A fascinating BBC news story emerged recently.
A controversial payday lender called Wonga came to a voluntary settlement with the United Kingdom regulator after admitting it had been lending recklessly, at high interest rates, to people otherwise excluded from the financial sector.
It has agreed to write off 220 million pounds ($402 million) of loans. These loans represent 330,000 clients who should not have been offered a loan, according to the regulator.
An additional 45,000 clients will no longer have to pay interest on their outstanding loans but will have to repay the capital.
The interest rates are a little steep, often exceeding 5,000 percent APR – no omitted decimals here.
The CEO admitted lending to people who could not “reasonably afford the loan in question.”
The company is funded by a variety of venture capital firms – former Goldman Sachs folk to be precise – and the management’s own shares.
Clients openly admitted how they had lied on application forms and got into deep trouble with over-indebtedness.
There are some important similarities between Wonga and microfinance institutions (MFIs) as well as some equally important differences between the payday lending industry and the microfinance sector in developing countries.
Over-indebtedness is chronic in the microfinance industry. Uncontrolled credit gets people into trouble. Mexico and Peru are the current best examples.
It doesn’t ultimately matter where you are, or even how wealthy you are, debt is a dangerous tool.
Aggressive debt collection methods are also problematic. The 54 suicides in Andhra Pradesh and stories of loan officers pressuring female clients to drink poison in order to get the insurance payment are two extreme examples.
This practice is not restricted to India. Wonga is a U.K.-regulated financial institution and was caught using aggressive and illegal debt collection techniques.
When companies and their staff are under constant pressure to reach targets, grow, boost return on equity and earn their next bonus, inevitably some will pile on the pressure a little too much.
The Wonga interest rates are high, but so are those charged by microfinance institutions.
Muhammad Yunus, an MFI pioneer, lamented in a New York Times article, “I never imagined that one day microcredit would give rise to its own breed of loan sharks.”
For example, global microfinance network Finca Zambia charges up to 347.5 percent APR, according to the most recent data available on MFTransparency, an independent nongovernmental organization that verifies actual APRs of MFIs. Do we really expect the poor to benefit from such rates?
This leads to a key question: What are the differences between vanilla microfinance and Wonga?
There are many, but I would like to point out one. U.K. citizens, like citizens of most Western nations, are protected by a reasonably effective regulator with teeth.
They have complaint mechanisms, bankruptcy laws and an open media willing to expose cases of “extortion” or “usury.”
The Church of England even intervened in the case of Wonga. U.K. citizens are fairly aware of their rights but often take this protection for granted.
The majority of microfinance clients have few meaningful rights in reality. There is no regulator protecting them from such practices. The legal systems are onerous and unaffordable.
They are terrified of defaulting on a loan and being excluded from even the microfinance sector, and thus some are inevitably forced into prostitution or selling their own organs to repay a loan. But investors in such institutions can get away with this, as they operate with impunity.
Microfinance is opaque, nontransparent and unregulated. The logic is often that celebrities like Bono support it and the websites look pretty so it must be OK.
The investors in microfinance, as in Wonga, are far removed from the reality the ultimate clients face and simply reap the benefits of this desperation.
What do we offer the poor by way of protective regulation? To be blunt, the best efforts of the microfinance sector are so pathetic to be almost laughable, were it not for the tragedy that befalls the victims in these far-flung corners of the globe.
According to the U.K. regulator, 375,000 of Wonga’s clients have been unfairly treated.
How many of the 200 million microfinance clients suffer similar treatment?
For all the rhetoric about financial inclusion and microfinance and empowering the wealth at the bottom of the pyramid, or whatever the latest catchphrase is, have we forgotten our obligation to act responsibly?
When have we, as a sector blighted with scandals, had the courage of the Wonga CEO to apologize for our actions?
Must we wait until the inevitable collapse of entire microfinance sectors, as has happened on countless occasions to date, before we consider the pain that over-indebted people go through?
That people want and need money is no justification to offer them loans at 5,000, 500 or 50 percent interest.
There seems to be a cruel double standard here. When British people are exploited by usurious predatory lenders, there is a scandal. When we do it in developing countries, it’s considered an ethical investment.
We deny the poor in developing countries the rights, which we ourselves take for granted.
If anything good can come of this Wonga mess, it is that perhaps people in the U.K. will question the wisdom of trying to solve poverty in developing countries with microfinance versions of Wonga.
Hugh Sinclair is a microfinance consultant, blogger and author. He works with organizations seeking to provide ethical, beneficial microfinance to the poor. In 2012, he wrote “Confessions of a Microfinance Heretic,” highlighting some of the more nefarious activities within the sector. A longer version of this article originally appeared on his blog, which seeks to publish breaking news regarding microfinance and to prompt lateral thinking in the microfinance sector. You can follow him on Twitter @MFheretic.
