Grameen Foundation in D.C.

My Will Ferrell titles and the content of my posts are diverging more and more.  This post has nothing to do with crêpes.

Another Haverford student and a friend of mine, Will Reilly, posted a comment a couple days ago.  His question was: “What kind of equity does Grameen have to absorb losses if they were to leverage up their winnings?”  First of all, thanks for the question, Will!  I actually don’t have any idea what he’s asking but I’m going to take his question, break it down, and use it to write a post that may or may not be at all related to his inquiry.

In order to abstract far enough away from Will’s question to render it useful to me I’m going to pick out individual words and reorder them.

Equity:  The balance sheet definition of equity is the amount of money contributed by the owners plus retained earnings (or losses).  The Grameen Foundation, as a nonprofit organization, does not have owners.  A lack of owners means that there is not an initial investment in the organization and also that profits (positive yearend earnings) are not paid out to owners (or shareholders).  The positive earnings are retained (ergo retained earnings) in order to be reinvested in the organization to encourage growth, weather losses, or achieve goals.   Where, might you ask, do these earnings come from?  The Grameen Foundation earns money through contributions/donations, investments, loans, and various fees.  These fees range from loan negotiation fees to implementation fees for mifos, the client management software that Grameen created.  By far the largest sources of income for the foundation are contributions and donations (from donors such as the Gates Foundation).  The majority of these grants, however, have caveats.  They are considered “restricted funds” and can only be put towards the specific programs or projects that the donor has chosen.

Leverage:  This is a perfect launching point for me to write about guarantees.  One of the Grameen Foundation’s purposes is to secure cheap financing for its partner microfinance institutions (which will now be referred to as MFIs).  Since many of these MFIs are not deposit taking (or at least not to the extent that they lend), they require loans from major banks in order to secure the money that they then lend out to the poor.  It is vital that they are able to borrow at low rates because the interest rates that they have to pay are directly reflected in the rates at which they lend to their clients.

Example: The Radiant Entrepreneur Mission of Yemen (an MFI that we will call REMY) needs to borrow money to lend to its poor Yemenite clients.  REMY borrows from Citibank at a rate of 6%.  To recoup their expenses, REMY has to tack 8% onto its loans.  This means that REMY has to charge a 14% interest rate to its clients in order to remain financially sustainable.

6% is a decent rate for Citibank to charge REMY.  If Citibank didn’t know REMY, or thought that they were disreputable or untrustworthy, they might charge a higher rate of 8% or 10%.  This would cause REMY to raise their rates, making it harder for them to accomplish their social mission of helping their clients move out of poverty.  In order to maintain low rates, the Grameen Foundation orchestrates loan contracts called guarantees.  Here’s a quick version of the process: Grameen matches a donor with a MFI.  The donor agrees to put up a certain amount of money.  An international bank (Citibank, Morgan Stanley…) then lends a larger amount of money to the MFI.  If the MFI defaults on part of the loan from the bank, the bank recoups its losses by calling up the guarantee.  The only way the bank loses money is if the total amount of the loan defaulted by the MFI exceeds the amount guaranteed by the donor.

Example:  REMY needs cheap money.  Grameen finds a donor that thinks that REMY is doing a great job of helping the poor.  The donor agrees to put up 2 million dollars.  Grameen links the donor up with Citibank.  The donor writes a piece of paper and sends it to Citibank that says that if Citibank lends to REMY, the donor will guarantee 2 million dollars (note: the donor usually doesn’t have to actually give Citibank any cash at this point).  Citibank says, “REMY looks like they have a strong management structure.  Their finances are all in order.  Their clients have an incredibly low default rate.  I’ll lend them 5 million dollars.”  Tada!  Leverage!!!  The 2 million dollar guarantee is leveraged to a 5 million dollar loan to REMY.  Now, fast forward a year.  There was a drought, an earthquake, and political instability.  Lots of REMY’s clients defaulted.  REMY can only pay 3 million dollars back to Citibank.  Citibank then turns to the donor and calls up the full amount of the guarantee.  Citibank, having been paid by the donor, ends up without a loss on the transaction.

NOTE:  These examples are pretty huge simplifications.  They assume that the loans from Citibank to REMY and from REMY to their clients all had terms of one year and that, due to some obvious blunder on Citibank’s part, the loan from Citibank to REMY was interest free.   Also I assumed that Yemen operates on the dollar, which they don’t.  Yemenites uses Yemeni rials (today’s exchange rate: 1 dollar = .004244 Yemeni rials).  Different currencies further complicate the matter because over the life of the loan there are inevitably currency fluctuations.  Citibank has to predict the potential fluctuations between the currencies of the guarantee and their loan to REMY.  This is really complicated and could be the reason why Citibank forgot to charge REMY interest.  I’d have attempted to work these aspects into my examples but microfinance is way too convoluted and I don’t understand a lot of it.

Losses and winnings:  I’m going to lump these together because I only have a short time to finish this post.  Taken entirely out of the context of the question, I’m going to consider what role the ideas of losses and winnings play in MFIs.  MFIs, at least those that adhere to Muhammad Yunus’ doctrine, are social businesses.  These types of businesses are said to have a double bottom line.  On one hand they are profit maximizing and on the other, social benefit maximizing.  This means that, as opposed to charities, MFIs seek to be financially sustainable.  They charge interest to clients to cover the MFI’s cost of borrowing money plus the cost of making the loan (personnel expenses…).  Any money that they earn over and above their costs (AKA profit) is then reinvested in the business in order to improve their services to clients.  However, most MFIs try to either maintain low profits or not earn any at all.  If an MFI earns high profits (earnings exceed costs) then they are probably charging too high of an interest rate to their clients (high interest rates are bad for clients because they reduce the benefit the client derives from the loan).  So, in summary, winnings for MFIs are reinvested in the business, and losses result in defaults on their loans from other banks.  These defaults translate to money lost on the part of the lending bank or a backing donor.

Well, I covered equity, leverage, losses, and winnings.  Hopefully my examples were more explanatory than confusing.  Ask me questions about Grameen’s earnings, or guarantees, if you have any.  I switched gears after the equity section and wrote mostly about MFIs and not the Grameen Foundation, although Grameen’s partner MFIs are its connections to the people that it is working for so even though they are separate organizations they all strive for the same goal.

Also, Will, in response to your question I think the answer is: no.

When things are crazy and it’s like your mind is trapped in a bottle.  Although that may be another Will Ferrell quote, it is definitely how I felt trying to get up to speed when I first joined Grameen in early June.

I thought I’d post a quick update since I haven’t posted in quite a while.  In a couple days I’ll put up a longer one covering a microfinance related topic that I’d like to discuss.

For now, I thought I’d describe what I’m doing here this summer.  I’ve posted several times about the ideas upon which microfinance is based upon but nothing about what my particular intern-y job entails.

My official title is “Intern in the Office of the President.”  It has a distinguished ring to it.   Upon introducing myself to other interns I receive the same looks that I get when I tell indie kids that I’m from Portland, the “ooooh-you-must-know-more-about-music/microfinance-than-I-do” look.  My apologies to all the Portlanders who have been riding this stereotype through their East coast college experience but, I still listen to Nickleback and Weird Al and, upon arriving at Grameen, probably knew only as much or even less about microfinance than the other interns.

As opposed to interns who work in specific departments (capital management, social performance management, development…), I am somewhat of a jack of all trades.  Working as an assistant to the assistant to the president I’ve focused on some of the president’s pet projects, comprising primarily outreach efforts, as well as coming up with a project of my own.

My three main projects this summer:

-Research and draft blog posts for Grameen’s partner in the Middle East/North Africa, Grameen-Jameel

-Comment on different websites, articles, and blogs, plugging various white papers that the Grameen Foundation has sponsored in the past year

-My personal project: compile a list of contact information for university microfinance clubs, reach out to them to start developing relationships, and plan a conference call that clubs can participate in this fall

In addition to these projects, much of my time here has been spent on various administrative tasks and educational events (offsite talks, sitting in on meetings, reading and researching).  I consider myself lucky to have had the opportunity to dabble in many of the Grameen Foundation’s divisions.  My miscellaneous projects have given me opportunities to work with and meet a large number of the Gramenies (no, I did not make that word up) stationed here in DC.

That’s it for now.  Feel free to comment or leave questions about microfinance if you’re feeling particularly mind bottled.

As part of an outreach effort, I am working to help the Grameen Foundation get the word out about a recently published paper that it commissioned.  The Foundation , as this white paper illustrates, makes it a priority to take an objective look at the impact of its work in the field of microfinance in order to better understand where it is most successful, and determine areas where it can improve.  The paper was authored by Kathleen Odell, a professor at the Dominican University Brennan School of Business, and is titled “Measuring the Impact of Microfinance: Taking Another Look.”

Though it was commissioned by Grameen, Professor Odell’s paper does not offer a particularly positive depiction of microfinance.  Instead, she examines the body of microfinance research published between 2005 and 2010 and concludes that, although microfinance does contribute to the growth of microbusinesses, it has not been found to have other widespread socially beneficial effects.   Microfinance is not the magic bullet solution to poverty that some of us might have hoped it would be.

Professor Odell’s paper raises another important and increasingly relevant issue: the immense contrast between academic papers and the press.   Her work, compared to popular media, does not endeavor to create a gripping story.  She fails to construct heroes or villains and presents no simple, clear cut answers to the questions surrounding microfinance.  Sadly, this type of objective analysis, examining each aspect of the question, differentiating between statistically significant and insignificant results, is diametrically opposed to the brand of writing found in most newspapers and magazines.  A New York Times article, published in April of this year, broadly characterized microfinance as a profit maximizing financial service aimed at taking advantage of the poor.  It is articles like this one that cater to the general resentment towards lending institutions in the wake of the financial crisis, and, thus, make irresponsibly generalized statements about an entire field by singling out just one or two microfinance institutions with questionable practices.

All in all, I highly recommend reading Professor Odell’s paper.  She describes quite clearly the difficulties inherent in measuring social change, and the experimental models necessary for studies to clarify exactly what microfinance does. If anything, her paper seeks to inspire the right type of thinking with respect to microfinance, and though it does not answer all of our questions, it certainly raises some important ones.

You can find Professor Odell’s paper here and the New York Times article here.