Wed, 02 Dec 2009

Kiva

I've been contributing to Kiva for a number of months now, and am sufficiently appreciative of them to want to tell others about them. The short version is that Kiva is a distributed, peer-to-peer microlending non-profit with the goal of alleviating global poverty.

Microlending

Microfinance is the practice of providing financial services to people in low-income parts of the world who are not generally considered profitable-enough customers to warrant service from traditional banking institutions.

Microlending (or microcredit) is a subset of microfinance that provides loans to low-income people, typically entrepreneurs in low-income area of the world, who do not have access to loans from traditional banking sources. Sometimes there simply are no banks in the area, but more typically the entrepreneurs don't make enough money to qualify for loans, don't have sufficient collateral, or don't have a sufficient credit history. Modern microlending started in the 1970s with the Bangladesh-based Grameen Bank.

The advantages of microlending over traditional aid programs are in its benefits to developing economies: it encourages growth of local businesses, puts more money into local economies, encourages local employment opportunities, and gives entrepreneurs a foothold to establish their businesses and a credit record. In some areas, it provides an alternative to tribal moneylenders, who charge high interest rates and respond to repayment failures with physical violence. In short, traditional aid addresses people's basic needs: food, shelter, clothing, education, sustainable agriculture; while microlending works on the next step of growing local economies.

Kiva's contribution

Kiva was created as the first distributed, peer-to-peer microlending organization in the world. It's peer-to-peer because all Kiva does is list loan applicants on their website; it's up to the users of the website to supply the money to fund the loans. As the loans are repaid, those repayments go to the people who supplied the money. Kiva is distributed because the funding for any given loan is made up of contributions from many different Kiva users. (And as the loan is repaid, each contributor is repaid according to his or her portion of the overall loan.)

The actual process is a little more involved. Kiva doesn't make loans directly. Instead, they partner with microfinance institutions (MFIs) in other countries. The MFIs accept loan applications, evaluate the applicants, disburse loans, and collect payments. During this process, the MFIs tell Kiva about the loans in batches, Kiva lists the loans, collects the contributions from Kiva users, and sends the money to the MFIs. When the MFIs collect money, they send the payments (again, in batches) to Kiva, which distributes the payments to the loan contributors. The MFIs often fund the loans before telling Kiva about them (to avoid the delays in the funding process and get the money to the applicant quickly), and then backfill the accounting once the loan is actually funded. In some cases, a loan will expire on Kiva without being fully funded; when that happens, any contributors will have their contributions refunded, and if the MFI already disbursed the loan, they will have to find another source of funding for it.

Loan repayment

When payments are received on a loan, the money is made available to contributors as "Kiva Credits". If you have Kiva credits, you can apply them to a different loan, donate them to Kiva itself, or transfer them into a PayPal account.

Defaults

Because most loans are made in developing areas of the world, if someone defaults on their loan, there is often no workable legal recourse for requiring repayment and the people who contributed to the loan are not repaid. The MFIs do research on the applicants before granting loans, and do a generally good job of selecting people who will repay their loans. Kiva has an overall default rate of about 2%. (For comparison, in 2004, the federal Small Business Administration, which makes loans to small businesses in the US, had a 2.4% default rate, which has hit 11.9% with the recession.)

This does mean that any loan made through Kiva carries the risk of losing the money contributed.

Interest

Kiva does not collect any interest on its loans. Consequently, Kiva users will only get back exactly what they put into the loan in the first place, unless the loan defaults. This means that anyone contributing to Kiva loans over a long term can expect to lose some money to defaults. Because Kiva is operated as a non-profit organization with the goal of alleviating poverty, they don't feel it is appropriate to add interest payments to the loans they fund.

The MFIs that Kiva partners with do charge interest, however. The interest that they charge pays for their staff and administration costs. Typically, they charge a small percentage of the loan in interest, plus a flat fee to cover the effort necessary for any loan, regardless of its size. This includes things like interviewing applicants and researching their financial history and dependability. Because the loan amounts are small, that fee often adds a noticeable percentage to the loan, leading to interest rates that seem surprisingly high. The average interest rate on Kiva is about 35%, but I've seen rates as high as 50%.

The MFI interest rates are another reason that Kiva doesn't charge interest themselves; they don't want to add any more to the borrower's repayment load.

For each of its partners, Kiva shows both the average interest rate for that MFI and the median interest rate for other MFIs in the same region. People worried about the high rates are encouraged to check up on the MFI before committing to a loan.

Kiva's Funding

Since Kiva doesn't collect interest and they apply all of a contributor's money to the loans themselves, they rely on donations to keep running. After you contribute to a loan, they ask for a donation and suggest an amount equal to 15% of your loan contribution. You have the option of choosing a different percentage (including 0%) or specifying a particular dollar amount. You can also give the repayments on your loans to Kiva as a donation, either manually (by donating your Kiva credits) or automatically (by specifying that all repayments should be automatically donated).

Kiva is a 501(c)3 nonprofit, so all donations are tax-deductible, although loans are not. (As mentioned above, loans are not even guaranteed to maintain value.)

Criticism

I feel it would be unfair to talk about Kiva without acknowledging that some people have criticisms of the microlending process.

The most common criticism about microlending in general is the high interest rates. Kiva does as well as it can in this area, recognizing that MFIs need to charge enough to fund their activities, but also being as transparent as possible about what is being charged. Kiva also periodically reviews their partners' claims and practices. (They have closed relations with at least one partner because of fraud--not interest related, in this case; the partner was claiming much higher amounts on its loans than it was actually disbursing.)

Conversely, some people argue that Kiva should themselves be charging interest. I can't find the article now, but I read a piece a while back that argued that when microfinance funding organizations like Kiva pay interest, contributors change from a "charity" mindset to an "investment" mindset and end up putting more money into system. Personally, I think that the charity mindset is a better fit here. If the goal is to alleviate poverty, then helping people establish businesses with as few impediments (including additional interest) as possible is a better approach than one that is beholden to the best return on investments.

There are also claims that microlending doesn't help all that much. There was an article in the Boston Globe a few months ago titled "Small change: Billions of dollars and a Nobel Prize later, it looks like ‘microlending’ doesn’t actually do much to fight poverty". Despite the inflammatory subtitle, the article is reasonably balanced. It refers to two unpublished papers about studies that concluded that microlending is not as effective as many people think. For one thing, I'd want to wait until the papers are published; peer review is likely to shake out any methodological problems in the studies. But the article points out that the studies found that microlending did make a difference for a lot of businesses and helped them either establish themselves or grow. It's not a panacea--if for no other reason than that the eligibility requirements for "who can take out a loan and be counted on to repay it if there's little government enforcement to rely on" mean that only a small part of the population will be considered in the first place--but it is a step in the direction of helping establish functioning local economies in poor regions. The article provides a number of pro-microfinance perspectives, most of which boil down to, "The studies show that microlending isn't magic, but it's a useful tool--as long as you understand that it isn't magic."

Kiva in particular was the target of some criticism recently when they began offering loans to entrepreneurs in the US. Many people felt that people in the US are either well-served by the standard banking system or have access to many government programs and would not get much additional benefit from a microloan. I tend to regard this as a place where it's best to give people the ability to make their own decisions. Kiva felt that there was benefit to offering loans in the US, and those who agree with them can now participate in those loans. Those who disagree have no obligation to fund US loans, and there are plenty of available loans in poorer countries. (There was a time when Kiva funded every loan it offered and sometimes ran out of new loans to fund. These days, there's more demand, and loans do periodically expire unfunded.)

Conclusion

I think that Kiva provides an important service to developing areas of the world, and I put a portion of my charitable giving into the site each month. Personally, I don't plan to take money out of it; what I put in goes either towards funding more loans or donations to keep Kiva running. Other people have different financial approaches, of course.

Kiva also isn't the only place I donate. In addition to local giving, I also contribute to more traditional aid organizations, because microlending is only effective if people are already healthy, educated, and empowered. For giving along more traditional lines, I recommend Heifer International, which mostly focuses on sustainable agriculture in developing regions.

Competition

Kiva was the first peer-to-peer microlending website, but many others have followed in its footsteps, and some of its competitors take different approaches to microlending. If you don't like Kiva, there might be another organization that's a better fit for you.

My Kiva History

If you want, you can look at my lender page on Kiva. So far, I've contributed to 11 loans:


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