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Flannery: Microfinance Just ‘One Factor’ in Economic Growth

Interviewee: Matt Flannery, cofounder and CEO of Kiva
Interviewer: Stephanie Hanson
March 11, 2008

Matt Flannery, cofounder of Kiva.org, a website that partners with microfinance institutions to allow people to loan money to entrepreneurs in the developing world, discusses the microfinance industry and its growing popularity among large financial institutions and the development community. He says the practice of providing financial services to the poor is not necessarily going to increase a country’s economic growth rate. Despite the high costs associated with making small loans, large financial institutions have become more interested in microfinance in recent years. Flannery says the combination of large sums of capital and limited opportunities for investment has caused the industry to become “clogged.”

Since you started Kiva, microfinance has become quite a buzzword in the development community. People are making very big claims about what microfinance can do in terms of poverty reduction. What do you think microfinance can do and what are its limitations?

Microfinance is the practice of providing financial services to the poor, which is a great thing in and of itself. The poor deserve to have credit. Then again, I’ve failed to see a study that proves that there’s a linkage between macroeconomic growth of a country and the provision of financial services to the poor. So my conclusion at this point is that microfinance is weakly associated with macroeconomic growth. It’s just one factor; it’s not necessarily going to cause a country’s GDP [gross domestic product] to increase. It has to be accompanied by things like good governance, infrastructure, transparency in economics, and all sorts of other things that microfinance cannot in and of itself to bring about.

It would be difficult or impossible to build a hospital with microloans, or to build a road. That’s really out of the scope. But a lot of people sometimes get into a trap of thinking these are tradeoffs and you have to choose one or the other. You either have to support microfinance or you have to support SMEs [small and medium enterprises] or you have to support microfinance or health care. And if you’re doing microfinance you have to argue that that is the best and that it’s the magic bullet—some people do that. But really the pathway out of poverty is a combination of so many factors that one set of services can’t really do it alone.

Kiva has had a lot of great publicity in the past year, and you have had a swell of interest on your website. Is there greater desire among people to lend than there is capacity to absorb that funding?

There probably is. In the end, we’ll see that there is more debt capital available to the microfinance industry than is easily absorbed. So our lenders have to grow with the industry as it grows. It’s going through a lot of growing pains as well. I would say the long-term constraint of our business and other funders in microfinance is finding credible, established places to safely place your money and know that it’s doing good work.

Part of your mission now is to expand your partners to what you call the long tail, these smaller, less-tested microfinance institutions. How has that changed your process of evaluating these partners?

There are hundreds—if not thousands—of small, medium MFIs [microfinance institutions] that are off the radar screen of international capital market funders. So it is very costly to work with a rather new, somewhat obscure MFI in some place far away. It’s very costly to do the due diligence. In the end you find that you might not be able to invest that much money into the MFI because it’s so small.

We’re using the Internet as a way to reduce the cost of working with one of those MFIs and also distribute the risk. Now you can lend smaller amounts of money at very low cost to many, many more institutions. They happen to be MFIs in our case, but eBay would do it with small craftsmen, sellers, or toyshops. You can distribute the risk along many, many, many more vendors for lower costs.

Let’s say you’ve identified a potential new MFIthat you’re interested in working with. What is the process that Kiva goes through to say, “Yes we’re going to partner with this institution.”

Traditionally we’ve relied on other people to do the due diligence. We’ve relied on networks heavily. There are many, many networks of microfinance institutions, whether they be local networks, networks in Ghana , international networks like Accion or Grameen Foundation or CHF International or Mercy Corps. We’ve relied on their references and their due diligences, especially early on; Kiva was just a few people in a living room in San Francisco—then finally in an office.

We’re growing. We’re going to start doing more and more due diligence ourselves because we have to reach further into the world. We’re actually opening offices in East Africa, Peru, and West Africa eventually. In many regions around the world we will have our own staff and start building an in-house due-diligence expertise.

We look for audited finances, external funders, credible references, a track record of lending, size of portfolio, portfolio at risk. All these things are put into a statistical model that we have, which spits out a risk rating. That risk rating generates a sort of fundraising cap. MFIs on our site that are very established and have a ton of references and a ton of due diligence that is very recent can raise a lot more money than a brand new start-up with promising management that is not part of a strong network. That is how we limit or reduce the risk—but there is risk.

How do you draw the distinction between having an office in one of these countries and having your own MFI ?

Running an MFI is a difficult business and is very different than doing due diligence on an MFI . We are looking to build expertise on due diligence and analysis of risk. To do that it takes a lot of visitation, auditing, and in-person work on the ground, essentially. Lending to the poor in a community is a completely different set of skills and experiences. That’s something we’re not trying to do because there exists an international movement of microfinance. We’re simply building on top of that.

Opening offices is quite capital intensive—how are you coping with this large increase in cost and where does that money come from?

Traditionally, our main source of income has been tips that our users pay us after we loan. We allow our lenders to send 100 percent of the money to the person they see on the Internet. We don’t ask for a mandatory fee. What we ask for is an optional fee, a tip essentially. With that we are getting quite good results. That’s our primary income stream. In 2007 we almost broke even just on that.

Our projections going forward have us continuing to break even in the long run. But in the short term, we have been increasing our costs faster than our user base pays us. So what we’ve done is raise grants from major foundations, like the Rockefeller Foundation, or the Dune Foundation in Holland, or the Kellogg Foundation. Several other foundations have come together and helped us bridge that gap.

Large financial institutions are becoming more interested in microfinance. Is there something that might make it difficult for them to be successful in microfinance, perhaps some of the things that you’ve mentioned, the high costs?

There are hundreds of funds now that are international money lenders or equity holders in the microfinance industry—in MFIs typically. What we’re seeing is a great enthusiasm to do that, which is a wonderful thing. Among the set of MFIs in the world there are very few that are really credit-worthy to take a commercial investment—two hundred or three hundred. But there are thousands of MFIs all over the world, so what you have is an increasingly crowded space where a growing set of funds are trying to put a growing set of money into a set of MFIs that is not growing that much and is getting clogged.

Kiva has different characteristics than a hedge fund or a pension fund or a broker deal like MicroPlace [eBay microfinance website]. Kiva relies on people lending twenty-five dollars at a time for reasons of affinity and emotional reasons. There’s a different risk profile than someone putting their retirement account into microfinance. Because of the different characteristics of the source of the income, we can place money in a different way—smaller amounts in a whole variety of MFIs, some risky, some less risky.

If you look at Kiva five years down the road, what do you see?

I think it’s up to our users to cocreate that. But you can imagine things like interest rates on the site, eventually, when that becomes important to our users—if that becomes important to our users. Allowing people to make an actual return on their money might be something we do. Right now our users aren’t necessarily begging for that so we are putting it off.

Another thing we could do is allow borrowers to become lenders on our site. We could allow women in Ghana to lend to women in Mexico. Increasingly you will see a general trend of blurring of the lines between first and third world. We’ve already had Mexicans lending to Mexicans. We’ve had Malaysians lending to Iraqis. We’ve had all sorts of blurring distinctions between the haves and the have-nots and that’s playing itself out on our site, which is really, really interesting to watch.

What do you think Kiva can do to facilitate that?

The real motivation behind Kiva was to blur boundaries between what we think of as poverty and who we think of as wealthy and who we think of as people in poverty. A part of that will be allowing interest rates to float on the site, allowing people to think about the people in poverty as business partners, not necessarily people to take pity upon. That’s really, really important to what we do.

Eventually I think you will see people in the global South actually lending to people in the global North. So someone in Chicago can take a loan from someone in Kampala, Uganda. That will be really, really interesting as well then all scenarios start playing themselves out.

Do you think all this information Kiva is gathering about individual lenders and about microfinance institutions could be used in academic research to look more rigorously at the effects of microfinance?

That’s one of its most promising aspects and that’s something we’ll try to do more and more. Kiva is a rich information resource and it’s going to get richer and richer, which is really exciting. In most cases, it’s actually just a tool for social consciousness more than a vessel for the maximum amount of money. It’s really about outreach. In the future, I think you will see things like social impact measured on the site, cross-country, cross-continent; it will be really interesting to see the social impact play itself out, either positively or negatively on this information resource. Academics will find that useful.

Have you had academics reach out to you about getting access to your information or developing some kind of study?

I’ve definitely had academics ask that and I’ve had funders sort of demand that. They’ve said, “We don’t want to see you just pour as much money as possible into MFIs. We want to see you measure the impact as you do that.” I think that’s the appropriate thing to start working on, although it’s a difficult problem.

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