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Change To Spare: How A Growing Industry Of Micolenders Is Banking To The Masses

In the late 1970's Muhammed Yunus brought microfinance into the developing world via his home country of Bangladesh. His operation, Grameen Bank, was and continues to be enormously successful. In the 1980's, Grameen attempted to branch into the southern United States, but their lending model failed in a market where the primary need was for job training and placement. Grameen stayed away until reopening its American operations in New York in 2008. American microfinance remained under the radar until the Clinton Administration, when welfare policies shifted away from cash transfers and towards achieving development goals. Since then, domestic microfinance has grown at a healthy clip.

What we call microfinance in the US is dramatically different from the model that came out of Bangladesh. Micro lending in the developing world means loans of around $100 or less, which are distributed to mutually guaranteeing groups of people, overwhelmingly women, who use the money to buy very basic capital goods or pay for living necessities. For example, a loan may be given to a group of women who use the money to buy a sewing machine, which they share, and use the proceeds made from selling goods to repay the loan.

In the United States, a micro loan is considered anything under $35,000, although loans tend to fall in the $1,000-$10,000 range. Lending is more often distributed to existing small businesses or employed individuals looking to create a secondary income. American borrowers have resisted the peer lending model, and as a result, domestic lenders focus on using collateral or guarantors to support loans. Funding is typically allocated for capital upgrades, like a new painter's van or an interior renovation at a hair salon.

All of these characteristics come with the caveat that when the borrower originates from a country where the developing-world model of microfinance is prevalent, they prefer to work with a similar model. Thus, Grameen's new office in New York exclusively uses the peer lending model and caters almost entirely to immigrant borrowers.

The important distinction between the nature of microfinance in the United States versus Bangladesh has to do with scope relative to the economy. Grameen, with assets of just under $1.5 billion, represents 1.4% of the Bangladesh's nominal GDP. In the United States, microfinance is administered by tiny lenders who manage to serve only a fraction of the 45 million Americans who have limited or no access to mainstream financial services. An important part of the lenders' mission is to create a credit history for their clients and provide financial and business education.

Oftentimes the loan itself is merely a part of a broader package that includes counseling, group support, workshops, access to online resources and credit building schemes. Yanki Tshering of the Business Center for New Americans (BCNA), describes micro lending as "private client financial services for a low-income clientele." The future of microfinance in the United States depends on whether or not this approach can either attract the interest of bulge bracket banks or create a few industry champions that grow to accommodate the domestic market.

And thus we arrive at the Holy Grail of microfinance: profitability. For now, very few American micro lenders have achieved profitability outright, and those that have are still dependent on low-interest funding from banks, notably Citibank, or funding from various federal and state agencies. Grameen has managed to attain profitability by virtue of volume. Its large size allows it to live off of miniscule margins, and it's peer-lending model puts the onus of administration on the borrowers.

Profitability will allow the sector to attract more qualified talent, which is a challenge for American lenders. More importantly, profitability allows lenders to outgrow the confines of their current capital pools, which are limited by government budgets and appetite for charity among banks and wealthy donors.

As long as profitability eludes domestic micro lenders, the sector will continue to remain small and function primarily as a conduit for people to integrate into the mainstream system. If profitability can be achieved and stabilized, the sector has the potential to become a staple of the American financial services industry.

[i] These changes were effected through the signing of the Riegel Community Development and Regulatory Improvement Act (1994), The Personal Responsibility and Work Opportunity Act (1996), and reform of the Community Reinvestment Act via regulatory and legislative changes in 1995 and 1999.