[Written by Kenneth Sharpe and Barry Schwartz]
In 1976, Bangladeshi economist Muhammad Yunis discovered that one of the things that kept poor Indian women impoverished was the usurious interest they had to pay for on loans that they used to buy the materials they needed to produce craftwork, like bamboo furniture, for sale. So spontaneously one day, he took money out of his own pocket—$27—and made small loans—microloans—at low interest to about 40 woman—artisans in the village of Jobra. These were women who had no collateral and would not qualify for ordinary bank loans. And thus was "microcredit" born.
Over the years, the bank Yunus started (Grameen Bank) has issued more than 8 million loans, for more than $6 billion, raising countless women and their families out of poverty. In 2006, Yunus and the Grameen Bank were honored for their work with the Nobel Peace Prize.
And microcredit has spread. It has spread across the developing world. And, it has spread from banks like Grameen to publicly traded, profit-centered banks like Compartmentos in Mexico, and SKS Microfinance, in India.
This seems like great news. What could be better than the spreading of a good idea? But not so fast. What has spread to these profit-centered, public companies is the technique of microcredit, but not the intention behind it. Compelled to satisfy shareholders, these new microcredit institutions have been charging interest rates that are as usurious as the ones that Grameen Bank replaced. The form may be the same, but the underlying intention, the telos, is completely different. And the result is that individuals are being driven into bankruptcy, and villages driven back into poverty, as they try to keep up with their loan payments.
For example, there is Durgamma Dappu, a widowed laborer from an impoverished village who took a loan from a private microfinance company because she wanted to build a house. She had never had a bank account or earned a regular salary but was given a $200 loan anyway, which she struggled to repay. So she took another from a different company, then another, until she was nearly $2,000 in debt. In September she fled her village, leaving her family little choice but to forfeit her tiny plot of land, and her dreams.
"These institutions are using quite coercive methods to collect," said V. Vasant Kumar, a minister for rural development. "They aren't looking at sustainability or ensuring the money is going to income-generating activities. They are just making money."
Reddy Subrahmanyam, a senior official in the state of Andhra Pradesh, accuses microfinance companies of making "hyperprofits off the poor," and said the industry had become no better than the widely despised village loan sharks it was intended to replace.
"The money lender lives in the community," he said. "At least you can burn down his house. With these companies, it is loot and scoot."
Unlike other officials in his industry, Vijay Mahajan, the chairman of Basix, an organization that provides loans and other services to the poor, acknowledged that many lenders grew too fast and lent too aggressively. Investments by private equity firms and the prospect of a stock market listing drove firms to increase lending as fast as they could, he said. "In their quest to grow," he said, "they kept piling on more loans in the same geographies." He added, "That led to more indebtedness, and in some cases it led to suicides."
These recent developments have given microcredit a bad name. Its power to produce economic uplift now seems a mirage. For those who have argued from the beginning that it was all smoke and mirrors-that "there is no such thing as a free lunch"-the current downfall of microcredit and its effects is vindication.
But this is the wrong lesson to take from the current unfortunate effects of microcredit institutions. As Yunus himself pointed out in an op-ed in the New York Times on January 14, commercialization has been a terrible wrong turn for microcredit. The volatility of the financial markets from which the commercial companies get their funds, together with the demand from shareholders for ever-increasing profits, ends up transferring financial risks to the poor-those who can least afford to assume them.
A central point in our book, Practical Wisdom: The Right Way to Do the right Thing, is that society desperately needs wise people, and that wise people combine the will to do the right thing with the skill to do the right thing. The will to do the right thing is all about honoring the proper goals-the proper telos-of an activity. Maximizing profit was not and is not the telos of microcredit, and substituting profit maximization for aiding the poor is destroying microcredit's positive effects.
It has been a truism since the time of Adam Smith that you don't need good intentions to get good behavior. Self interest—the profit motive—together with competition, will get good results even from people without good intentions. The only trouble with this truism is that it isn't true. Intentions matter. Telos matters. Character matters. And the deterioration of the microcredit adventure begun by Yunus is just another sad example of how this false truism impoverishes the lives of some and diminishes the lives of us all.