In 2011 the Nigerian government handed out 60 million dollars to about 1200 entrepreneurs, and three years later there are hundreds more new companies, generating tons of profit, and employing about 7000 new people.
24,000 Nigerians applied, the government selected about 6,000 to get some training and advice to develop their plan, the plans were scored, and about 1,200 were funded. They got an average of $50,000 each. Fifty thousand US dollars! Who the hell thought this was a good idea?
All the highest scoring plans got funded automatically, but McKenzie worked with the government to randomize among the runners up.
The results are amazing. Looking just at the people who had no firm to begin with, 54% of the control group have a firm after three years, compared to 93% of those who got the grant. And these firms are bigger. Just 11% of the control group have a firm with at least 10 employees, compared to 34% of those who got the grant. They’re more profitable too.
The Nigerians did a lot of things right for this one, especially when it came to choosing the winners and avoiding graft. The results are amazing and inspiring.
The important implication of findings like these is that while there will always be a minority who will waste the money, the vast majority of humans are a good investment under the right circumstances. And the cost of weeding out the duds (like in social security and development programs that require extensive proof of need and high prescribed standards to meet) is far higher than the cost of just giving away cash and accepting a few failures.
In 2008 I entered the microcredit business.That year I discovered the peer-to-peer lending platform MyC4, which lets you lend money to entrepreneurs in various African countries. My initial views on the platform were published in the German weekly “Der Freitag” but for those who don’t speak German or don’t like klicking links, here is a short round-up on MyC4:
As “investor”* you can open an account with MyC4. The platform then let’s you choose from a number of open loans, which have been vetted by local partner organizations, the so-called “providers”. The lending itself is competitive – it uses the “Dutch” auction system. You can place a bid (say 20 € at 15%) on an open loan. Once the total loan amount has been funded, new bids need to be better than the existing ones. The worst bid of a loan will be kicked out if another investor makes a better offer, thereby reducing the average interest on the loan. Once the interest passes a predetermined threshold (usually between 10 and 15%) the provider can close the loan, but most loans end up several percentage points below the asked interest. This system is supposed to ensure that investors with varying doing good/making profit expectations can participate in the platform.
Over the years, I dedicated a total of 1000 € from my savings to MyC4. My objective was to make a modest profit, which would render my investment sustainable. Sometimes during the last year I realized that my approach was not working out and I stopped reinvesting. Now almost all my loans are either paid back or defaulted and I can try to draw a conclusion.
As of today, I have invested a total of 2070.12 € through the platform. This is double the amount of money I actually put into it. This is possible, as MyC4 loans are repaid on a monthly schedule, thereby opening the door for rapid reinvestments. From a social perspective, I think this is far better than donating money, as this way I can give again and again and again, all while leaving a maximum of responsibility with the borrower, who after all knows best what he needs the money for.
While the social aspect of the experiment certainly worked out, the idea of making a profit sure didn’t. 17 of the 97 loans I participated in defaulted (an unacceptable 20% default rate), which resulted in a total loss of ca. 200 €. Worse, even the 73 loans that were fully repaid only barely broke even, because of massive currency deprecation.**
This criticism has to be qualified though. First of all, 73 hard-working entrepreneurs honored their contracts and repaid loans that asked for interest rates far higher than those common in the EU or USA. They deserve applause. Of those who didn’t repay in full (the average defaulted loan resulted in a 50% loss of the invested capital) we don’t know the stories and it may well be that some of them are not personally responsible for what happened.
Also, a part of these losses is due to beginner mistakes made by myself. Especially in the beginning, I did not spread the investments over enough borrowers, providers, countries and industries. I also didn’t calculate currency risk correctly, which resulted in the bad result for the repaid loans.
Most importantly though, a huge part of the losses is due to a Ponzi Scheme run by one of the providers, which gave rise to huge criticism on how MyC4 was run:
I don’t want to examine the whole story, but fact is that one of MyC4’s Kenyan providers put up fake loans on the platform, raked in the money of the lenders and subsequently made off with it. MyC4 itself did not participate in this criminal behavior, but they certainly neglected their duty to check on their business partners and ensure compliance to transparency standarts.
I guess at least half of my losses are due to this racket. As far as I know, there are still court proceedings going on in Kenya relating to this case, but I doubt that I will see any of the money I lost again.
MyC4 has made several changes to its procedures as a consequence, but I doubt that anything safe of a total makeover of the legal framework in the respective countries could fully mitigate the risk of such a thing happening again.
The long and the short of it
Investing in MyC4 has been a mixed experience. While it was certainly more effective than simply buying a goat through a donation to a large NGO in terms of “helping”, the promised profits have not materialized. As I said, I have transfered practically all of my remaining investment as a consequence of this.
But I will return! I am still convinced that micro-lending is a great way to combine supporting entrepreneurs in the developing world and making a small profit. While MyC4 had to fight many problems over the last few years, the changes they have made seem to result in a much more stable platform which reduces (though not eliminates) the risk of defaults and outright theft. Also, countries like Uganda and Ghana will join the ranks of oil-exporting nations this year, which will likely reduce the volatility of their currencies.
My new investment in MyC4 will reflect my experiences. I will adhere religiously to a doctrine of spreading my loans over various countries, providers and industries. I will limit the value of a single investment to a maximum of 20 €. And I will be more rigorous in calculating my asked interest rate to make sure that I ideally realize a profit around 3%.
Are you investing in microloans, either thorugh MyC4, kiva or other organizations? Which experiences have you made?
While competing platforms like kiva focus on the “giving” aspect of microcredits, the approach of MyC4 focusses on “profit” for both the borrower and the lender.
** The main culprit for this one was the weakness of the East Africa Shilling currencies over the last years. This seems to be normalizing now.