Why Micro Loans Work & The Economics of Lending To The Poor
Last year I took a walk around a village where we gave out 10 loans to female entrepreneurs averaging $170 per person. I interviewed each person and asked them how their life had changed. Three of them had grown their income by 50%-100%, five of them had more than doubled or tripled their incomes, and the other two grew their incomes by 4x and 7x—this was just five months after receiving their tiny loans.
Every woman that we talked to had a similar story…
"I wasn’t eating enough.”
"I was depressed.”
"I couldn’t afford school fees to send my kids to school.”
Some had even more traumatic experiences…
“My shop was robbed and my stand was destroyed. I was left to starve…”
“My husband’s an alcoholic and doesn’t work. I was left to take care of the family on my own.”
Despite the traumatic experiences that everyone in this village had recently suffered through, the town was unusually upbeat. The people were unusually optimistic, happy, and the children were smiling and playing in the street. Everyone was excited and happy to talk with me about how their loans had changed not just their businesses, but their entire village.
Toward the end of my interviews, I had a wake up moment where I questioned, “did we just double their local economy?”. Think about it... we had given loans for about a third of all the businesses in this village and the majority grew their incomes by two to three times.
So I asked my credit officer, “Would it be unreasonable to say that we doubled the economy?! Maybe that’s too unrealistic..."
“No, no no! That’s not unrealistic at all. You should have seen this place before.” and I could vividly imagine it as I had seen with too many other poor communities in the past. Hopeless faces sitting on the front step of broken down shacks, feeling sad, broken, and hungry.
How could a community like this have such a 180 degree turn around in just a few months? To answer that question, you have to understand the S-Curve of poor economies…
What’s the S-Curve?
Imagine that you are a seamstress with a small clothing store. You’ve had decent success so far making dresses, pants, and shirts for the people of your village. Then one day your kid gets sick. You have to rush them to the hospital for an emergency treatment, which consumes all your savings—the money you were going to use to buy your next roll of cloth.
The good news, your kid gets the life-saving medicine that he or she needed, but the bad news… you have a sewing machine and no cloth. You’re out of business and now you’re forced to pick up casual labor jobs (the worst paying jobs) until you can save up enough money to buy another roll of cloth.
Despite all your hard work, all your saving over the last few years, you’ve just been knocked back down to where you started five years ago, and to make matters worth, you’re starving, your kids had to drop out of school, and saving your next $200 feels impossible. How hopeless would you feel? After doing everything right for years… you’re stuck in a cycle of poverty, where you’re earning the equivalent purchasing power of someone who has $3/day to live off of in Miami, Florida.
It’s a false myth that poor people are hopeless and can’t save on their own. In fact poor people are ingenious savers (I’ll cover this in a later post), what’s really tough is that they suffer from extraordinary high levels of risk. A kid gets sick, a shop gets robbed, a drought kills your crops, your cow dies, and overnight your life savings disappear.
The story I just described to you is the story of our 7x growth customer. She borrowed $200 from us for some cloth, which she paid back in just two months, then she borrowed another $300 for a second reel of cloth. She paid the second loan back in three months, and in just 5 months she was debt free and her income grew from $3/day to $21/day.
To put this in perspective it would be like a single mom in the USA who makes $20,000 a year with several kids. They’re on food stamps, they can’t pay their mortgage, their kids are suffering in school because of their home situation… then all of a sudden in just a matter of months they’re making $140,000 per year and are among the richest people in their neighborhood. Now the problems they’re worrying about are how to expand their business to multiple locations.
How can two tiny loans make such a big difference? Because at the bottom of the S-Curve you have people who have suffered from extreme hardship in life. They live in risky environments that are constantly challenging them and forcing them to expend all their resources just to stay alive—or to keep their kids alive, leaving them without inventory to sell.
These hardships are then reinforced by a psychological process. Imagine you’ve worked hard on something for months just to lose it all. Perhaps you can relate to how that feels? They often lose their confidence and hope in the future. Then hunger emphasizes the burden, and seeing their kids (which are often the social security net for the poor) lose their shot to escape poverty, leaves people feeling hopelessly worried, stressed, and depressed making simple tasks like working, sleeping, and eating difficult.
That’s why nearly all of our loans are to the poorest, most fragile people in their communities. First, it’s to help provide them with working capital to buy inventory so that they can become self employed. Second, it provides them with the hope and stress relief that they need in order to work hard again. When you go from having nothing to sell and no energy to work to being able to make money again and have high hopes, your return on investment is huge.
There are all sorts of businesses that get held up in dead-lock because they don’t have the money they need in order to afford the inventory or supplies that required to keep working. This is the seamstress with a sewing machine and no cloth. This is the market vendor with a market stand, but no fresh vegetables, the electrician who repairs broken TVs without the money to buy new parts.
That little loan is the tiny bit of help and encouragement that these people need in order to jump from the bottom of the pyramid to earning a respectable income, feeding their families, sending their kids to school, and having hope in a bright future. And once they jump back up to the top of the S-Curve, you just have to sit back and watch them flourish.