Open Up Your Virtual Wallet

What is online microlending? Online lending is a new model of microfinance funding in which retail loans or investments are made over the Internet by average people around the world.

With the media hype surrounding Kiva.org and the recent launch of eBay’s MicroPlace, the phenomenon of online microlending has taken off, creating a brand new virtual class of retail investors and lenders for microfinance institutions (MFIs) - perhaps changing the face of microfinance capital.

Hundreds of people sign up each day to provide loans to microentrepreneurs around the world through Kiva.org. In just two years, Kiva has provided over $25 million in microloans from Cambodia to Togo to Iraq. At their current growth rate, they are raising $1 million every 12 days. Similarly, in its first three months after launching, MicroPlace successfully raised more than half a million dollars in investment capital for MFIs.

How does this new internet-based microfinance funding model work? Are there differences between Kiva and MicroPlace? What are the advantages, critiques, and challenges ahead for online microlending?

The roots of online microlending

Kiva founders Jessica and Matt Flannery

Both Kiva and MicroPlace, the two major players in online social lending to MFIs, were founded by young, California-based, socially-conscious entrepreneurs.

Kiva was created by newlyweds Matt and Jessica Flannery. Inspired by a 3-month trip to East Africa, they created a way for average people, with a thirst to make a difference, to lend to microentrepreneurs around the world. “The real motivation behind Kiva was to blur boundaries between who we think of as wealthy and who we think of as people in poverty,” says Matt.

MicroPlace founder Tracey Pettengill Turner

MicroPlace founder Tracey Pettengill Turner returned from a stint with Grameen Bank in Bangladesh with a dream to create opportunities for socially-minded people to invest in the power of microfinance to reduce poverty. Leveraging her experience as a social entrepreneur and business executive, Tracey established MicroPlace, an online platform for retail microfinance investments. “We want people to open their investment wallets, not their charity wallets,” explains Tracey, who believes this strategy accesses a much larger pool of capital than donations. 

Kiva vs. MicroPlace - the differences

While both online platforms respond to the microfinance industry’s need for debt financing and desire for globally minded do-gooders to help alleviate poverty, their approaches are different.

MicroPlace is a for-profit online broker-dealer, wholly owned by eBay, that connects retail investors with MFIs. Investors purchase SEC-regulated debt securities from security issuers (currently Calvert and Oikocredit) on MicroPlace.com to finance specific MFIs. The cost of this MicroPlace financing to the MFIs is about 8% per annum. If an MFI defaults, security issuers bear the risk and utilize loan loss reserves and credit enhancements to protect investors. The investments provide a small rate of return (currently 1.25% - 3% per annum but soon up to 7%). The average maturity of the investments issued by Calvert and Oikocredit is currently 27 months. As of April 2008, MicroPlace offers 34 investments in MFIs in 22 countries.

Here's how it works: Kiva MicroPlace   Kiva partners with an MFI     MFI posts microentrepreneur profiles on Kiva.org     Lender chooses a microentrepreneur to lend to and provides loan online by credit card     Kiva aggregates online retail loans and wires funds to MFI, which in turn provides microloans to the microentrepreneurs chosen by lenders     Lender receives principal payment, without interest, at end of loan term; Also receives microenterprise status updates over course of loan More on how Kiva works…   MicroPlace partners with a security issuer and MFI     Security issuer sells debt securities on MicroPlace.com, to be directed to specific MFIs     Investor selects MFI to be funded and purchases online security from security issuers partnering with MicroPlace     Security issuer uses funds generated to invest in selected MFIs     Investor receives interest and principal payments from security issuer over length of investment More on how MicroPlace works…

On the other hand, Kiva is a non-profit that connects online lenders with microentrepreneurs through MFI partners - currently 88 MFIs in 42 countries. As of April 2008, Kiva’s 270,000 lenders have loaned a total of almost $27 million. The average loan term is 10.2 months. Kiva financing is offered to MFIs at 0% interest and lenders do not receive any interest on the loans they fund through Kiva, only repayment of the principal. Kiva lenders bear the risk if a selected microentrepreneur defaults on his loan. However, Kiva plans to add an option in the future in which MFIs can choose whether to cover entrepreneur default themselves or pass this risk on to Kiva lenders.

Kiva vs. MicroPlace - A Summary   Kiva MicroPlace Launch date October 2005 October 2007, Bought by eBay in 2006 Legal structure Non-profit For-profit, SEC-registered Model Lenders provide loans to microentrepreneurs and receive updates Investors purchase investment securities of MFIs User experience Focus on individual microentrepreneur and peer-to-peer connection: Lenders engage with borrower stories on website Focus on microfinance institution and investment terms, with prospectus available online Who can lend or invest? Anyone with a credit card or PayPal account; Lenders come from 71 countries (with 80% from the U.S.) United States residents only, due to SEC regulations

Challenges on the horizon

Awash in socially-conscious dollars, Kiva’s task ahead is to identify new MFI partners where these funds can be safely and responsibly managed. Staff is increasing as they build in-house due diligence expertise based in Latin America, Africa, Asia, and Eastern Europe to solidify microfinance partnerships beyond the traditional local and international networks. Kiva is also trying to integrate its technology platform with partner MFIs’ management information systems (MIS) to lessen the reporting burden on MFIs. The central database will further provide Kiva with more accurate, transparent, and extensive MFI financial data.

“The ultimate question in the long term is whether Kiva positively fuels the growth and capacity of MFI partners to better reach new and unserved low-income clients.” – Kiva president, Premal Shah

A fundamental challenge for Kiva is making its lending process more transparent to lenders. Currently, Kiva lenders select microentrepreneurs to finance from the website, Kiva loans are disbursed to MFIs, and then MFIs on-lend those funds to the selected microentrepreneurs. Kiva is trying to clarify this process by educating lenders about MFI partners and the interest rate spread, and ensuring that MFIs comply with directing funding to the lender-selected microentrepreneurs. Some industry experts are also concerned about the impact of having short-term, hard currency denominated funding sitting on the balance sheets of MFIs. Kiva is exploring different ways to reduce the foreign exchange risk this creates for MFIs.

As a new site, MicroPlace’s main challenge is expanding its investor base as well as raising the average MicroPlace investment which is currently $350 (as compared to Kiva’s $96). To respond to this challenge, MicroPlace is launching a new marketing strategy to excite more socially conscious investors in the United States by raising awareness of microfinance.

“Microfinance won't succeed unless we build it in a sustainable way. Everyone needs to earn a return - from the investor in Indianapolis to the borrower in Bangladesh.” – MicroPlace founder, Tracey Pettengill Turner

At the industry level, critics question whether online microlending platforms offer a sustainable model to expand access to finance. They argue that increasing foreign funds could become a distraction, reducing MFIs’ interest in developing domestic capital markets and savings mobilization. Kiva’s interest-free loans to partner MFIs may further distort the market. To ensure that partner MFIs do not rely too heavily on Kiva loans, Kiva restricts funding to no more than 30% of an MFI’s gross loan portfolio. Kiva is initiating an incubator program to meet the financing needs of younger, riskier MFIs with fewer debt capital options. In this program, the 30% financing ceiling will be more flexible.

Alongside the challenges ahead for these innovative online microlending models is a tremendous opportunity to engage the public on microfinance – transparently and truthfully, create a new class of retail investors and lenders for the microfinance industry, and ultimately, generate greater access to appropriate financial services for microentreprenuers around the world.