Thursday, August 19, 2010

$120 Billion Opportunity for the Poor

A few months ago I wrote a blog piece entitled Build It and They Will Come in which I commented on an op-ed piece in the Financial Times concerning ways banks might help the poor. The author wrote about how more funds might be raised to assist the poor. I argued that we needed better anti-poverty infrastructure to ensure that funds are effectively deployed in the fight against poverty.

Now comes a research paper from Hope Consulting entitled Money for Good that shows there is $120 billion in potential funding for individual impact investments for the poor. Now that’s a lot of money! But I still think we need to focus on infrastructure to make this money work for the poor. “Unlocking” this resource will be a major topic at the upcoming SOCAP10 conference to be held in San Francisco October 4th 5th and 6th. In fact, the conference has initiated a contest called the “SOCAP10 Impact Challenge” to generate ideas. You can read Banking on the Poor’s modest proposal and vote for it here.

The rationale of my proposal to unlock even a fraction of this $120 billion is that we must create human capital for community development much in the way Teach for America is creating human capital for the classroom. Social investors need assurances that their funds will be invested responsibly and effectively. I have argued that for-profit financial institutions won’t do this work because it is too costly and doesn’t generate sufficient returns to meet the requirements of mainstream investors. However, I believe an enterprise of the type defined by Muhammad Yunus in his book Building Social Business could make a sustainable, scalable business distributing investors’ funds to low-income entrepreneurs.

As described in my entry to the competition the major components of my proposal are:

1. To create certificate programs at academic institutions to train students for jobs as community development bankers;
2. To place the “certificated” community bankers with non-profits and MFIs serving low income communities; and,
3. To work with financial institutions to provide loan processing and portfolio management services.

Over the next few weeks I will discuss here in more detail each of these components but I thought I would start by looking at some key numbers.

Let’s assume that we are looking at building a portfolio of Individual High-impact Investments (IHIs) for low income entrepreneurs in the U.S. Proposals for such funding usually fall in the range of $10,000-$25,000. Let’s assume an average IHI is for $17,500. This would mean approximately 5,700 entrepreneurs could be funded for $100,000,000 which is less than one tenth of one percent of the amount Hope Consulting estimates is available for such investments.

Now let’s assume that each IHI pays a 3% up front fee and 6% p.a. fully amortizing over a term of 3 years. That translates into an effective interest rate to the entrepreneur of approximately 7.35% p.a. Allow 3% of the 6% spread to provide social investors with a modest return and use the remaining 3% spread and the upfront fee to cover the costs of managing the program (mainly salaries for the Community Development Bankers). Once the portfolio is fully invested it will generate approximately $7.8 million in revenue after paying investors their 3%.

So how many Community Development Bankers (CDBs) are required to invest $100,000,000 in IHIs and how much should they be paid? Seeking out and mentoring viable businesses run by low-income entrepreneurs will be people-intensive, time consuming work. I believe 175 well-trained CDBs originating a little less that three transactions a month could successfully place $100,000,000/year in quality IHIs. After three years each would be managing a portfolio of about 100 IHIs at various levels of maturity. My “back of the envelope” analysis seems to indicate they could earn about $35,000/p.a.

Banks and financial advisors to the wealthy are understandably reluctant to recommend directly to clients alternative social investments. However, as the Money for Good study indicates, their clients are looking for effective ways to employ some of their wealth for social causes. Working through a social enterprise focused solely on providing low income communities with access to individual impact investment funds could be the link for unlocking the $120 billion.

Please go to Build Human Capital for Social Investment and cast your vote for Banking on the Poor’s proposal. This is a work in progress so comments and suggestions are very welcome.

Monday, August 9, 2010

Is Greed Good for Microfinance?

“Greed is good. Greed is right. Greed clarifies, cuts through and captures the essence of the evolutionary spirit” proclaims the character Gordon Gekko in the movie Wall Street. Milton Friedman, a Nobel laureate in economics, asked in a televised interview “Is there some society that doesn’t run on greed?” He went on to opine that “The world runs on individuals pursuing their separate interests…The only case in which the masses have escaped grinding poverty…is where they have had capitalism and free trade.”

So should we be shocked to see investors making millions from the IPOs of large microcredit enterprises such as Compartamos in Mexico or more recently SKS in India? The blog Philanthrocapitalism praised this development as “an important step towards fully engaging the mainstream capital markets in the fight against poverty.” Really? Now that donor funded non-profits have pioneered an infrastructure into the bottom of the pyramid, it’s okay for market-oriented lenders to exploit this access to the poor to provide financing at rates that will satisfy “mainstream” investors? I think Muhammad Yunus is spot on when he calls this development “pushing microfinance in the loan sharking direction.”

Mainstream capital is increasingly aware of the money to be made in the fight against poverty. In my last blog (July 20 below), I discussed how Wal-Mart is profiting from the IPO of Green Dot, the largest issuer of pre-paid cards for low income consumers. Gary Rivlin, a former journalist at the New York Times, has written a fascinating book, Broke USA, that shows how entrepreneurs have figured out how to get rich off the poor. All the big pay-day lender chains are publicly traded companies that seem to have no trouble funding their operations with loans from big banks too timid to lend directly to the poor.

What is particularly disturbing about the SKS IPO is the involvement of some directors and major donors of the non-profit Unitus. Apparently, while supporting SKS in its pre-IPO phase with funds donated to the non-profit, they set up a separate for-profit investment vehicle to invest directly into SKS and subsequently benefit from the IPO. We can debate the virtues and “rightness” of greed but one thing has always been clear—it tends to corrupt.

For-profit MFIs have an inherent incentive to push high cost debt onto the backs of the poor in the same manner as pay-day lenders. For this reason, the “social business” model espoused by Professor Yunus is a much better solution for increasing capital devoted to fighting poverty. His idea is that low income borrowers should be able to support a business run on the basis of “no-loss, no dividend.” If the poor have to pay the kind of risk premiums required to attract “mainstream” investors then they are no better off than borrowing from village loan sharks or pay-day lenders and their ilk.

The causes of extreme poverty are many and complex. Greed has certainly played a role. It’s hard to see how greed will end poverty. Frankly, it seems obscene to suggest that focusing on one’s individual self interests is a good way to help the poor and end global poverty.