Building Banks in Tanzania

The King will reply, “Truly I tell you, whatever you did for one of the least of these brothers and sisters of mine, you did for me.”

– Mt. 25:40

In April 2015, I visited a network of small banks that lend money to farmers in Iringa, Tanzania. They are supported by Iringa Hope USA, a Lutheran ministry (https://iringahope.org/). The fancy term for this kind of lending is “microfinance”, the now-widespread practice of making small loans to very low-income business proprietors – in our case, mostly peasant farmers – so that they can grow their businesses and thereby lift themselves out of poverty.

Microfinance has been criticized in recent years after several prominent studies showed that it generally doesn’t achieve its goals. Yet the program we are running does appear to achieve its goals – and more. In part, this can be attributed to the fact that the program is not really built on the conventional microfinance model at all, instead resembling the credit union model that has served developed countries well for over 100 years.

So I traveled to Tanzania to figure out what we’re really doing there, how well it is working, and whether the problems of microfinance are likely to be our problems, too. This is a short summary of what I learned. 

Overall, my belief is that the program works well, and overwhelmingly to the benefit of its borrowers. Most importantly, the borrowers think this too. But since this conclusion flies in the face of what is now often believed about microfinance programs globally, I’m going to have to explain myself.

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 Neither a borrower nor a lender be;

For loan oft loses both itself and friend.

And borrowing dulls the edge of husbandry.

– Hamlet 1.3.79-81

Shakespeare probably took out loans; most people do. But in the passage above, Polonius reflects a sentiment that’s at least 3,000 years old. “If you lend money to any of My people who are poor among you, you shall not be like a moneylender to him; you shall not charge him interest.” (Ex. 22:25-26) Until modern times, borrowing and lending have had a bad reputation; lending at interest is often illegal. In some cultures it still is. That said, people will always figure out a way around the rules, and borrowing at interest – legal or not – happens in every culture.

Still, isn’t it a little odd that a network of churches would launch a program of lending, at interest, to the poorest of the poor? Widespread lending at interest has given us debtors’ prison, “pay day” lenders, the mortgage crisis, credit card overhang and more. Even microfinance led to its own financial mania in the mid-2000s, drawing hundreds of millions of dollars in investment into the sector, complete with IPOs at unrealistic multiples and a big, hard hangover after the party ended. And lending at interest to the poor is exactly what Exodus 22 prohibits.

So what are we doing building a network of institutions that will add to the debts of the poor? Well - it’s important to think about where we all would be if we didn’t have access to credit. Most of us wouldn’t own our houses, and we’d be renting our cars. In fact, we would have to rent nearly everything, and starting a business would be awfully difficult. Credit is an important financial tool, even though it can also be a dangerous one. So the goal of Iringa Hope is to provide that tool to people who wouldn’t have it otherwise, and to offer it in an affordable manner. So that’s what we are doing – but it isn’t without risks.

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Primum non nocere – “First, do no harm”

–Latin maxim echoed in the Hippocratic Oath

They say you can drown in an inch of water. For a penniless borrower in default, the corollary to this is that the difference between a $10 debt and a $1,000,000 debt is just the number of zeros you can’t pay. You’re in the same situation either way. From the lender’s perspective, of course, the difference is $999,990. That’s nothing to sneeze at, so it’s traditionally the lender who watches how much money goes out the door. 

But even with small loans, it’s possible to push already-poor debtors into an uncontrollable spiral of debt. A peasant farmer takes out a $50 loan to pay for seeds. His low-lying acreage floods, destroying the crop. The loan comes due so, under pressure from others in the village, he takes out another loan (at a higher rate) to pay off the first loan. That loan has an annual interest rate well above 100%; the cycle repeats in this way or that, and a $50 debt becomes $200 and then $400 and then more. He sells the roof of his shack to make payments, and then sells the labor of his children. (We used to call that indentured servitude; now, perhaps, we call it human trafficking. It’s often related.) The last step is suicide.

This nightmare is realistic, and in some parts of the world it’s unfortunately quite common. The idea of microfinance has somehow become blessed among caring people, as though there were no risk in lending at interest to the poorest of the poor. Well, it’s not risky for us. I have never considered killing myself over the money we’ve given to this project. But it’s risky for the people who take out a loan when they have nothing to back it up. In fact that’s the whole point. Micro-lenders offer credit at more reasonable rates to those who don’t have collateral. And that can be an incredibly good thing: it offers hope to people who are – truly – hopeless without it. It offers a means of taking ownership in an operation that used to own you. It offers escape from high-interest moneylenders. It offers the possibility of paying for secondary school for your kids, feeding them better, earning your dignity. But still, you can drown in an inch of water.

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This week was only a week, but I saw a lot of success at Iringa Hope and no evidence that its loans do more harm than good. In fact, I am cautiously optimistic that they are doing very little harm at all – currently. But I still squint when I look at the books, or talk to the borrowers or the leaders, because many experts would say that we’re deceiving ourselves. With that in mind, here’s why I think this program is succeeding.

That requires a bit of critical background, even for the initiated. Microfinance as traditionally practiced offers very small loans to individuals who bind together in a group to commonly commit to repayment. The loans are just big enough to allow a trader to buy some stock at rates lower than a moneylender would offer, and the loan duration is only a few days or weeks, meaning that he only needs to turn over enough stock to repay the loan. That is what the world regards as conventional microfinance, and that is what has been studied extensively by dozens of scholars for over a decade. This is the model that has been shown not to be very effective at lifting people out of poverty.

The problem with the conventional microfinance model is that the trader, seamstress, carver, or farmer is still in exactly the same business she was in before, producing the same thing and selling it at the same price. Microfinance changed the way the money flows, and hopefully reduced her interest rate, but it didn’t increase output. If you don’t increase output, you haven’t really lifted anyone out of poverty. The logic is that at least you’re cutting out the moneylenders, which should have some positive distribution effects – but all research efforts to prove this have failed to show any real net benefits. (The best write-up on this issue is Due Diligence: An Impertinent Inquiry Into Microfinance by David Roodman.) 

What lifts people out of poverty is industrialization: adding capital that increases output. Finance can play an instrumental role in achieving this, but microfinance rarely does. Thus the problem.

Since microfinance unquestionably does help many people, it’s best to consider its overall failure in terms of a bundle of loans. If 100 people each take out a loan, we know that four types of results will always occur:

• Some of them will use the money to make much more money and pay it off easily.
• Some will make just enough money to pay the loan off on time.
• Some will struggle and pay it off a little late.
• Some will crater, lose the money, and come back with nothing.

This has always been true; Jesus told essentially this story in the Parable of the Talents (Matthew 25:14-30). So – when we say that microfinance has never been shown to be a net benefit to borrowers, we mean that there are success stories in every portfolio of loans. But those winners don’t outnumber the losers by enough to make the whole thing a positive overall, and people are not, on average, lifted out of poverty.

To be successful, microfinance needs to result in more output. It isn’t enough for people to borrow at better rates if that doesn’t facilitate better investments in productive capital. You actually have to make more or better food, clothing, furniture, or whatever you’re selling in order to increase output. That’s what growth is, and conventional microfinance too rarely achieves that.

It’s also true that lending requires growth in order to work overall, and when lending goes bad it’s because it didn’t result in enough growth. In financial terms, to pay off a loan at 36% annual interest, I need to invest that money in a thing (fertilizer, seed, whatever) that has at least a 36% annual return on investment. If not, I won’t make enough money to pay off the loan, and I will get further into debt.

If finding an investment that returns 36% sounds easy, consider that no stock market in history has ever had a long-run average return anywhere near 36%. If someone gave me $100 and told me to use it to pay off a $136 loan a year from now, I’m honestly not sure what exactly I would do to make that happen.

In Tanzania, the program’s borrowers do seem to be consistently finding capital investment opportunities that return well over 36%, but we need to keep in mind that it's no cake walk. The borrowers are taking real risks, and farming in Tanzania (generally with no irrigation and no machinery) is hard enough even before you leverage it up.

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So – why is Iringa Hope lifting people out of poverty if microfinance is supposedly incapable of lifting people out of poverty?

I believe it's because we aren't really doing microfinance. 

This is a little awkward because we have a Microfinance Institute and we just put up a beautiful building that says “Microfinance” on the front. But Iringa Hope isn’t doing conventional microfinance – and that’s a very good thing.

There are several reasons why the microfinance that has been judged not to work is different in critical ways from what we’re doing. Each of these differences explains why Iringa Hope works better.

1. Our loans are bigger. They are not “micro” by the standards of the industry, and they sure aren’t “micro” from the perspective of the borrowers. The lending institutions (called a SACCOS – a Savings and Credit Cooperative) are commonly lending between 200,000 and 1,000,000 Tanzanian Shillings per borrower. That amounts to $115 - $575. In a country where annual average per capita GDP is $1700, that’s serious money to a poor peasant farmer. The size of the loans matters because one problem with traditional microfinance is that it doesn’t offer enough money in any given loan for the borrower to make an investment in transformative capital. The borrowers are a little better off, but they’re in the same business at the same productivity level for the most part. This is partly because the loans are too “micro” to be effective. Because our loans are bigger, the prospect of transformative investment is greater. 
2. Investment Opportunities are Better. In most of our locations, the agricultural investments have a very high return. This is a reflection of the lack of development in Tanzania. As the region and country develop, we should see this erode, but for now it’s easy to get massive output increases as a result of modest investments. Our borrowers can take out a sizeable loan, buy hybrid (“green revolution”) seeds and quality fertilizer, and this will often multiply their crop yields. So we’re not talking a 36% improvement; we’re talking a 100% or 200% improvement – when things go right. There’s still risk, but overall the investment opportunities we’re dealing with are better. 
3. We offer – and require – savings accounts. Conventional microfinance – Kiva.org is a good example – finds it far easier to offer credit than it does to offer a savings account. Most microfinance organizations do not have any kind of savings accounts available. (In fact, the poorest of the poor actually pay money for the privilege of putting their money into a savings account. Forget about earning interest: you’re paying someone to watch your cash so it doesn’t get stolen from your mud hut while you’re out in the fields.) Well, the problem with not offering a savings account is that it encourages borrowers to use credit as a substitute for savings. If that sounds weird, think about it this way: you literally, physically have no place to put your money. Maybe the way to solve this problem is to just run your life on credit, keep little to no cash, borrow more when you need it, and pay down the lender whenever you make some money. Does this work?  Is it a good idea? Not at a moneylender’s 100%+ annual interest. But if you don’t have the option of a savings account, what are you supposed to do? 

To the surprise of nobody, the same studies that show micro-borrowing to be largely ineffective have shown that micro-savings do lift people out of poverty. This may be why neither the Bible nor Shakespeare condemns the practice of saving money. Savings provide the same buffer that credit provides, build wealth, and can displace and eventually eliminate the need to borrow altogether.

Iringa Hope not only offers savings accounts, but in fact we require savings in order to take out a loan. And the savings determines the loan amount: members can borrow a maximum of three times their savings. This encourages more savings, limits the amount that can be taken out, and is a structural/prudential rule that protects the credit cooperative in the event of defaults.

I saw in the records this week good evidence of borrowers taking out loans, paying them back, growing their savings from their earnings, and in effect “saving their way” to a larger loan. That larger loan, in turn, allows for a more transformative capital investment that can help them to earn more money. This still isn’t risk-free, but it’s healthy and it’s how economic growth is supposed to work. Iringa Hope is doing what conventional microfinance has struggled to do.

1. We’re building community infrastructure – not just behavioral infrastructure. Conventional microfinance is not a giant waste of time. Even if it does not, on net, lift people out of poverty, it typically achieves at least the following things:
2. Access to credit gives people more control over their lives.
3. People choose to borrow; they don’t have to. This in itself is an option that creates more options, and at least for some people that will be very helpful.
4. If you can drown in an inch of debt, it’s equally true that an inch of credit can sometimes save you. Micro-credit may not increase your total annual income, but it can get you through lean times by smoothing your income.
5. Behavioral infrastructure. The very fact that a person, family, or community develops the habit of regular borrower meetings, paying on time, tending to financial matters in an orderly way – all of this is good. Conventional microfinance tends to develop these habits. 

But there’s something missing in this. Conventional microfinance banks are not located in the village and their employees are not villagers. If they leave, there’s nothing left behind. The villagers may have learned to play tennis, but the people with the tennis court folded it up and left. They have behavioral infrastructure, but they’re missing community infrastructure.

So – we’re succeeding where conventional microfinance fails partly because each Saccos is local. They are member-owned and member-run. This is not conventional microfinance. It’s a credit union. There’s nothing dodgy about a credit union. Some of the world’s largest banks started out as agricultural credit unions. And each credit union is a piece of community infrastructure in its own right. It creates and holds social capital – accounting skills, lending capability, behavioral habits, perhaps a building and some equipment. So even if the lending and savings accounts don’t perform well, there’s still infrastructure there. There’s a way of going forward and hoping for more success in the future. Even if the thing goes bust, there’s enough leftover infrastructure (skills, papers, buildings perhaps) to start it again. 

An analogy: If you put a water tower and some pipes in town (most villages don’t have this yet), even if the water stops flowing for a while, you’ve still got the infrastructure, and you can benefit from it later by getting water back in there. There’s a distinction between (a) having the system and (b) having the system perform. Having the system is a benefit unto itself, even if the system isn’t performing correctly right now. Owning the system at the village level is what we have that conventional microfinance doesn’t.

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So – those are some of the reasons why I think Iringa Hope is working far better than conventional microfinance. In short, we’re not doing microfinance. We’re doing credit unions. But because what we’re doing has a lot in common with microfinance, we will be well served to learn from the mistakes of that sector across the last 20 years.