Tiny Loans Were Going to Solve Global Poverty. Then Big Money Got Involved (2024)

Microfinance has generated returns for banks and government aid agencies—and exploited millions

May 3, 2022, 5:00 AM EDT

Suicides, debtors’ prisons and delinquent borrowers forced to sell their land—the grim social costs linked to microfinance a decade ago were supposed to be a relic of the past. But efforts to clean up the industry lost momentum, and today billions of dollars are flooding into a system that promises the world’s poor a better life while often compounding their misery.

Government aid agencies, commercial banks, nonprofits and socially minded investment firms are pouring record amounts—more than $50 billion of committed funds in 2020, industry data show—into an international array of lenders. The infusion of capital has continued despite annualized interest rates that can top 100% and aggressive debt-collection tactics that have left some borrowers homeless.

As financiers have replaced philanthropists in the microfinance industry, consumer protection has been weakened. Taxpayer-funded development banks, which could fix the problem, are instead channeling hundreds of millions of dollars earmarked for poverty alleviation into some of the most predatory lenders.

Interviews with dozens of borrowers in Cambodia, Jordan, Sri Lanka and Mexico, as well as with lawyers, academics and human rights groups, paint a picture of a changing industry, one that’s offering new types of loans, including consumer finance, as some lenders prioritize profits over helping the poor.

In Cambodia, the average loan provided by so-called microfinance institutions has ballooned sevenfold over the past decade to about $4,200, almost three times the country’s average household income, data compiled by the Cambodia Microfinance Association show. Women there have been pressured to sell their homes to repay loans, according to human rights groups and academics who have studied the matter. In Jordan, one of the few countries that still imprisons people for nonpayment of debt, more than 23,000 women were wanted by the police in 2019 for owing less than $1,400 each, Justice Ministry officials have said. In Sri Lanka, consumer-advocacy groups estimate 200 women indebted to microfinance companies committed suicide in the past three years.

Watch the Bloomberg documentary “The Dark Side of Microfinance” →

Yet the World Bank, the European Investment Bank, the U.S. International Development Finance Corp. and other development banks continue to invest billions of dollars of public money. More has come from commercial banks and impact investors. Citigroup Inc. had lent about $1 billion to 89 microfinance institutions as of January 2020. Japan’s Sumitomo Mitsui Financial Group has invested billions of dollars in Asian firms, including in Cambodia. JPMorgan Chase & Co. sold a $175 million collateralized loan obligation in 2019 backed by microfinance and small-business repayments. Among the 26 lenders it’s funding are three accused of pressuring borrowers to sell land in Cambodia. JPMorgan declined to comment, and Sumitomo didn’t respond to inquiries.

A wave of suicides in India a decade ago challenged the idea that microlending might eradicate poverty, but today’s more modest goal of financial inclusion, an attempt to reach people without access to the banking system, is no less fraught. The expansion of the loosely regulated business—all those loans added up to $160 billion in 2020, about twice the amount 11 years earlier, according to industry estimates—has resulted in millions of new borrowers for whom the dream of inclusion has turned into a nightmare of debt.

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Development banks say microfinance remains the most effective way of reaching the poor, who might otherwise borrow from loan sharks, and that the vast majority of the more than 5,000 microlenders behave responsibly. But even conscientious lenders have struggled to make a lasting improvement in the lives of the poor, a number of academic studies have found. That was also the conclusion of a Government Accountability Office report last year that said the $1.1 billion budgeted by the U.S. Agency for International Development for microfinance programs from 2015 through 2018 had produced “little evidence of sustained effects.”

Investors, meanwhile, have been richly rewarded. Initial public offerings of once-charitable organizations have enriched funders. Some microlenders in Cambodia, the Philippines and parts of Africa and Latin America have reported annual returns on equity exceeding 25%. In 2020, even as the pandemic devastated Cambodia’s economy, six of the country’s eight biggest microfinance companies posted record earnings, company filings show. One is a unit of a company in Sri Lanka owned by one of that country’s richest men.

As the market has evolved, many microfinance companies have strayed from their original mission of providing loans for income-generating activities to offering credit for daily living expenses, consumer goods, home improvements and loans to pay off other loans. Some have started lending to small and medium-size businesses. It’s a long way from the vision of Muhammad Yunus, the Nobel Peace Prize-winning economist who founded Bangladesh’s Grameen Bank in the 1980s to lend small sums to people too poor to qualify for bank loans. Yunus, who once predicted that microfinance might relegate poverty to museums, is distressed by how things have turned out.

“The development banks promoted this personal profit-making version and brought in business investments along with their own investment,” says Yunus, who’s no longer associated with Grameen Bank. “The concept of microcredit was abused by some and turned into profit-making enterprises for owners of microcredit institutions. Many went in the inevitable direction of loan-sharking. I felt terrible that microcredit took this wrong turn.”

Ringing the Dinner Bell

The roots of today’s microfinance industry can be traced to a $27 loan. It was 1974, and Yunus, who had a Ph.D. in economics from Vanderbilt University, was searching for ways to help people find a path out of poverty. In the village of Jobra, he met farmers and artisans too poor to qualify for bank credit who financed their businesses with small loans at usurious rates. Yunus helped them refinance to a much lower rate by calculating the total debt of the village’s business owners and lending that amount to 42 women who agreed to act as co-guarantors. That model—small loans at low interest rates to groups of borrowers—became the template for Grameen. It also launched a worldwide movement.

That feel-good story ended with the first microfinance IPO, in 2007, involving Mexico’s Banco Compartamos. Founded in 1990 as a nonprofit that followed the teachings of Mother Teresa, Compartamos converted to a commercial bank in 2000, then used investments from the World Bank and Accion International, a financial inclusion organization, to transform itself into the model of a for-profit microfinance company. When it went public, the company had an implied valuation of more than $1.5 billion, providing a windfall to founders and early investors.

The World Bank made $210 million. Accion, which invested $1 million it received from the U.S. government, saw the value of its stake balloon to $350 million, much of which was used to seed additional profit-seeking microlenders. Those gains came at the expense of borrowers who paid interest rates higher than those at other Mexican banks and credit unions and often took on more debt than they could handle. Accion didn’t respond to requests for comment.

For many banks and impact investors, the IPO was like ringing a dinner bell. When India’s SKS Microfinance went public in 2010, the fund management arms of Morgan Stanley and JPMorgan, and George Soros’s Quantum Fund, were among the investors, according to a report from the Consultative Group to Assist the Poor, an industry organization housed at the World Bank. U.S.-based venture fund Sequoia Capital was another early investor.

SKS was the biggest microlender in the state of Andhra Pradesh and was criticized by human rights groups and lawmakers there in 2010 after local media reported more than 200 suicides linked to over-indebtedness. The Associated Press reported in 2012 that SKS managers had been aware debt collectors were forcing borrowers to pawn possessions and harassing them verbally and physically. SKS denied any wrongdoing.

Citigroup, a backer of Accion, has helped channel hundreds of millions of dollars to microlenders, including Compartamos and Jordan’s Tamweelcom, which has reported dozens of delinquent borrowers to authorities, landing them on police wanted lists, legal filings reviewed by Bloomberg News show. A spokesperson for Citigroup said the bank only works with “microfinance institutions whose lending and collection practices are best in class and who treat all borrowers respectfully.” Tamweelcom didn’t respond to requests for comment.

While Citigroup CEO Jane Fraser has been closing some consumer operations in the developing world, the bank remains committed to microfinance—to being what former global director of inclusive finance Bob Annibale once called “the bank to the bank to the poor.” Last year it sold a $1 billion social finance bond as part of a wider pledge to invest $1 trillion in what it calls sustainable finance by 2030. It also arranged $70 million in loans for Compartamos through the U.S. International Development Finance Corp., known as DFC, and the Japan International Cooperation Agency. Citigroup’s mission, the spokesperson says, is “to empower micro-entrepreneurs around the world.”

That’s not how things have worked out for Compartamos customer Cristina Pina. The 58-year-old baker in Villa de Zaachila, Mexico, near Oaxaca, got sucked into a vortex of debt two years ago. After saving to make a $2,500 down payment on a piece of land, she lost her job during the pandemic. She took out a $500 Compartamos loan at an annualized 100% rate to help finish paying for the land and avoid losing her equity. She ended up borrowing from other lenders, some at even higher rates, to repay Compartamos and is now juggling six loans.

“Before you know it, I am borrowing to pay, pay, pay, pay,” Pina says at a coffee shop near the town’s central plaza one day in September, opening a small floral print notebook where she keeps track of past and future payments. “Borrow, pay. Borrow, pay. Borrow, pay. We are stuck, and there is no way out.”

A spokesman for Compartamos, now owned by Gentera SAB de CV, said in an email that Pina has been “a valuable and responsible client” for many years and that the bank allowed her and others to defer payments for three months during the pandemic. Chief Executive Officer Patricio Diez de Bonilla says it’s not always easy to know if customers have other loans. “Before Compartamos,” he says, “they didn’t have access to credit, so it is better than not having credit or going to loan sharks.”

Compartamos is now the largest microlender in Latin America, with more than 2.5 million customers. It has 40% of Mexico’s microfinance market and is one of the country’s most profitable financial institutions, posting a return on equity in 2019 and 2021 that exceeded 20%, according to company filings, almost double what Mexican banks earn on average.

Despite those profits and advertised charges for microloans that put its annual interest rates well above 80%, Compartamos continues to receive U.S taxpayer money from development bank DFC. Pooja Jhunjhunwala, a DFC spokeswoman, declined to comment about Compartamos but said the agency has a robust vetting process and is committed to funding only those lenders that are both financially solvent and socially responsible.

But those due diligence reviews downplay consumer protection, according to half a dozen current and former DFC executives who asked not to be identified because they aren’t authorized to speak about the program. Microfinance lenders are required to open their books to show their long-term viability, the executives say, and they’re asked questions to ensure they aren’t involved in child labor, human trafficking or environmentally damaging businesses.

They’re also supposed to follow client-protection standards developed by the industry-funded Smart Campaign, which include transparency and responsible pricing, according to Jhunjhunwala. Yet the reviews contain few specific guidelines about what debt loads, interest rates, profit levels or collection tactics should be considered unacceptable, the former executives say. The Smart Campaign said in 2020 that it was suspending operations, ending its certification program and handing off its library of resources to two other industry-funded groups.

Sophie Sirtaine, CEO of the Consultative Group to Assist the Poor, said in an email that although microloans have helped millions of low-income people around the world, policy makers, investors and lenders can do more to protect borrowers. “Development funders should incorporate consumer protection considerations in their funding’s due diligence,” she said. She cautioned against focusing on capping interest rates. Doing so, she noted, might “make it unviableto serve excluded or underserved segments and may push responsible providers to close.”

After the Compartamos IPO, donors pressured microlenders to release balance sheets and loan terms. MFTransparency, a consumer-advocacy group, pressed for responsible pricing and published details about costs and profit margins. But as the industry became more commercial, the lenders’ transparency faded, says Chuck Waterfield, who founded the group in 2010. After it published a report showing some microlenders making profits of more than 25%, the pushback intensified, Waterfield says. By 2015, lenders had become so reluctant to release information about the cost of loans that he disbanded the organization.

Waterfield says that when he spoke at conferences and described business models that would allow a reasonable profit, “someone from an impact investing firm would come up and tell me, ‘You’re right about all that.’” Then they’d tell him they had clients who wanted 25% returns.

Cambodia’s Debt Glut

Cambodia is a poster child for what can go wrong. The loan portfolio of microfinance companies there has increased about 13-fold in the decade that ended in 2021, to $8.7 billion, according to the Cambodia Microfinance Association, as lenders expanded into offering new credit products, including household finance and loans to small and medium-size businesses. In 2009, LOLC Cambodia, one of the country’s largest microlenders, reported that micro loans accounted for 99% of its gross loan portfolio and household finance just 1%. By 2018, micro’s share fell to 65% and household finance grew to 22%, according to a Bloomberg analysis of data compiled by the Microfinance Information Exchange, or MIX, an industry initiative.

By 2020, one in five adults had a microloan, according to a report by industry group Microfinance Index of Market Outreach and Saturation, also known as Mimosa, which gave the country its worst credit-saturation score. When the National Bank of Cambodia imposed an 18% rate cap in 2017, lenders increased loan sizes and tripled commission fees, exacerbating the problem, according to an International Monetary Fund report.

Cambodia is also one of the only countries that requires microfinance borrowers to post collateral such as land titles. In a 2020 survey of borrowers, 45% said seizing asset collateral was the second-most common means of collecting delinquent loans after verbal reminders, according to the Mimosa report. It warned that “client protection regulation needs substantial strengthening to ensure long-term market sustainability.”

One borrower who could have used some protection is a 47-year old widow named Nan who took out a $4,500 loan from LOLC Cambodia three years ago to repair her one-room wooden house. Nan, who asked that her last name not be used because she feared retribution, stopped making her $129 monthly payments after Covid-19 ripped through the country and her daughter lost her job as a garment worker. That’s when loan officers on motorbikes started showing up at night in her village in central Cambodia, telling her to go out and find money to repay them. When she couldn’t borrow any more, she says, they pressured her to sell her home and land to repay the debt. She sold the property two years ago and moved in with her daughter.

“They forced me to go out to find money for them at night” and wouldn’t leave until she paid them, says Nan, sitting in a makeshift bedroom under a house built on stilts, protected from the elements only by sheets of corrugated metal. “They came like they wanted to rob us.”

LOLC said in an emailed statement that it never received any complaints from Nan and that it does not pressure borrowers to sell their homes to satisfy their debts.

Regardless, Nan says she sold her land for $9,000, substantially less than the $20,000 it was worth, because the loan officers told her she had to sell quickly. She says she used the proceeds to pay back LOLC Cambodia and others she’d borrowed from, and to settle another microfinance debt.

Nan is one of thousands of women forced to sell their land or homes to repay microloans, according to estimates by the Cambodian League for the Promotion and Defense of Human Rights. The group, known as Licadho, has been documenting reports of abuses by microlenders for years. “This is a massive crisis that demands urgent action from investors and regulators, as well as relief for borrowers,” says Naly Pilorge, the group’s outreach director.

LOLC Cambodia started in the 1990s providing cheap loans to poor rural women. It was founded under another name by Catholic Relief Services, a U.S.-based charity affiliated with the Catholic Church. As microfinance became more profitable in Cambodia in the 2000s, when the country had one of the fastest-growing economies in southeast Asia, foreign capital poured in. Developing World Markets, a U.S.-based impact investor, bought the lender in 2010 and sold it to LOLC Holdings Plc in 2014. By September, its average loan size had increased more than fourfold to about $3,000. Last year, the lender said it plans to more than quadruple its loan book by 2025 and boost net profit by about 350%.

Majority-owned by the family of Ishara Nanayakkara, LOLC Holdings is one of Sri Lanka’s most profitable listed companies and a recipient of more than $500 million in loans and guarantees from development banks, a review of filings shows. It was set up with the help of the World Bank’s IFC in 1980 to provide lease financing for construction equipment but now calls itself the world’s largest multi-geography microfinance platform, with operations in Myanmar, Indonesia, the Philippines, Pakistan and elsewhere. In 2020, LOLC Holdings sold its 70% stake in Cambodia’s biggest microfinance institution, Prasac, for $603 million.

While Nan and many other borrowers lost income during the pandemic, LOLC Cambodia posted a record net profit of $45.4 million in 2020, up 33% from the previous year. Its return on equity that year was 28%, more than three times the average for commercial lenders in Cambodia. Despite reports about abusive practices, it has received more than $25 million from French and Norwegian development banks since 2020, a review of their portfolios shows.

U.S. officials were so concerned about borrowers in Cambodia losing their homes that many argued against subsidizing microlenders that accepted land titles as collateral. “It’s unethical to create secured lending to the poor based on mortgages or land titles because the poor, by definition, can’t repay,” says Wade Channell, a former senior economic adviser at USAID. “What you end up creating is a homelessness project.”

Still, investors kept pouring into Cambodia. The IFC arranged $425 million in loans in the past two years to three microlenders implicated by Licadho in land sales. LOLC wasn’t among the recipients. The IFC said it had received assurances from government regulators that there hadn’t been any forced land sales. It said it vets all recipients according to strict guidelines regarding responsible finance, particularly in overheated markets like Cambodia, and is working with local microlenders to bolster client-protection principles. “We have become much more selective about who we do business with in Cambodia” and have stopped funding some lenders, says Martin Holtmann, an IFC microfinance official, declining to identify which lenders were cut off.

Proparco, a subsidiary of France’s taxpayer-funded development bank, said it had halted new investments in Cambodia a few years ago because borrowers were over-indebted. But it said it had found no evidence of “systemic unethical behavior,” and it defended its existing investments in LOLC and two other microlenders. “We are only rolling over our positions with existing clients with whom we are really confident on the client-protection front and with their responsible attitude,” says Jeremy Brault, Proparco’s director of financial inclusion. “Some worrying reports have been out in the press, that is why Proparco has been, and still is, very focused on the reliability of the institution to avoid such cases.”

LOLC Holdings said in an email that it hasn’t received any complaints from borrowers about pressure to sell their homes. “We have a rigorous policy on fair and ethical business practices which is compliant with the regulatory requirements as well as global best practices,” the company wrote. The firm said its profit projections are based on expanding lending to small and medium-sized businesses.

The Cambodia Microfinance Association said in a 2021 report that it had found no evidence that forced land sales were a widespread problem. In 2020, the central bank asked microlenders to restructure delinquent loans during the pandemic. While that may have helped borrowers temporarily, it also meant interest kept piling up.

Sri Lanka Suicides

“I wanted everything to be over,” says Madhuka Kumari, a 30-year-old mother of five, sitting on the veranda of her sister-in-law’s house near an elephant preserve in central Sri Lanka. “Everyone was shouting at me. Dying felt like the only option.”

Kumari had borrowed $425 from LOLC Finance, a Sri Lankan lending unit of LOLC Holdings, to start a small business selling mats. When heavy rains made roads impassable and she fell behind on her monthly $30 payments, loan officers came to her house near the town of Minneriya, she says, shouting at her in front of her family and neighbors, telling her she had to sell her possessions, threatening to report her to the police. That prompted quarrels with her husband, who hadn’t known about the loan. In 2018, after months of despair, she poured kerosene over her head and set herself on fire as her children slept. She was five months pregnant at the time.

Kumari’s husband doused the flames and got her to the hospital. While she was there, she says, loan officers showed up at her bedside and demanded payments.

LOLC denied that its agents put any pressure on Kumari or visited her while she was in the hospital. “This incident was due to a domestic dispute and not due to over-indebtedness,” a company spokesperson said in an email, adding that it had received no complaints. Kumari said it was the aggressive tactics of LOLC’s loan officers that pushed her to attempt suicide.

Aggressive collection tactics are common in Sri Lanka’s microfinance market, according to a 2019 report by Juan Pablo Bohoslavsky, an independent UN expert on foreign debt and human rights. He wrote that he had been told about numerous instances in which women were pressured into trading sexual favors or had offered to sell their kidneys to repay loans.

The aggregate amount of loans in Sri Lanka rose more than 50-fold from 2006 through 2020 to more than $3.2 billion, according to central bank data. LOLC Finance is one of the country’s biggest and most profitable microlenders.

In 2018, after newspapers reported on the suicides and protests around the country, the government said it would write off the debts of 75,000 women in areas affected by drought, and the central bank capped interest rates at 35%. Critics argued it was too little, too late as the waiver didn’t cover many of the country’s most indebted borrowers and the rate cap applied only to new loans. In the run-up to the 2019 election, leaders of both major parties promised to cancel all microloans, prompting many borrowers to stop repayments. But lawmakers failed to deliver on that pledge, leaving thousands of women burdened with unmanageable loans.

“It was the suicides that brought it to the top of the political agenda,” says Indrajit Coomaraswamy, Sri Lanka’s central bank governor at the time. He says canceling all debt would have wreaked havoc with microlenders’ balance sheets. “There was no easy fix,” Coomaraswamy says. “In Sri Lanka, microfinance hasn’t worked out as well as it could have at helping people at the bottom of the pyramid get out of poverty. There is also a big gap when it comes to consumer protection. This has meant that vulnerable women have not got the protection they deserve and are suffering as a result.”

Hema Bansal, a consultant for Dutch development bank FMO and the former Asia director of the Smart Campaign, agrees with that assessment. “The concept of consumer protection needs more attention from the Sri Lankan central bank and microfinance industry,” she says. “There are big issues of over-indebtedness, multiple lenders pushing loans. The regulator is not equipped to deal with the crisis.”

Meanwhile, Kumari is worried LOLC may still take her to court to retrieve the money she owes. Scarred from her burns and still in pain, she needs further medical treatment, which she can’t afford. Her husband has been mostly unemployed since the pandemic began, and she often goes house to house, begging for food.

“I don’t know what will happen to me now,” she says.

Editors: Robert Friedman, John Voskuhl and Alex Tribou

With additional work by: Michael O’Boyle, Rana Sweis, Aanya Wipulasena, Narin Sun, Jason Grotto and Cedric Sam

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