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I’ve had some interesting conversations lately regarding microlending in the U.S. and it’s left me wondering why there isn’t a more reliable system here. What we do have are community-based micro loan programs which are spread out all over the country but access to those programs is incredibly restricted. The programs also have very limited funds to say the least and they have yet to get anywhere near the profitability mark meaning the programs are not self-sustainable.

A solution to the limited funds problem would be to work with Kiva or an organization like Kiva that is focused on the U.S. market (this type of group has yet to be founded – I may have to add that idea to my someday/maybe list). This way the U.S. microlending programs could send the Kiva-like organization any good candidates for microloans that they can’t help simply because they don’t have the money to loan to them.

It seems to me that a system like the one described above might have a shot. However, there are a lot of issues that hamper microfinance efforts in the U.S. that will need to be addressed.

A paper on microlending programs in the U.S. written by Mark Schreiner (Washington University in St. Louis) and Jonathan Morduch (New York University and Princeton University) back in 2001 discusses some of the hurdles facing microlending in the U.S. (download the PDF and give it a read if you have the chance). Here is a brief overview of the hurdles Schreiner and Morduch outline in the paper:

Size of the microenterprise sector: The microenterprise sector is very large in the Third World and very small in the U.S. This makes it difficult to reach critical mass. If you were to have a U.S. wide microlending program it would be hard to reach everyone in an effective way but having small independent groups in certain areas leaves those groups with a very small addressable market of potential people to loan to.

Safety net: In the U.S., unlike a lot of Third World nations, there is a safety net that essentially deters people from self-employment. The safety net comes in the form of welfare programs and and abundant amount of low wage jobs. The low wage jobs and welfare not only give folks an alternative to starting their own company via a loan they also set wage floor expectations that, at least initially, the microfinanced business may not yield.

Competition from the big guys: In the Third World stores like Wal-Mart and Best Buy aren’t present for the most part but in the U.S. they are ever present. This means that miceoenterprises in the areas covered by the big guys will have a very hard time competing. Due to this situation it seems that service based businesses would be the way to go for microentrepreneurs in the U.S.

Competition from commercial lenders: Ahhhh, the old credit cards. Here they come again. Most folks, if they have a decent credit history and a job can get a credit card which essentially provides them with small hassle-free loans whenever they need them. Therefore, credit cards provide competition to microlenders in the U.S.. On the other side of the coin credit systems in the Third World basically consist of moneylenders which charge much more interest than microlending organizations making microlending the preferred choice.

Group lending faces issues in the U.S.: Group lending is at the core of most microfinance programs around the world. The theory is that the groups will keep all the members honest and also provide background on members looking for loans. The problem with that type of system in the U.S. is that there can be less of a community feel at times. Just because people live near to one another it doesn’t mean there is a community there. In the Third World people are tied to a group of people and a plot of land making the group lending system very effective and we don’t have those same ties in the U.S..

Microfinance for housing: Sometimes people that take microloans can use some of the proceeds to fix up their house and in some cases the loan is specifically sought to fix up their house. In the U.S. this becomes a little tricky since most lower income housing does not allow for improvements and drastic changes that someone might want to make with their loan money.

Regulation: Here it is. The pièce de résistance. Unlike Third World countries where there are sections of the countries where taxes and regulations are essentially absent the U.S. is regulated to the hilt. The other interesting thing about the U.S. in the context of regulations is that banks and non-profits are under scrutiny and if they are found to have charged the poor more interest than the rich they will be taken to task in the press.

Considering that microlending programs in the Third World charge anywhere from 20% – 30% interest they are way above the interest rates charged to someone like me meaning that they wouldn’t be able to use the same interest rates in the U.S.. Unfortunately microlending is expensive so the high interest rates are justified (and they are usually far less than the local moneylenders in Third World nations charge which is why they are accepted and embraced).

Microfinance is expensive because borrowers are spread out so getting to them is costly. Also, loaning $1mm to one person or $1mm in ten thousand $100 installments to ten thousand individuals is a very different animal. The earlier is much easier to scale than the latter meaning the cost to administer the earlier is much less leading to lesser interest rates for the rich.

I still think the answer to the problem must lie in the internet. Yeah, I may be a bit biased but hear me out. The internet allows you to scale quickly since anyone in the world with a connection, and in this case anyone in the U.S. with a connection, can find you and interact with you. Of course the key phrase here is “with a connection.” Since a lot of the poor are still without an internet connection we need to hop that hurdle.

This is where that Kiva-like system comes into play. The microlending organizations in the U.S. can be the folks that source the loans and pass them up to the Kiva-like organization (man, I need a snappier name than that) which will place the listings online and allow anyone in the world to loan to them. This would bring more cash into the mix and hopefully allow the U.S. microfinance organizations to cut a lot of their costs in relation to sourcing funds and to make more money since they can get more loans out into the market.

We’ve seen peer to peer lending in this country starting to make another push with both Prosper.com and Facebook’s new P2P lending program leading the way. People could use these systems to get their microloans but this still assumes the people in question have access to the net. The digital divide needs to be bridged and it can br bridged now by having folks on the ground finding people in need and then passing them up to internet based lending systems.

Of course this is easier said than done but the first step could be to unite all of the fragmented U.S. microlending folks together and then possibly build that Kiva-like system for them to share.

In the end of the day we still need to work on regulations that incentivise people to become microentrepreneurs. The regulations will be a big catalyst in the U.S. microlending push. Once the regulations get hammered out the national microlending network with Kiva-like system could get things moving in the right direction.