Loan Use: Not As Simple As You Might Think

By Chris Paci, KF16, Tajikistan

For many Kiva lenders, loan use – or what an entrepreneur plans to do with the funds he or she receives – is their most important consideration in deciding which entrepreneurs to support. On the Kiva website, it’s the single most prominent piece of information supplied about any featured entrepreneur. Take a look at Muso, for example, a taxi driver from Tajikistan who has applied for Kiva funding through Kiva’s field partner IMON International. His loan use is stated just to the right of his picture – “To buy a car” – and expanded upon in his borrower description below – “He has been providing a taxi service for seven years and loves his business and does it with satisfaction. He is requesting a loan for the purchase of a new car in order to expand his business.”

As it turns out, though, predicting what borrowers will use their loans to do is more complicated than you’d think. A recent paper by economists Dean Karlan and Jonathan Zinman, written in August 2011 and soon to be published in the Journal of Development Economics, illustrates the problem.

The Research

Karlan and Zinman met with borrowers of two microfinance institutions (MFIs) in Peru and the Philippines, both of which place a strong focus on microenterprise development. Both MFIs encouraged and expected their clients to take out loans for that purpose alone. Indeed, when their loan officers directly asked these borrowers “So what did you use your loan to do?,” the percentage who said that they had spent more than a quarter of their loan on things other than business development was less than 10%. But when Karlan and Zinman used research techniques that ensured the responses they received would be anonymous, they found a very different story. In reality, fully 31.3% of borrowers had spent at least a quarter of their loans on household items, 23.1% on medical expenses, and 33.2% on their children’s education.

So, what’s going on here? Are these borrowers deliberately misleading their loan officers? Are the loan officers doing insufficient due diligence before giving out loans? Are these MFIs just not monitoring their clients effectively enough?

Based on my experiences as a Kiva Fellow with IMON International, I don’t feel any of these statements are quite fair. Without stepping too deeply into the debate, I want to share some of the things I’ve seen in the field to hopefully shed a bit of light.

The Reality

As you may know, most Kiva Fellows are asked to complete a borrower verification as part of their fellowship (read KF15 Michele Wehle’s Fellows Blog post for an excellent description of this deliverable). I’m no exception – I’ve spent the last few weeks traveling all over northern Tajikistan, visiting Kiva entrepreneurs at their homes and businesses, and generally being bowled over and inspired by all the amazing things they’ve managed to do.

One of the first borrowers I met was a livestock dealer named Ikromjon. An incredibly friendly man, he welcomed us into his home, thanked us for the Kiva funding he had received, and took us around back to see his flock of 13 sheep and 2 cattle, which he had been able to expand thanks to his loan. After taking a look around, we eased into our borrower verification interview, and I dropped the fateful question on him: “So what did you use your loan to do?”

It was just a formality, I thought. After all, I was standing there looking right at his purchase. But in front of his loan officer, completely without guile, Ikromjon rattled off a two-minute list of all the things his Kiva funding had enabled him to do. He bought those two cows, sure – just like the Kiva website had said. He bought a few more sheep to further increase his profits. He also invested some of the loan in his other business, a large cotton field he maintained behind his house. As for his other other business, a transportation service, he used some of the loan money to make much-needed repairs to his vehicle. What else? Oh yes, thanks to that loan, he was also able to start adding a new room onto his house – piles of mud bricks and wood already stood in the courtyard. He was going to need the extra room soon, because his oldest son was about to get married – and, by the way, he was also able to fund part of the wedding thanks to that loan.

My eyes bugged out a little. How could anyone get that much mileage out of a relatively small loan? Either Ikromjon was the Bill Gates of Tajikistan, or I was missing something. As our interview continued, though, the explanation became apparent: The money didn’t come solely from his loan. It also came from profits. Ikromjon’s loan from IMON International, and the Kiva funding he received, had enabled him to increase the profitability of his livestock sales and cotton farming businesses, which gave him and his family a lot more money to use in other ways. But he had no idea exactly what money had come from Kiva, what had come from the profits, and what had come from capital he already had.

Regardless, Ikromjon’s loan was a wild success. It helped him stabilize his economic situation and make sustainable, permanent improvements to his family’s way of life – just what we all hope will happen when we lend to entrepreneurs on Kiva. The effects are clear. But what happened in between? Why did Ikromjon have such a tough time separating out his profits and figuring out what he’d actually used his loan to do?

Because Money Is Fungible

That’s a big part of the explanation. But what does it mean for money to be fungible? In economic terms, it means that every dollar in your pocket is exactly the same as every other dollar in your pocket. As a result, it’s tough to place firm restrictions on how you can spend any one of those dollars. When you go to an ATM, you don’t receive one type of money that can only be used to buy ice cream and another type that can only be used to make life-changing loans on Kiva.org (though we wouldn’t complain!) Any dollar in your wallet can be used to buy, well, anything money can buy.

This means two big things for Kiva entrepreneurs like Ikromjon:

1. Though their loans are technically earmarked for a specific use, entrepreneurs, in practice, are free to spend some of their loan money on other things. This means that they can’t be locked into business plans that may no longer reflect changes in their situation. If a more lucrative business opportunity comes up, they have the freedom to take it. Many MFIs monitor their clients and cut them off from further credit if they deviate too brazenly from their stated loan use – for example, if they applied for an agricultural loan and went out to buy a big-screen TV instead. But the range of acceptable loan uses can be surprisingly wide.
2. Not only are the loan funds fungible – all the other types of money the entrepreneur has are fungible as well. Their loan funds, their business profits, and their preexisting capital are all indistinguishable from each other. We in the developed world often correct for this issue by using a constellation of financial products to divide our money into chunks: a checking account for everyday expenses, another one for business expenses, an IRA for retirement, a savings account to fund our children’s education…. But in the developing world, and especially among microfinance clients like Ikromjon, these sorts of complex financial products are often inaccessible. Instead, all of the money Ikromjon’s family receives, including Kiva funding, goes into a single pool from which they continually draw to improve their lives in myriad ways.

So what does fungibility mean in practice? If you’re a developing-world entrepreneur like Ikromjon or Muso, it means that you can maximize your ability to get ahead. It means that you can seize business opportunities as they arise. It means that you can continually make the choices that are best for you and your family, without staying beholden to plans that may have been laid long in the past.

Our perspective, as Kiva lenders who want to know what to expect from our investments, may be different. But it’s valuable to keep both in mind.

Chris is a roaming Kiva Fellow (KF16) currently serving with the microfinance institution IMON International in Khujand, Tajikistan. In his first few weeks, he has visited more cattle than he ever could have imagined. To lend to one of IMON International’s Kiva entrepreneurs, visit its list of fundraising loans on kiva.org!