Charity and Intermediation
Kiva.org is a fascinating organization: it allows individual members of the public to provide credit to microenterprises of their choice around the world. (Disclosure: My wife and I received a gift of a $200 Kiva credit, which we lent out.) The candidate microenterprises are listed by local microfinance institutions (MFI’s) that are Kiva partners. The local MFI’s actually receive the funds, disburse the loan, and collect repayments. Kiva loans earn no interest for the lender but do entail risk: the individuals who chose to lend to a given microentrepreneur don’t receive their money back if that microentrepreneur defaults.
Kiva has many characteristics of a charity. Resources are transferred to needy individuals in developing countries. Lenders are motivated by the prospect of using their resources to do good. Lenders accept the possibility of defaults, and accept that they will earn no interest on their loans.
In addition, Kiva has characteristics of a financial intermediary, like a bank. Most banks, however, pool the deposits they receive and then make loans out of that common pool of funds. In fact, this is what is typically meant by the term “financial intermediation”: by undertaking this pooling, an institution mediates between borrowers and lenders, and shares default risks among all of the people who lend to it.
Standard economic models would imply that Kiva is inefficient: lenders via Kiva could, it seems, have their risks pooled. Since Kiva does not do this, the lenders must be compensated for the risk they continue to bear, driving down the amount they’re willing to lend and driving up the interest rate they require as compensation.
Despite these indications of inefficiency, I see two reasons the current arrangement might not be completely baffling. First, when I was in Gujarat in April, I met a Kiva representative who said that Indian financial sector regulations– which substantially circumscribe opportunities for foreign entities to operate in India– effectively kept Kiva out, too. I suspect that a variety of other regulations also act as constraints. Presumably under the current structure Kiva is not considered a US depository institution, for example, avoiding tomes of requirements.
Second, it could be the case that individual lenders enjoy the connection to individual borrowers; and/or that individual borrowers are more intrinsically motivated to work hard at their enterprises, in order to repay, when they know individual lenders have placed faith in them. This reason would be more fundamental to the Kiva approach; to the extent financial sector rules liberalize (or, perhaps, differ across country borders) and allow intermediated microlending from Western creditors to LDC borrowers, we may learn whether the intrinsic aspects are operative.
All in all, I’m not concerned about Kiva’s strategy: It’s much more important to give LDC borrowers access to world capital markets in any form than it is to protect developed-country lenders from risk. That said, it would make more sense if mainstream Western financial institutions could provide debt or equity to Kiva, diversifying lenders’ portfolios.
