Microloans, Macro-interest

Image from Predatory Lending Association

I thought Business Week's article "The Ugly Side of Microlending" had a familiar ring to it:

The transactions are so minuscule they hardly seem worth the bother. The average loan amounts to $257. But for Banco Azteca, a swiftly growing bank affiliated with Latin America's largest household retailer, the small sums represent a torrent of revenue that has caught even its founders by surprise. For three decades, micro-lending was seen as a tool of nonprofit economic development. Now poor people are turning into one of the world's least likely sources of untapped profit, primarily because they will pay interest rates most Americans would consider outrageous, if not usurious.

The interest rates quoted in the article - 50%-120% - are quite outrageous to this American, but they're definitely not unheard of.  What I'm speaking about, of course, is the ubiquitous payday loan, which can charge interest rates of 500% per year.  (Check out the satirical Predatory Lending Association for more alarming statistics, not to mention disturbingly spot-on parody.) 

These shady business practices are nothing new, but they sure sound a lot nicer when spoken of alongside Nobe Peace Prize-winning programs that extend small loans to businesspeople in the developing world who don't have the collateral for traditional bank loans.  It's an association that most may not make with the payday loan model, though they are essentially the same thing.  So it's not surprising to learn that Mexican non-profit microlending institutions have transitioned into the for-profit world, and quite comfortably. 

Banco Compartamos portrays itself as the gentler lender to Mexico's poor. Compartamos means "let's share," reflecting the philosophy of its founder, José Ignacio Avalos Hernández. The scion of a cosmetics business family, Avalos, 48, is a devout Catholic who in 1990 converted a nonprofit donating food and clothing to the deprived into one that made loans guaranteed by borrowers' neighbors.

...

In 2000, Compartamos sought greater scale by becoming a for-profit, which led to the founding of the bank in 2006. Today it has a portfolio of $316 million lent to 765,000 clients, dwarfing nonprofit micro-finance organizations in Latin America. Fueled by annual interest rates that can exceed 100%, it is one of Mexico's most financially successful banks, providing investors with an average annual return on equity of 53% over the past seven years.

And so a shady business trades on its former saintly image, and the working poor are again saddled with higher costs for the same financial services that middle-class and upper-class consumers use. 

For more information on these and other predatory lending practices, see the Center for Responsible Lending.  If you haven't finished your holiday giving, consider donating to (or donating in the name of a gift-recipient) Kiva, a non-profit organization that collects small donations ($25, $50, $75) through the internet and directs them to microlending institutions throughout the devloping world. 

Comments

[Neil the Ethical Werewolf]

That graphic made my jaw drop. The website made it drop further. Damn.

[Sir Charles]

I remember the payday loan business by its older street name -- loan sharking.

Why the states aren't acting to curb this abusive practice by setting reasonable caps on interest rates and terms is beyond me.

[Nate]

What's a reasonable cap? You would hope if a person had a normal credit card with reasonable interest they would be using that instead of a payday loan. If someone doesn't qualify for a credit card because they are a poor risk shouldn't they pay more? Are you suggesting we legally forbid people from getting loans they are willing to pay the interest on? If I need $500 right now and am willing to pay 200% annual interest to get it the government has no right to tell me I can't do it.

There are also numerous ramifications your not thinking about. Write a $50 check and realize you don't have enough money to cover it, you could easily be looking at a $30 NSF charge from your bank as well as another $30 from the payee. That's over 100% penalty in one day, annualize the interest rate for a year on that. If given the choice would you borrow $50 and pay 1/12 of 120% interest or bounce the check and pay $60 in late fees?

Besides not accounting for credit risk the size of Microloans isn't given fair consideration. It takes the same amount of work to process a $257 loan as it does a $500 or $1,000 loan. $20 in cost recouped from a larger loan amount would drastically reduce the interest.

[Sir Charles]

Nate,

The government has long set caps on interest rates and punished usury as a crime. The notion that there is no legitimate state interest in preventng predatory lending is a puerile one.

I am not advocating caps that would curtail all high risk credit, but I think a balance needs to be struck here that protects unwitting consumers from taking on truly destructive forms of debt.

[Sara]

Charles, it's good to emphasize "unwitting," because a lot of this information is hidden from consumers. And this includes stuff like overdraft loans, which bank customers often aren't even notified that they're signed up for.

[Nate]

Laws intended to protect the most unwitting almost always infringe on the rights of the witting and responsible. Besides high interest loans some other examples;

If I eat a perfect diet and am the model of health but want to allow myself to indulge once a year on my birthday NYC and others won't allow me to eat Trans fat.

If I am a 20 year old soldier just back from my 2nd tour in Iraq and want to enjoy a beer on my front porch I could be arrested by an officer's who salary is paid with my taxes.

If I am highly trained in the use of a firearm and schooled in the legal use I'm still not allowed to carry one for personal protection in numerous cities.

The way to protect the unwitting isn't to shelter them from reality it's to let them suffer the consiquences of poor decisions so they learn to not do it again or deal with the punishment if they make bad decisions. When do we stop limiting the freedoms of responisble adults because of the actions of the unwitting and irresponsible?

[Sara]

Nate, you're drifting way off-topic, not to mention inferring quite a lot that isn't being stated. Misrepresenting the terms of loans, hiding information in tiny fonts, signing bank customers up for programs they didn't request and aren't notified they are involved in - those are unfair business practices. That's sheltering people from reality, aka lying, until it's time to collect the interest. In the long run, it may be in an individual's best interest to shell out 500% interest for something they need, because they do in fact need it, but when financial services are making a mint from charging huge amounts of interest on loans given to people already over a barrel, it's not really accurate to say that those poor suckers are suffering the punishment they deserve. For me, the "punishment" would be cutting out the fancy schmancy organic food. For someone who has to work two jobs to make ends meet, the "punishment" is losing their home or their car or not filling their prescription that month. Regulations that require these institutions to make clear what exactly they're selling, organizations that can get people out of intractible financial arrangements - that's what people are talking about, not holding the hands of everyone who wants $400 for a new TV. As it is, the worldwide average interest rate for microloans is 31%. That's pretty crappy, even compared to credit cards, but it's obviously necessary to make lending to such high-risk borrowers feasible. As it turns out, there is a middle ground between begging for an allowance from the nanny state and indentured servitude.

[El Viajero]

"Poor people have poor ways"

Before the payday lending, there was always the pawn shops who made short-term secured loans but still charged 20% per month (240% yr). If there were entrepreneurs that could make money lending at a lesser rate, they sure didn't step forward into that market.

The reasons why the poor have always paid more for financial services (and always will) is because they have bad habits....like not paying people back. The poor are simply more expensive to do business with.

I'm not saying that some lenders don't take advantage of the poor, but the poor will always pay more for financial services because they are riskier than those who have good credit.

[Nate]

II agree with most of what you said Sara as far as disclosure, I don't think font size matters my personal rule is you read first what is in the smallest font. Always start with what they don't want you to read then when your all done read the fluff in big fancy type.

My comments where in response to; "but I think a balance needs to be struck here that protects unwitting consumers from taking on truly destructive forms of debt." An unwitting consumer is far different then a mislead or deceived consumer. If Sir Charles intent was to protect deceived consumers I agree 100%, since this can't be traced back to me I'll even admit I would love to see a governmental organization that pursued action against companies that deceive or are dishonest. I would like it to file the small claim case and support the consumer. On top of any settlement would be a fee paid to this organization to fund it. It would resemble contractor boards. Even the small claim legal system in the country is daunting and not cost effective for small amounts after paying for court cost and service. My personal experience it was also very inefficient, when my case finally got to trial it took an entire day at the court house and they settled before ours was heard, they schedule like 20 cases for the same time and you wait for yours to get called.

History is full of examples of Government infringing the rights of the honest to protect someone else. Every piece of legislation I have seen addressing pay day loans and similar lending was misguided as such. Politicians aren’t intelligent enough to understand the issue they only get the emotion and the polling. Two perfect examples from the Liberals running Vegas where trying to outlaw ATM fees, not from your bank but the other bank who’s ATM you used, never dawned on them the bank incurs expenses providing the ATM and keeping it filled. The second one a requirement that gas stations not charge for air, great sound bites “air is free, it’s all around how dare they charge for it.” The air is free but the machine to compress it and the electricity to power it aren’t. Both of these failed fortunently but when proposed where masked in the rightoues endeavor of helping the poor and those not as well off.

I would like to see churches, charities, and local service providers get into the loan business. I think default rates would be lower and profits could be eliminated. Credit can be a powerful empowering agent, I think we need to be careful any time we limit it.