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Microcredit is not a new idea. The practice of making small loans for entrepreneurial activities has been around at least since the 19th century. But the idea has taken off in recent years. In 1983, Bangladesh's Grameen Bank was founded explicitly to make microloans. The success of the bank spawned literally thousands of imitators and earned Grameen and its founder, Vanderbilt-educated Muhammad Yunus, the 2006 Nobel Peace Prize.
Grameen's success notwithstanding, microlending has mostly been seen as charity, a philanthropic activity. Organizations such as Kiva.org have used the internet to match borrowers and lenders. Now, Patrick Fisher and others want to scale the idea by turning microfinance into an asset class.
Fisher, 30, is the founder of Chicago-based Creation Investments. He has an MBA from the Kellogg School, not to mention Bank One and JP Morgan/Chase on his resumé-including tenures in Latin America and China. (He's fluent in Spanish and describes his Mandarin as "intermediate.") But more to the point, he has launched a projected $50 million fund that will make investments in banks and other organizations that make microloans to poor people in developing countries.
"The investment world has orders of magnitude more money than the philanthropic world," Fisher said. "If we can demonstrate the viability of microloans as an asset class, we'll have access to investment dollars, not just charity dollars, to help the poor."
To that end, Fisher plans to invest the fund he is currently raising in banks in Cambodia, Kosovo, and Mexico. His $50 million fund is considered small by either hedge fund or venture capital fund standards, but Fisher and industry observers say it is large enough-if managed properly-to demonstrate the viability of the process. "If we make money for people in this first fund," Fisher says, "then perhaps people will want to participate in a larger fund in the future."
Organizations such as Opportunity International have been at this-as a nonprofit organization-since the 1970s, and the group serves more than 1 million people. Steve Nelson is the vice president for strategic initiatives for Opportunity International. He welcomes all comers to this corner of the financial world. "The need to get entrepreneurial capital to the poor is huge, much too large for one or even 100 organizations," he said. He believes, however, that "for the next five or 10 years, microfinance will remain largely in the social sector." That is, he believes microfinance will remain in the domain of the philanthropic, rather than the much larger investment, world.
His skepticism is well-founded. For all the pioneering work of Grameen Bank to make microloan recipients more accountable and the asset class less risky, the cost of running a microcredit operation remains high. Nelson explains that most true microloans are less than $500. So to deploy a meaningful amount of capital takes a large number of transactions-and, thus, significant administrative costs. Nelson says, "It costs us 23 cents to lend a dollar."
That translates into a 23 percent interest rate even if investors are willing to accept a zero rate of return. That's why most microloans charge anywhere from 30 percent to 40 percent interest, which the theologically minded consider to be violations of biblical injunctions against usury. For Fisher's fund, the problem is compounded by the need for investors to earn a competitive return as well as the expenses incurred by the fund itself.
Opportunity International's Nelson defends the high costs. "The alternative is not good," he said. "Either the poor can't access credit at all and remain in the most degrading conditions of poverty, or they are victims of loan sharks who might charge them as much as 1,000 percent."
Creation Investments' Fisher acknowledges that the rates are high, but he believes the costs will come down as the industry matures. "There's no better guard against usury than competition," he said.
Or, to borrow a line from an American financial institution: When microfinance organizations compete, the poor win. So far, that line has more promise than proof, but given microfinancing's growth, the right answer-or answers-will likely emerge.
Editor's Note: This article has been edited to reflect that Patrick Fisher has launched a projected $50 million fund.