the interest and the loan installment. There may be rare cases where the Borrower has actually climbed out of poverty because of a microloan but that is an exception and surprisingly the same borrower and her story along with her pic can be found on the webpages and brochures of all microfinance lenders most of the times.

[Taj · Rating 5 out of 5]

Enlightening account of the sordid state of Microfinance today. Once considered a panacea for global poverty, Microfinance quickly found its practice overtaken by greedy loan sharks who have exacerbated poverty conditions and left the poor more destitute than imaginable. The commercialization and ultimate hijacking of a fascinating development theory is disappointing to say the least. Sinclair's depiction of MFI's is humanizing and realistic, coupled with high levels of detail and in depth research to support findings. Credit, considered a "human right" by many MFI institutions, begs humanity to question as to what expense? To those who are denied basic human rights everyday such as food, shelter and education, does credit make its way to the top of human rights' hierarchy b/c of its profiteering abilities for those who have power privileges? It otherwise has demonstrated to have no impact on poverty but rather, has found itself intertwined in a vile history of greed, distortion, violence and even in some cases, death.

[Morgan · Rating 5 out of 5]

This book was recommended to me by a potential boss in a job interview with an organization that does microfinance loans coupled with business training, and charges from 10-30% interest (so they say). Having been a shameless Kiva enthusiast in my undergraduate university days and a somewhat ashamed graduate student as the academic consensus coalesced around the dubious poverty alleviation claims, I found this book to be excellent in that it sheds light on various aspects of why microfinance isn't working, without, as Sinclair rights, throwing the baby out with the bathwater. It seems to grow clearer and clearer to me that no poverty intervention will work unless there are institutional mechanisms that prevent those who are able from taking advantage of the system, both rich and poor. Friends who read my review but don't plan on reading the book, please be wary! Before you donate to any MFIs or participate in a program like Kiva's, make absolutely certain you know the real interest rate the borrowers are paying, and gather as much data as humanly possible.

[Joe Zhang · Rating 4 out of 5]

A great book, a small pity.

I learned a few things:
(1) in many cases microfinance hurts the poor, and it does good only sometimes.
(2) the business model may be faulty in microfinance. I ran a for-profit microfinance firm to the ground. Personally I lost big, and wrote a book about it: “Inside China’s Shadow Banking”.
(3) the most effective way to reduce poverty is probably industrialisation. Fair governance of the economy.

Hugh did a poor job explaining why a flood of money into MFIs and thus competition does not drive down interest rates charged of the poor.

A wonderful book nevertheless. Thank you.

[Llreichel · Rating 5 out of 5]

A counterpoint to the marketing machine that exists like a protective bubble around microfinance. I appreciated that the book was more personal than comprehensive based on experiences and observations of the author and that he ultimately still believes that microfinance is a good solution for some people. A healthy viewpoint shining a spotlight on the issues gave the impression that the goal of the book was to fix the system rather than condemn it, despite the harsh title.

An excellent prerequisite to anyone with microfinance aspirations

[Robin · Rating 3 out of 5]

Others seem to have liked this book more than I did. I did not care for the accusatory and defensive tone. The field must be changing quickly because even though it was published in 2012 it makes no mention of Kiva Zip which actually does make loans directly to borrowers. It seems to be working well for one of the small groups from the class we took at Christian Theological Seminary this spring called "Creating God's Economy".

[Michael · Rating 4 out of 5]

In 2009 I thought Kiva and microfinance was the answer for poverty. I was not alone. Fast forward to 2012, Hugh Sinclair, perhaps the one person in the world who could have written this book, blows the doors off that concept. I cannot put this book down. In addition to illuminating the dark recesses of microfinance, it's a pretty good exploration of how important swimming against the current can be.

[Meg]

I think I"m going to disagree with him, but it will be interesting none the less

[Christian Conti · Rating 3 out of 5]

I registered a book at BookCrossing.com!
http://www.BookCrossing.com/journal/11327567

[Erick · Rating 4 out of 5]

Very insightful.

[John R Naugle]

I saw Hugh Sinclair, the author, interviewed on CSPAN and he was very knowledgeable. His book sounds fascinating.