A Magical Loan Closing

By Tim Stay

I wrote this in January of 2004 after returning from a expedition to India for Unitus. I am a co-founder of Unitus and currently serve on the Unitus Board. Unitus is a Global Microfinance Accelerator, helping Microfinance institutions grow faster as they serve the poor, primarily through the use of microcredit loans.

A Magical Loan Closing
Under a Full-Moon in India

January 12, 2004

I had never witnessed a financial transaction quite like this one. It was a warm magical evening, right at twilight, and a big full moon was rising over the central Indian plains above us. We sat on the dusty ground, barefoot, observing the wondrous scene before us. We had removed our shoes as a sign of respect before entering into the circle on a small patch of open land and we sat down to watch these women pass their test and finalize the organization of their group, in preparation of completing their financial transaction.

We sat in front of a house in a little village of several thousand outside of a little town called Medak, which was several hours away from Hyderabad in central India. The house was a simple structure, made of hand-cut stone, with water buffalo dung used as plaster to patch the holes and smooth the walls. The roof was a thatched roof of reeds and grasses. There was no electricity in the home and we had small lanterns and the light of the full moon to illuminate the scene before us.

The five women sitting facing us were completing the fifth day of training in order to borrow small loans from SKS, an Indian Microfinance Institution, which had received funds from Unitus, the group we were with. An officer from this microcredit bank had traveled the 10 kilometers along a small dirt road to meet with these borrowers to test their readiness to enter into a loan with SKS.

Testing the comprehension of illiterate women of a financial transaction

The testing consisted of several steps before the loan transaction could be completed. One of the first steps was that each woman had to sign her name. Nervously each woman came forward to show she could sign her name. Later, when it was time to finalize the transaction, she would have to sign the loan documents as well. We didn’t think it was that big of a deal, until it was later explained to us that none of the five had ever written their name before. It was especially meaningful to later enter into one of their homes and find their name written over and over again in chalk on her mud floor as she had learned and practiced writing her name.

Next, one of the five began to recite their pledge to the bank. As she spoke each pledge, the other four would repeat in unison the pledge. This pledge would be recited at the beginning of every meeting they would hold with the bank. In the pledge, they promised to attend each weekly meeting without fail, to pay back the loans in weekly installments, to help the needy in their group, to abide by all the rules of the group and to use the loans to uplift their family’s economy.

The SKS Branch Manager who was conducting this testing sat on the ground facing of the five women. She got out five pebbles from a bag and laid them on the ground in front of her and told the women that the pebbles represented each of them. Over the next few minutes she rearranged the pebbles into different groupings as she asked them a series of questions. She would ask questions and the group in unison would answer back. It was almost musical to hear the questions and the beautiful voices of the women responding back.

Sandia, the Branch Manager, asked them a series of questions that included the following:

Who do the stones represent?
“They represent our group,” was the answer.

What does the group want to do?
We want to borrow money.

Even though each of you will get money from your loans, who is responsible for paying it back?
All of us are responsible.

What if one person doesn’t make their weekly payment?
The rest of us have to pay for her.

What happens if the group doesn’t have the money to cover their missing payment?
The group can borrow funds from their group savings account to cover it.

What does this group need to do each week?
We need to meet with the loan officer and make our weekly installment payments.

What happens at these meetings?
We make our principle payment, we make our interest payment and we make our savings deposit.

What is required for this group to be successful?
We must trust each other, support each other and keep our commitments.

Understanding Principle and Interest

Sandia then took out a thousand rupees (about $20) and placed it in front of one of the women. She asked this woman, who couldn’t read or write, to show how much she needed to pay back each week for a 50 week loan. As I struggled in my mind with the mental math, this woman quickly laid out 28 rupees for her weekly payment. The loan officer asked her to separate the payment into three groups, the principle payment, the interest payment, and the weekly saving requirement. She quickly separated the money into three piles. In the first pile were 20 rupees to be paid as a weekly installment on the principle. (20 rupees x 50 weekly payments = 1000 rupees). The second pile had 3 rupees (3 rupees x 50 weekly payments = 150 rupees, which equals about a 15% straight interest rate or about 28% effective rate). In the third pile were 5 rupees for the required savings deposit, which would total 250 rupees by the end of the 50 week payment cycle.

SKS requires each borrower to have a mandatory savings account. If these funds are never used, they receive the money back at the end of the payment cycle. In their group lending methodology, if a member of the group cannot meet their weekly payment, then the other four members of the group need to cover her repayment. If the group wants to, they can borrow money from their savings account to cover that amount. They can never borrow more that 50% of their savings account balance. They also must repay their savings account loan, but it is only principle repayment, as no interest is charged on their own money.

Sandia takes the 1,000 rupees and then makes a new pile in front of another woman. This time the amount is for 5,000 rupees. The woman quickly makes 3 piles to show her weekly payment. One pile for principle of 100 rupees, one pile for 15 rupees for interest, and one pile for 5 rupees for the savings requirement. Sandia repeats this test varying the amount of the loan with each of the women. Most are able to quickly do the math and show the weekly payments, but one struggles with getting the right amount, and the other women in this borrowing group quickly jump in and help show her the right amount.

Social Collateral

This is one of the fundamental principles of microcredit. Some have called it Social Collateral. Unlike a traditional bank, where the loan is secured by some asset, micro-credit loans are given without any collateralization of assets. While specific methodologies vary, most Microfinance Institutions (MFIs) loan money to a group and rely upon the group dynamics, this social collateral, to help ensure repayment. Several factors seem to take place. One is that the poor have seldom had anyone ever trust them before and they are determined to show that they are worthy of this trust. Another is that the other members of their groups are their neighbors and friends that they have to live with the rest of their lives and they don’t want to upset the goodwill between each other. These groups are self-selected and so it is unlikely that a person that is not trusted would be invited to be part of a group. If a member of a group shows to be untrustworthy, the group can replace her and bring another member into the group. They also know that 100% repayment is required for the group to get subsequent and larger loans. The resulting repayment rate is astonishing, varying between 95-100% repayment across the industry.

When we first became acquainted with SKS and they told us that their repayment rate was 100%, we were skeptical. But as we did our thorough and complete due diligence of their accounting, their processes and their IS systems, we began to believe the numbers. What we found is that most of the time, the individuals made their weekly repayments on-time and without any problems. However, there were some times when payments were missed by the individuals. When this occurred, their missing payments were required to be covered by the group. If the group could not cover the missing payment, the group could borrow from their mandatory savings account and make the missing payment. Even still there was one more safety net to ensure that the payment was made.

Each group consisted of 5 women. SKS organized their weekly meeting to consist of a meeting with 8 groups all-together, which formed a center. So a center meeting would have 40 women in attendance, with each group making their weekly repayment and receiving new loans if they had requested them. Each group of women elected a group leader and the group leader handled all the transactions with the loan officer. The 8 group leaders elected a center leader and that center leader would conduct the meetings and verify the proceedings. In the event that a group could not cover the missing payment of one or more of its members, the center was then required to cover the missing amount.

The center meeting we later attended was held under a huge tamarind tree in the village. This tree was one of the sacred trees of the village and important community meetings and village decision were made under this tree, adding to the seriousness of their center meeting.

With the combination of the group covering the missing repayment, being able to tap into their savings account if they needed, and having the backstop of the center covering anything else, we came to believe that SKS actually did have 100% repayment on the loans that they made.

Debunking the Myth that the Poor are not Credit Worthy

Microcredit refutes the myth that the poor are not credit-worthy. Microcredit fills a gap in the financial markets making capital available to a segment of the market that does not have access to capital or only has access to very expensive capital. In the MFI industry, you will see effective interest rates that range from 20-60% depending upon the local economy and competitive interest rates. In the case of the 28% interest rate that SKS charges, it is similar to the interest rate charged on credit cards in India and is certainly much less that the rates of 50-150% that the local money lenders offer.

As I watched these women demonstrate their understanding of principle and interest, I wondered if these loans would actually make a difference in the lives of these women. Later I asked what they would be using their loans for. One woman was going to borrow 8,000 rupees (about $200 US) to purchase a buffalo. Each week she would have to pay 189 rupees (160 rupees in principle, 24 rupees for interest, and 5 rupees for savings). With her buffalo, she would be able to get about 6 liters of milk per day that she could sell. She could get on average about 12 rupees per liter, so she would get around 72 rupees per day or 504 rupees per week. The buffalo could graze on the country side for free so there was no food cost. After paying her loan payment, her weekly profit for the buffalo was 315 rupees per week or 45 rupees per day. Considering that by working in the fields for a landlord or local farmer that she could earn around 25 rupees ($0.50 US) per day, her buffalo loan increased her daily income by more than 180%.

Over the years there have been countless well-meaning development projects. Some have been great successes, but others have been miserable failures, especially when you consider the huge sums of money that have been thrown at these problems. Some have focused on increasing nutrition. Some on increasing access to medical care, others on creating access to clean water supplies and appropriate sanitation facilities. Microcredit focuses on increasing income for the individual and studies have shown that increasing income allows the individual to improve their nutrition, their educational opportunities, the quality of their water supply and the accessibility to medical care, and it is done in a sustainable fashion. If a whole region can increase the income per capita, then more macro-level development issues can start to be addressed and programs maintained.

I realized that I had about $200 in my pocket. For the amount of money that I had in my pocket, I saw that I could change someone’s life. And I could do it in a way where they maintained their dignity, independence and self-reliance and avoided the dependency of the dole.

Whose Money is it?

Before Sandia executed the loan documents with the women, she did one more test. She took the three piles of principle, interest and savings that one of the women had made and asked the group about each pile of money.

She picked up the principle pile and asked several questions:

What is this money?
It is the principle payment, was the answer in unison
What is this payment used for?
It is to payback the loan.

She picked up the second pile.

What is this money?
It is the interest payment.
What is this payment for?
To cover the cost of the loan.
Whose money is this?
It is SKS’s money.
What does SKS use the money for?
To pay for the cost of the loan officers and to make new loans.

She picked up the third pile.

What is this money?
It is the savings deposit.
Whose money is this?
It is our money.
Who can use this money?
We can borrow this money if we need to.
How much can you borrow?
We can only borrow up to 50% of the savings.

Breaking the Chains of Poverty on a Global Basis

As the MFI industry has grown up over the last 25 years, billions of dollars have been lent and repaid in millions of small loans around the world in transactions just like the one we were observing. In some countries, millions of the poor are benefiting from the access to capital as a means to improve their lives and break the vicious chains of poverty. We are seeing MFIs become very sophisticated in their use of the world’s financial services as they seek for cheaper and cheaper sources of capital that they can lend and most exciting of all, we see many of these MFIs reach sustainability. This means that these MFIs do not require more and more donations from charitable individuals and institutions, but that they can become self-reliant and become mature enough fiscally to access the financial markets at competitive rates for their source of capital. And even more exciting, it that these organizations will be able to recycle their capital over and over, without it being depleted, and more and more poor will be able to be assisted.

Unitus, the Seattle-based nonprofit group that we are part of, believes that microcredit can actually alleviate poverty on a large scale. We believe that millions and millions on the earth can be freed from this overwhelming bondage of poverty. We see our role to identify the best MFIs out there in the world that have the right management teams, the right processes and accountability systems, and the right vision of the future and then help them accelerate their growth and ability to serve more of the poor. We help with making grants to help build their infrastructure, management, and systems. We help by making loans at low interest rates. We help with making equity investments to make them more attractive to local financial institutions, and we help with corporate governance issues and with networking opportunities. And we help access and create new financial instruments that can be utilized by the MFIs.

We believe that SKS can reach 300,000 borrowers by 2008 with the help of Unitus. If you assume that each borrower is part of a family of at least 4 people, that is over 1 million people being helped out of poverty. We believe that Unitus can help reach tens of millions of poor over the next decade with other MFIs and we believe that will help change the world.

Lessons I learned in India

It was time for the execution of the loan documents. As I watched each woman come forward to tentatively sign her name to the document, and receive her account booklet that would be filled out each week, I realized that these women probably understood the responsibilities of borrowing this money far better that I did when I took out my first loan. They understood the concept of principle and interest, they understood the consequences of not repaying the loan and they understood that good credit history would determine their ability to access capital in the future. I didn’t know all of that when I took my first loan and I realized that I haven’t taught these principles well to my kids. Suddenly I was humbled to realize that I had been taught a great lesson by these illiterate women sitting on the dusty Indian ground on this warm moonlit night.

A few days later, I stood at the Gandhi museum in New Delhi. As I followed his life from a successful lawyer with a profitable and comfortable lifestyle and saw him take a series of steps where he became more and more selfless and more and more caring of the poor and the downtrodden, I saw how his circle of influence grew and grew until I saw how this small man dressed in simple home-spun clothes brought about independence for his country through his philosophy of non-violence and through the devotion of his mind and soul. Next to a memorial of his death was a quote from Gandhi that struck me to the core.

Above the case holding the blood-stained garments he was wearing on the day he was assassinated, was this quote by Gandhi:

“My life is my message.”

I stood there and asked myself, “What is my message? When my life is over, what message will be told? Will it be one of wealth and comfort or will it be one of devotion and service? Will the world be better because of my presence? Will I have been able to help reduce the suffering and misery in this world or will I have added to it?”

This is why I am part of Unitus I believe I can help be part of something that can change the world. I want this to be part of my life, because I want part of my message to be that I helped in an effort that relieved suffering for millions and millions of people.