Negative Side Effect of Microlending

While only finding out about it roughly a year-and-a-half ago, I’ve grown to be a big proponent of micro-financing. Essentially, micro-financing — also called micro-lending — is when an entrepreneur or micro business owners is looking to raise some capital ($250 to $2000) to start or expand their business. Typically, this business is in a 3rd world country, and other means of gaining funding involve too much risk (homes or other property as collateral) or extremely high interest rates (over 100%). Here’s where microlending comes to the rescue and ironically could lead to potential long term government economic issues.

Looking at the loan applications on Kiva, most of the businesses are located in countries with either an unstable government or under the control of a long term regime. As a result, their banking infrastructure does not provide a reasonable method for poor individuals or micro business owners to get loans.

How micro-lending works

• Business owner or entrepreneur looks for a loan
• A Field Agent/Broker assesses the loan (business plan, risk, collateral, payback period etc.)
• The business owner’s profile is posted online
• Lenders can contribute a relatively small amount (typically between $25 to $100)
• After securing the necessary financing, the loan from multiple lenders is disbursed to the borrower
• Borrower pays back the Field Agent/Broker at an agreed upon interest rate
• The Field Agent/Broker pays back the lender at zero percent interest, until it is paid off

On a micro level, these loans are an extremely innovative way of helping out small businesses and /or individuals to grow to become fully self-sustained. Which is great. However, on a macro level, what these loans essentially do is increase a country’s money supply — leading to micro-inflation. The way that the money supply impacts inflation is through the interest rate, which is basically the price someone is willing to pay for money. When key government interest rates are lowered, it makes it easier for people to borrow money, which also increases the money supply in the economy. Micro-lending bypasses certain government monetary controls by operating around them — which can be both a good and bad thing depending on the view point.

I hope this was a good intro into microlending, and its many positive as well as some of its unintentionally negative side effects. In future posts, I’ll look to examine its impact on the value of currencies, draw possible parallels between microlending and the financial/housing market melt-down, as well as look at it from a macro level (these loans help create jobs, distribute money and create infracture).

As always, whether you agree or disagree with me, please leave a comment below.