It's a pittance in the West. A loan of only $500 to $1,200, however, can make all the difference for a man or woman eking out a living in the developing world. Just that much—the typical range of microfinance loans, according to Michael Chu, a poverty expert and HBS senior lecturer—is sufficient for someone to get off the ground: enough to buy inventory, rent space, and begin to generate an income in order to feed, clothe, and shelter a family.
A legal loan of that amount from a real bank is also the difference between paying fair interest or living under the thumb of a loan shark. According to Chu, himself a Wall Street refugee with grounding in consulting and buy-outs, microfinance has "a double bottom-line." It brings above-average returns for first-movers who tap into what finance specialists see as a new market, and it brings enormous social impact to the lives of the poor by removing the high cost of everything they need.
Chu discussed the benefits and complexities of microfinance with Harvard Business School alumni on June 4, in a session titled "Microfinance: Harnessing the Market for Social Impact."
"I think we're at a point in which something very fundamental is happening to business," Chu told the alums. "We are, I think, at a new frontier. Until now business was defined by the goods and services we provided to two billion people—people in the first world and the elites of the world. But today we are on the verge of understanding how to unlock goods and services for the remaining four billion."
Poverty is the "normal state" of the world, he said. Fifty percent of global citizens live on less than $2 a day. Poverty reigns, despite the fact that since World War II organizations such as the World Bank have poured resources into hundreds of schemes to end poverty.
The World Bank alone has dispersed about $550 billion since its founding in the 1940s, Chu said. Adding in contributions from the "alphabet soup" of other organizations with acronyms such as UNDP and EBRD probably means that trillions of dollars have been deployed with little effect.
"I think if in all our business lives we throw a trillion dollars at something and we still lose market share, it's probably time to think about whether there's another way" to address a problem, he said.
"Poverty has to be rethought. To vanquish a problem, we have to understand it."
Start with the question, "How do people eat?" suggested Chu. People develop economic activities that are of worth to someone else, he continued. "That's the source of employment for most of the world. Microenterprise, like any other business, needs financing" so a vendor, for example, can pay for inventory.
Radical Youth, Then Wall Street
Chu's own background makes him uniquely situated to bridge the worlds of abject poverty and sophisticated finance. A self-described radical youth whose family emigrated from China to Uruguay, Chu graduated from Dartmouth College in 1968 "right in time to go back to Latin America at the time of the Dirty Wars," he said.
He saw extreme political polarization, urban guerillas, terrorism from both the liberation movement and the state, and torture.
"When I left Dartmouth I thought that change came out of the barrel of a gun. … But life has many surprises for twenty-year-olds." He pursued an MBA degree from HBS, graduated in 1976, and joined the Boston Consulting Group, eventually gravitating to Kohlberg, Kravitz, Roberts & Company, where he handled buy-outs.
To vanquish a problem, we have to understand it.
"I thought I was going to live, work, retire, and die in New York City," said Chu. "Then a friend of mine invited me to join the board of a nonprofit, ACCION International. I'd never been interested in nonprofits, let alone in becoming a staff member. But I ended up retiring from Wall Street and being the president and CEO of ACCION International, which I then ran for seven years." In 2000 he handed the reins to "a superb number two" and with four friends founded Pegasus Capital, a firm that deploys equity capital in Latin America. Chu still runs Pegasus but also joined HBS in 2003. His courses include "Effective Leadership of Social Enterprise" and "New Opportunities in Emerging Markets," the latter about managing investment opportunities, Chu said, "where angels fear to tread."
All-in Cost
The relevant measure for people struggling to build a microenterprise, be it selling onions, scrap metal, cell phones, or translation services, has to be the all-in cost of financing for working capital and fixed assets. Loan sharks charge interest rates that may be anything from 5 percent a day to 5 percent a week. The poor are often faced with the market failure of no commercial banking, Chu said. Where capital is so scarce its marginal productivity is enormous, he added.
"But at prevailing rates, the increase in productivity goes to the source of capital instead of the entrepreneur" so the microenterprise has no chance to grow. In addition, people have to cope with fluctuations in inflation, infrastructure failures, and the lack of a delivery system. In short, he said, "the poor pay more for everything."
His former organization, ACCION International, was a pioneer in the evolution of microfinance. It began in 1961 as a sort of pre-Peace Corps program working on community development with the poor in Latin America. In the 1970s it experimented with and developed a lending model. In the 1980s it made two important observations, he said: The poor can pay for what they need, and scale is not a challenge but a friend. In 2003 it had over one million clients, said Chu. Microfinance was not the purview only of ACCION, however. In 1992, Bolivia's Bancosol, he said, became the first commercial bank regulated by national banking authorities to be dedicated to microfinance. Just in Latin America there are now many others, in Colombia, Peru, Mexico, Honduras, Ecuador, and Venezuela. Some partner with conventional banks. The return on equity for these banks in 2003 ranged from 4 percent to 54.2 percent, he said.
At prevailing rates, the increase in productivity goes to the source of capital instead of the entrepreneur.
But the real success of microfinance is that serving the poor has the same benefits as anywhere else, he said: It attracts competition and creates an industry. "The poor are part of the definition of business. This has dramatic impact," he said.
Philanthropy can be a victim of fashion, Chu argued, citing the "Save the Whales" campaigns that rise and fall from time to time. Microfinance, on the other hand, sees the poor not as aid recipients but as clients. Aid recipients are passive and grateful; clients are active and demanding, said Chu.
Though it is not the answer for everyone (not all enterprises merit a loan, he said) and it is only one way in which a market has opened to serve the poor, its benefits are important to today's world, he said. Microfinance may be a social safety net when no other social safety nets exist, Chu added, "which is the case in the vast majority of the world."