Two years ago, the wrong sort of credit actually brought poverty into seamstress Ul Phala's life. She borrowed from a moneylender to pay emergency medical expenses and found herself falling deeper into debt trying to repay the crippling interest rates of up to 20% a month.
Then a loan officer from a microfinance institution who grew up in her neighborhood of wooden shacks on dirt roads in northern Phnom Penh explained that she was eligible for a micro-loan. Ul Phala suddenly went from being a part-time tailor earning $3 per day to a successful small business owner and landlord within a year.
"I did it by taking out a loan that I could afford to pay back," she says. The principle has been proven elsewhere. "The poor have skills or they wouldn't have been able to survive. All you have to give them is access to capital. Most of them can take it from there," Muhammad Yunus wrote in Banker to the Poor.
The 2006 Nobel Prize winner founded the Grameen Bank in the early 1980s to help empower Bangladesh's rural poor. His model of issuing unsecured micro-loans to the very poorest showed the world that the poor not only repay their loans 98% of the time, but they know what to do with the money. Yunus believes that microfinance can provide a solution to reducing poverty because it gives the poorest the tool they need to help themselves - credit.
Microfinance, also known as microcredit or microlending, is the principal that issuing small loans to poor people to start or expand a business potentially helps them lift themselves out of poverty. It is seen by microfinance institutions (MFIs) as the key to create sustainable economic development that will benefit the poor, and not only the rich. They also provide savings accounts and offer small loans for projects no commercial bank would find worthy of funding.
MFIs function essentially as a bank, in that they are product and services driven businesses rather than non-profit, with the same type of accountability and reporting practices required by their shareholders. However MFIs are designed to plough profits back into the community in an effort to lower the price of financial services.
Customers have a choice from whom they want to borrow money, so MFIs compete to offer the lowest interest rates, most convenient locations, and best customer service. Since they are profit driven rather than donor funded, there is incentive to keep their costs low so that they can offer competitive rates and still earn a profit. Figures show that the trend towards microfinance is increasing, due in part to the well-publicized success of Grameen and in part to their high repayment rate. In 2006, a total of 10,000 institutions in 85 countries lent money to 150 million entrepreneurs, according to MFI statistics. Most loans are secured by women, and the repayment rate is an average of 98% worldwide, far exceeding the repayment rate for commercial banks. Most MFIs are run by local staff - often members of the communities they serve. This has the twin advantages of keeping costs low and building trust between lender and borrowers, and credit officers reciprocate the friendship.
"I like it because it's a new position for me and I have a lot to learn," says Meng Ly, a credit officer with CREDIT for just over a year. "I meet a lot of different people and enjoy learning about their standards of living, their jobs, and the way they earn money. Also, I like having so many different experiences. If one day I have the opportunity to take on another position at CREDIT, I would like to do so as well." Authorities such as the Asia Development Bank acknowledge that the microfinance sector in Cambodia is young, successful and thriving.
Cambodians have lost money when Cambodian banks have failed in the past, so building a stable reputation was key for MFIs to reach the up to three million Cambodian poor who would potentially benefit from access to financial services - a fact noted by Prime Minister Hun Sen in a speech on the subject in 2006. Five years ago, the Cambodian government formalized the MFI licensing system. What has resulted, according to the National Bank of Cambodia, is a remarkably accountable system with the capacity to reach the most vulnerable clients and help them build financial security. CGAP, a respected global microfinance industry group, has given top awards in financial transparency to five MFIs in Cambodia out of the 24 registered here, and the Cambodian MFI sector has become a global model, attracting funding from donors including US Aid.
For most borrowers, this is their only way to access capital. Uch Rin, a pig farmer in Siem Reap Province, is an example of a first time borrower. "Small loans are a way for poor families to improve their life. I could have never have purchased more pigs and increased my income without this loan," she says.
For years, she hesitated to take out a loan before because moneylenders are too expensive and she didn't qualify for a bank loan. With her micro-loan of $800, repaid over 18 months, she bought 14 pigs from which she earned $1,400 this year by selling their offspring.In addition to buying more food for her family, she reinvested the profits in a rice-grinding mill and more pigs to keep growing her income over time. By September 2007, the microfinance sector in Cambodia had reached over 300,000 savers and lent $400 million to 750,000 borrowers, according to CGAP. By paying interest on deposits and offering monthly interest rates ranging from 2.5-4% on loans as small as $25, advocates point out that MFIs can offer financial services to the most disenfranchised citizens. MFI loan officers ride their motos through the most underprivileged areas of Cambodia, seeking customers and encouraging people to plan their financial futures and showing them how they can use a small loan to start or expand their own business, thereby increasing their family's future income.
There is no arguing about how accessible MFIs have become either, with branch offices springing up across the country in markets, near gas stations, and dotted throughout remote rural communities. Repayments are made either to collection officers who make monthly home visits or by customers at a branch office. The largest microlenders in Cambodia include ACLEDA, AMK, AMRET, CEB, CHC, CREDIT, HKL, IPR, PRASAC. ACLEDA Bank, the leading lender, developed from a NGO microloan program in 1993, became a commercial bank in 2003, and has now diversified beyond microfinance into all aspects of commercial banking.
But most of the other MFIs offer basic savings accounts and several types of loans designed to serve the financial needs of the poor and poorest in the country. Farmers might be interested in a "balloon repayment" loan in which the principal is paid back in several large payments after crops are harvested. Customers without collateral might be interested in joining a group of other borrowers since the repayment responsibly that falls on the entire group takes the place of collateral. And borrowers with collateral or a good credit history can take out a progressively larger series of loans to fund the expansion of their business step by step. No commercial bank would have issued a microloan to Ul Phala. Her first loan from CREDIT was only $5, disbursed as a part of an "uncollateralized" group loan where each member of the group shares responsibility for the entire loan repayment. She has taken out and repaid several loans on her own since then with an excellent repayment record. Her strong credit history with CREDIT enabled her to borrow $500 to build three additional rooms onto her one-room house to rent for $45 per month. She now saves enough money to send her daughter to private English classes and to invest in groceries that she sells to her community out of her house. She says she anticipates borrowing again to open a grocery shop towards the end of 2008.
Critics of microfinance argue that microloan interest rates are prohibitively expensive - a claim MFIs obviously dispute. They point out that, like loans from traditional banks, interest rates are tied to the size of the loan, amount of collateral, and currency of disbursement. So for an unsecured loan, the MFI might charge a higher interest rate to cover that risk, loan a smaller amount or suggest the client join a group of borrowers. However after the first loan, good repayment history can take the place of collateral over time and allow the client to take out larger loans, they say.
Down a rutted red dirt lane in the countryside of Kampong Cham, Phe Soknav, her husband, two children, and mother live in a one-room thatched house on stilts. Phe Soknav has been hugely successful using four micro-loans to expand her fruit stand into wholesale distribution, earning up to $20 from each supply trip. Three times a week, she leaves home at 4am to make the three-hour journey to the Vietnamese border on a motorbike with a small trailer attached. She takes advantage of the lower price of fruit in Vietnam by buying in bulk and transporting the goods back to her village to sell to other vendors.
Before borrowing capital, Phe Soknav had to rent an expensive motorbike for the journey to Vietnam to purchase small quantities of lemons to sell in the market for $5 per day. Her first loan for a motorbike was very small as she had no collateral. She has since built her credit worthiness by paying back three previous loans on time at an interest rate of 2.5% per month, which allowed her to borrow $1200 for her fourth and largest loan yet.
She used the first two loans to purchase a motorbike and trailer. She focused her third and fourth loans to completely fill her trailer each trip with a greater variety of fruit to diversify products to buffer her business from market demand and price fluctuations. She plans to take out a fifth loan to purchase a van so she can buy in even larger quantities and take advantage of bulk price reductions by the Vietnamese supplier.
Her increased income along with her husband's earnings of $3 per day as a horse cart driver pays for her family's food and her children's school expenses. She can afford to pay for extra lessons in the afternoon her children take to pass their exams. They are able to improve their family's standard of living, save money for the future, and make plans to build a better house one day with several rooms and a tin roof. But she doesn't squander the income.
"I save," she explains, "So I can put the money back into my business to grow it larger for my children".
For more stories of individual entrepreneurs, go to www.kiva.org
The Advisor, 4th Edition