As I was visiting the MFI clients in the field, the borrower would often proudly annnounce that he or she was on their 5th loan… or their 7th loan… or even on the 9th one. Although this does show an impressive credit history, something about it was bothering me.
Before coming here, I had a few assumptions about what a business loan is all about. I pictured a budding entrepreneur who borrows money to purchase supplies or to expand inventory. They pay a relatively high interest rate (say, over 30%+ per year), but it’s worth it because it gives them a boost in their business. Without that loan, they’d either never have an opportunity to grow or it would simply take a very long time.
When the entrepreneur is done paying off the loan, he or she – hopefully – has a higher revenue stream, along with a bigger take-home profit. So far, so good – this is what I’ve been seeing among the borrowers.
But then, I imagined that they take the extra profit and plow it back into their business in order to take it to the next level. However, the reality on the ground was quite different than I expected.
Instead, many borrowers were using the increased profits they made as a result of a loan for personal purposes. One client fixed up their house. Another one used the money for a wedding. A third decided to put in a row of gold teeth. All valid uses. After all, the whole purpose of micro-finance is to help people increase their standard of living and all of these things do that.
But the thing that wasn’t adding up was that the entrepreneur was going right back to the MFI to take out an even larger loan and continue to pay the 30%+ annual interest on that money.
The big question that I’m struggling to answer is why aren’t the borrowers using the profits – that are interest-free – and putting it back into their business first? Granted, this would mean postponing the immediate benefit of using the money for consumption. But over the long haul, it would yield them a much better return and more opportunities to improve their standard of living, as they would avoid paying the interest. At 30% per year, that’s a significant amount in savings.
It’s difficult to put oneself in somebody else’s shoes and make a decision on what’s more important – a roof that doesn’t leak and a loaf of bread today or a two-story house and three loaves and a kilogram of beef next week. I don’t have the answer to that.
But there is even another caveat to the story that made me think. As I spoke to the borrowers, it turned out that most of them rarely kept any sort of a financial document where they’d record how much they made, how much they spent, and so on. All of this was kept in their heads.
While that may be sufficient for day-to-day operations, without a historical record, it becomes very difficult to project how much money one could make by funding the business using the profits rather than debt. As Bob Parsons, a self-made millionaire, once said – “everything that’s measured, grows.” Perhaps, the opposite is also true.
What do you think?
* This post has been written by Boris Mordkovich, a Kiva Fellow working for 10 weeks in Tajikistan for MLF Humo and Partners. Check out currently fundraising loans by Humo and join Kiva Lending Team – Supporters of Tajikistan */>