We only ship to addresses in the USA. Live somewhere else? Please order from our international distributor. Click Here
Product added to carts.
BK Blog Post
Posted by Hugh Sinclair, COO - Economist - Author, Alliance Microfinance.
Hugh Sinclair works in turnaround management, helping ailing Microfinance Institutions in accounting, software automation, rescue strategy, and doing due diligence.
A fascinating story emerged on the BBC today. A controversial payday lender called Wonga came to a voluntary settlement with the UK regulator (FCA) after admitting it had been lending recklessly, at high interest rates, to people otherwise excluded from the financial sector. It has agreed to write-off £220m of loans, which is quite a hit given its post-tax profit in 2013 was only £30.6m (down 51% from 2012). These loans represent 330,000 clients who should not have been offered a loan, according to the regulator. An additional 45,000 clients will no longer have to pay interest on their outstanding loans, but will have to repay the capital. The interest rates are a little steep, even by microfinance standards, often exceeding 5000% APR (no omitted decimals here – five thousand percent). The CEO admitted lending to people who could not “reasonably afford the loan in question”.
The company is funded by a variety of venture capital firms (former Goldman Sachs folk to be precise) and the management own shares. Clients openly admitted how they had lied on application forms, and got into deep trouble with over-indebtedness. Earlier this year the BBC reported “Payday lender Wonga must pay £2.6m in compensation after sending letters from non-existent law firms to customers in arrears”. The CEO at the time commented, “Today is not a proud day for Wonga and I’d like to apologise”. The director of supervision at the FCA warned: “This should put the rest of the industry on notice… they need to lend affordably and responsibly.”
How is this related to microfinance? There are some important similarities, and some equally important differences between the UK payday lending world, and the microfinance sector in developing countries.
We know this is chronic in many microfinance sectors. Mexico and Peru are the current best examples. Uncontrolled credit gets people into trouble – how many times do we have to repeat this? It doesn’t ultimately matter where you are, or even how wealthy you are, debt is a dangerous tool. The firesale of MiBanco was not actually MiBanco’s fault per se, but was caused because its main shareholder, Grupo ACP, took on more debt than it could afford to pay, and then defaulted. The entire country of Argentina is in technical default on its sovereign debt currently. You can postpone the problem by borrowing from Bank A to pay Bank B, but only until the music stops.
Aggressive debt collection methods
Remember the 54 suicides in Andhra Pradesh? Stories of loan officers pressuring female clients to drink poison in order to get the insurance payment? This is not restricted to India – Wonga is a UK regulated financial institution and was caught using aggressive and illegal debt collection techniques. When companies, and their staff, are under constant pressure to reach targets, to grow, to boost return on equity, to earn their next bonus, inevitably some will pile on the pressure a little too much. Vulture shareholders and greedy management with equity in the game add fuel to this fire.
Extortionate interest rates
The headline Wonga interest rates are high, no doubt about it. But so are those charged by microfinance institutions. Yunus lamented in an NYT article, “I never imagined that one day microcredit would give rise to its own breed of loan sharks”. Finca Zambia charges up to 347.5% APR, which although substantially lower than Wonga’s highest rates is still a little on the high side. I shan’t rant about interest rates here, as I have done so extensively on this blog, but do we really expect the poor to benefit from such rates? And in Wonga’s favour, at least they were pretty transparent about the rates they charge (probably because they are obliged to publish them). Check out the website of Opportunity International and search for the interest rates – these are kept well under wraps.
Where are the differences between vanilla microfinance and Wonga?
There are many, but I would like to point out one. UK citizens are protected by a reasonably effective regulator with teeth. They have complaints mechanisms, bankruptcy laws, the Citizen Advice Bureau, and an open media willing to expose cases of “extortion” or “usury”. The Church of England even intervened in the case of Wonga. UK citizens are fairly aware of their rights. A Wonga loan officer cannot wonder into the house of a defaulting UK citizen and confiscate her pots and pans. And UK citizens take this protection for granted.
The majority of microfinance clients have few meaningful rights in reality. There is no regulator protecting them from such practices. The legal systems are onerous and unaffordable. They are terrified of defaulting on a loan and being excluded from even the microfinance sector, and thus some are inevitably forced into prostitution, or selling their own organs, to repay a loan. But investors in such institutions can get away with this, as they operate with impunity. Microfinance is opaque, non-transparent and unregulated. Bono supports it, so it must be okay, and the websites look pretty. The investors in microfinance, as in Wonga, are far-removed from the reality the ultimate clients face, and simply reap the benefits of this desperation.
What do we offer the poor by way of regulation? The Smart Campaign. The best efforts of the sector to protect the interests of the poor are so pathetic to be almost laughable, were it not for the tragedy that befalls the victims in these far-flung corners of the globe, miles away from a regulator or Bishop or watchdog looking after their interests. 375,000 of Wonga’s clients have been unfairly treated, according to the UK regulator. How many of the 200 million microfinance clients suffer similar treatment? For all the rhetoric about financial inclusion and microfinance and empowering the wealth at the bottom of the pyramid or whatever the latest catchphrase is, have we forgotten our obligation to act responsibly? When have we, as a sector blighted with scandals, had the courage of the Wonga CEO and apologise for our actions? Must we wait until the inevitable collapse of entire microfinance sectors, as has happened on countless occasions to date, before we consider the pain that over-indebted people go through? That people want and need money is no justification to offer them loans at 5000%, or 500%, or 50%. Many countries have interest rate caps precisely to avoid these sorts of abuses. In the US these are set at 40%. The UK has no such caps, but according to the BBC the government is considering introducing them next year. And no surprise who will object to these most vocally – Wonga, its shareholders, the venture capital firms behind such moneylending, and anyone else who benefits from exploiting vulnerable people.
There seems to be a cruel double standard here. When British people are exploited by usurious predatory lenders there is a scandal. When we do it in developing countries it’s considered an ethical investment. We deny the poor in developed countries the rights which we ourselves take for granted.
If anything good can come of this Wonga mess it is that perhaps people in the UK will question the wisdom of trying to solve poverty in developing countries with Wongas.