Loan Shark

Borrowing dulls the edge of husbandry, and the loan oft loses both itself and its friend. So spake the wise Polonius to his son, Laertes, in a pre-capitalist era. But now, Shakespeare’s sage advice seems hopelessly outdated. Debt is now so deeply entrenched in our society that it is almost impossible to imagine a world without it.

I am currently attending the Global Philanthropy Forum in Washington, a gathering of remarkable people drawn together from around the world with one main objective: to find ways of improving the human condition. Much discussion has centred around the success of the microfinance movement in developing countries: the positive impact of providing poor people with small (and hitherto unavailable) amounts of credit which enable them to improve their lives. Microfinance advocates use heart-warming anecdotes to illustrate its success in lifting individuals out of poverty. It makes a great story.

In this morning’s newspaper, my eye was taken by a headline concerning a Presidential probe into US credit card interest rates. President Obama is making good his campaign promise to investigate the high cost of consumer debt at a time when, we are told, it is ever more important to raise consumer spending and unfreeze the market for credit. Apparently, many credit providers have recently hiked the cost of debt, in some cases to 30% per annum. Make no mistake, with inter-bank lending and depositor saving rates close to zero, this looks like exceptionally good business for financial institutions, laced with more than a dash of market failure. Bring on the regulator!

And yet interest rates at or above 30% are the norm in the world of microfinance, the latest “donor darling”, which seems to suggest that this cost of money – so unacceptable to policy-makers in the USA – is somehow entirely acceptable across the developing world. The fact is, that unless inflation is high, it is almost impossible to use expensive finance like this for anything other than short term trade finance or urgent consumption requirements, like health care or school fees. While this is unquestionably useful, in that it does provide access to short term money, it is harder to identify any systemic impact on poverty – if anything, interest rates like this will impoverish rather than enrich borrowers.

In defence, Microfinanciers say that these interest rates are fine: people are willing to pay even higher rates. They quote a willingness to pay rates of 50%+, but they seem to have missed the simple point that poor people in desperate need of cash have always borrowed unwisely: loan sharks and tallymen have always found a ready market in poverty.

Certainly, in East Africa, my own experience suggests that microfinance seldom, if ever, leads to increased employment. The small size of loans, allied to extremely high interest rates, usually means that microfinance is restricted to sole traders. With the best will in the world, a thriving economy cannot be built on sole traders alone. If we are going to have a real and long term impact on poverty, we need businesses that can generate employment for others, which means more small and medium-sized enterprises. In an environment like East Africa, where, as a result of rapid population growth more than 2 million people will be entering the labour market every year for the forseeable future, the need to create jobs is essential.