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Friday, November 20, 2009

Vittana: Student Loans and a New Generation of Microfinance

By Manuel Bueno

Microfinance is widely touted as a major private sector success in tackling development. According to the State of the Microcredit Summit Campaign Report 2009, microfinance now reaches more than 100 million people through more than 3,500 organizations. Nonetheless, like many forms of financing, microfinance is a coarse tool to lift people out of poverty insofar as it usually lends to people who may be willing to invest in the development of fixed assets, traditionally in farming or small businesses. More recently, microfinance products have tried to sharpen their focus to stimulate investment in particular assets such housing or healthcare.

However, one of the most glaring omissions in the 30-year development of the microfinance industry has been the lack of attention paid to possible synergies between microfinance products and education. Although there are already some mechanisms to promote basic education in low-income communities through Conditional Cash Transfer programs, there are few microfinance institutions (MFIs) offering micro-loans for students who may want to take their education beyond the secondary level. With the exception of a handful of avant-garde MFIs working independently or in partnership with Vittana, MFIs have yet to figure out the right approach to profitably offer student loans directed to those wanting to enter into tertiary education. Furthermore, investors are reluctant about risking their money in exploring possible venues to develop these business models. After all, the benefits of doing so would not be captured only by the investors themselves but by the whole microfinance industry, while the exploration costs would be accrued by the investors alone. This results in a “vicious circle” by which no organization has yet developed a suitable business model.

Such a lack of private sector solutions is an important market failure. Studies show that tertiary education, while often neglected in favor of primary and secondary schooling, can be an equally effective poverty alleviation tool. Private returns to tertiary education in low-income countries seem to be frequently on par with the returns from primary education. For example, at the country level, in Sub-Saharan Africa, a one-year increase in average tertiary education levels is estimated to raise annual GDP growth by 0.39 percentage points (World Bank, 2008). At the individual level, each additional year of education can yield 10% to 15% returns in the form of higher wages (World Bank, 2008). The private benefits for individuals are well established and include better employment prospects, higher salaries, and a greater ability to save and invest (Bloom, Canning and Chan, 2005). These benefits may in turn result in better health and improved quality of life (Bloom, Canning and Chan, 2005).

Stimulating tertiary education also seems to make business sense.  MFIs estimate that the market for student micro-loans will amount to between 10% (Peru) to 40% (India) of their future portfolio (Source: internal market studies from MFIs and Vittana). Time appears to be ripe for a profitable microfinance product that enables prospective borrowers to further their education.

Vittana is a young, non-profit start-up founded 18 months ago that is aiming to fill this market failure. It was founded by Kushal Chakrabarti (at left), who used to run the personalized recommendations team at Amazon.com, along with Brett Witt. Vittana’s stated mission is to break the vicious cycle mentioned above by which big investors are not willing to start offering student micro-loans until they see a significant track record of student micro-loans being profitable and having a positive social impact. To this effect it has developed a business model to offer student micro-loans based on two pillars.

First, Vittana makes use of its extensive field experience to share best practices with MFIs and to co-develop a micro-loan product adapted to local markets. Many of the ingredients required to develop student micro-loans are not as similar to standard microfinance practices as one could expect. For example, instead of lending to groups of individuals, Vittana suggests that mothers of prospective borrowers should co-sign the loan. Moreover, the ideal student-borrower is a high school graduate wanting to enroll in a vocational school to acquire a set of skills that will allow him or her to find formal employment. The majority of the “best” student-borrowers are often the children of successful previous microfinance borrowers, to whom MFIs have easy access and about whom they have good financial information. Therefore, finding successful and efficient MFIs is crucial in order to gain scale and fine-tune the loan product to specific regional circumstances. MFIs are fully responsible for marketing the loan, finding suitable borrowers and managing the customer relationship. Moreover, Vittana is engaged in random audits of their partners to ensure that the individual lenders’ money is well spent.

However, this first pillar alone is not enough to break the vicious circle because the business model remains to be conclusively proven. This need gives rise to the second pillar, Vittana’s search engine. Following Kiva’s footprint, Vittana has developed a person-to-person microlending website. Since there are no big investors willing or able to step in, Vittana’s solution is to make it possible for potentially millions of small investors to fill in the financing gap. Their website allows individual lenders to browse through possible student-borrowers and select an individual to receive the loan. You can view, for instance, the profiles of several of their current student-borrowers here: 1, 2 and 3. Vittana has no capital of its own to disburse, so it exclusively depends on individual lenders to generate cash for their loans. According to Vittana’s strategy, these two pillars will enable them to develop and provide a source of finance to a healthy portfolio of student micro-loan products.

Given their innovative model and the importance of the gap they are trying to address, it is no wonder that the Huffington Post has named Vittana number one of the top 10 “game changers” in philanthropy. Vittana makes no secret of its huge ambition and its early success in its promotional video and in its public figures. After Vittana’s first agreement  with a Paraguayan MFI one year ago, people around the world (mostly the United States, but also Sweden, Germany, and The Netherlands) have been disbursing more than $10,000 in loans every month. Loan volumes are experiencing double digit monthly percentage growth rates with nearly perfect (97%) repayment rates. Vittana now supports about 50 students and is adding 10 students per month to its portfolio.

Even though it currently operates exclusively in Paraguay, Nicaragua, Peru and Mongolia, Vittana is looking forward to expanding into other countries very soon. In the long term, it aims to jump-start a broad, global system in student micro-loans and become a focal point for MFIs interested in figuring out how to add this type of loans to their array of services. In fact, there are already indications of this: Vittana is emerging as the “go-to” organization for interested MFIs eager to find a way of increasing their bottom line as microfinance products such as business loans, home loans and other credit lines become increasingly standard.

Those of our readers interested in lending money to Vittana should know that the full amount of their money will go towards the loan. After the disbursement they can also make small donations to Vittana as well (there is a short video explanation online about how the loan process works). As in Kiva, many individual lenders are needed to reach the total amount of money required by the borrower to enroll in further studies (usually between $500 and $1,500). The typical loan recipient is between 18 to 25 years of age and takes 6 to 24 months to fully repay the loan.

Neither Vittana nor Vittana lenders receive any interest on the loans, although MFIs do charge some interest to cover their operating costs. These rates are usually much lower (10-15% per year) than those of traditional microfinance (40-60% per year). Vittana's daily activities are maintained by optional donations made by its lenders, as well as generous support from its lead funders including the Mitchell Kapor Foundation, several Unitus board members and alumni (including its founder, Mike Murray), the Peery Foundation, and a number of top-level Amazon executives.  Additionally, they count as advisors a number of top-level executives and founders from technology and microfinance companies like Amazon, Real Networks, Kiva, Unitus and Apple.

With such a sharp and well-defined business model and powerful supporters, this organization may be well on its way to making a significant impact in the world of microfinance. It may also represent a way forward for the next generation in microfinance in which networked MFIs jointly develop particular learning hubs devoted to specific products as a way of tackling more pervasive social ills (MFIs representatives interested in hearing more about what Vittana may have to offer are welcome to contact the organization through questions@vittana.org). Additionally, the partnership blueprint developed between Vittana and other MFIs represents an interesting model for other knowledge centers in developed countries, such as research institutions or public/private investors, for gaining access and leveraging their skills in the field. I advise our readers to keep a close watch on Vittana – I am sure we will hear more about them in the near future.

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    Citi Foundation
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