The greatest difficulty in opening banking services to the poor is the lack of information. The poor live on the margins of society and are absent from documented processes. The low volume of money they both earn and spend make it difficult for any type of financial history to be created for them. Group lending and other innovations have helped to place the burden of information on social structures (such as peer pressure) rather than formal processes that are expensive and price the poor out of the market.
The nature of poverty is such that one often oscillates between having enough to provide for one’s family and not having enough. Shocks to one’s finances such as funerals, illness, domestic violence, etc. are unpredictable and can have lasting consequences. The poor way have enough income on an annual basis to provide for their families but on a day-to-day basis certain event cause the poor to drop to dangerous levels so as to not have enough for proper healthcare, education, nutrition for their kids, etc.
Microfinance is often portrayed as business capital for the poor which at times it is but the larger role it plays in offering a vital social safety net for the poor. The ability to smooth one’s consumption (borrow in times of need and save in times of excess) has shown to be very important so that one can plan for the future. Both research and my time in Uganda has revealed the great demand the poor have for these services.
At 31 Bits, workers are paid significantly more than what they were making before joining the company yet their wages are often no enough to provide enough capital for shocks to their expenses or working capital to invest in business opportunities that presented to them. One of the goals at Bits is to graduate women out of making jewelry to start their own business where they can potentially earn even more and have a larger impact in the community. Initially these businesses were to be started on with the capital that each worker saves on their own but in the past year Bits has taken a much more active role in this process with the introduction of savings and also loans to the women.
The great advantage Bits has in loaning to the women versus a bank is that we know these women. We know their employment history, income, and personality. We can do a much better job at assessing the risk of these borrowers than a bank can. Even more, we are able to hold their future earnings (provided they continue to work) as collateral for any non-payment. Therefore we are able to assess their risk much more accurately than a bank would and thus charge them a much lower interest rate. Instead of taking a loan with the local bank at 30% or even higher rates if the bank denies them, they are able to take a loan from us at 10% (we also offer advances at 0% depending on the intended use).
Microfinance is a win-win for social businesses and exactly the type of solution that they should be looking for. Beyond the liquidity to fund the program at the start it costs the business nothing to run the program (given they have the resources to manage it). In fact, the business may be able to make money off of it because of the interest paid. Furthermore workers are benefiting greatly from this service. Microfinance creates social benefits yet does nothing to compromise the ability of the business to produce a cost-competitive product. In fact, it enhances the company’s competitive advantage if they are wise to convey the additional social impact that the business now has with the addition of microfinance to the development mix that the business employs. More benefit, same cost.