Making microfinance work in Wales

The story of the establishment of the Grameen Bank by Muhammad Yunus and the roots of microfinance are well known. Lending only to the poorest people in Bangladesh, Grameen has grown to become a profitable and successful institution, with extremely low default rates on its loans and it can claim to have improved the lives of large numbers of borrowers by providing them with the capital to make their businesses succeed. There are now many microfinance institutions throughout both the developing and (more recently) the developed world with varying levels of success. There is also still much debate on how successful it is as a means of tackling poverty.

Established just under three years ago, Purple Shoots is a small not-for-profit organisation offering microfinance in Wales, following as closely as possible the core principles of microfinance: accessibility, simplicity, affordability and inclusiveness. Its loans are aimed at helping the most disadvantaged people to start businesses to empower them to work their way out of poverty – those who are unemployed, those recovering from long term illness or who have been out of the workplace for some time for many different reasons and those who are rejected by mainstream lenders.

Microfinance in its purest form had not been tried in Wales before and Purple Shoots was greeted with a certain amount of scepticism by some in the business and financial sectors. Many believed that all loans would be lost because the client group is seen as so high risk and that Purple Shoots would disappear within six months.

There are elements of the Grameen success which are difficult to replicate in the UK situation – perhaps the key one being the group lending principle, whereby small communities form groups to receive loans and repay them. Individuals from the group can also have a loan – the group is an effective form of collateral. This is difficult to replicate both because of our independent and individualistic culture and because of geography of Wales – those in poverty are scattered and communication difficulties mean it is hard to get groups together. The other issue is that the level of regulation in the UK makes starting a business more expensive than in a third world country.

There is a great pride in being Welsh and a great loyalty both to Wales and to whichever community an individual comes from

Purple Shoots launched with funds donated by a philanthropic investor and has raised further private investment since. Being regulated by the Financial Conduct Authority and the Charities Commission means certain obligations have to be met but within those restrictions it has devised a very simple application form and all subsequent information is collected during a face to face meeting.

The borrower has an opportunity to explain the business idea and can also talk through his/her financial circumstances, perhaps explaining why they have been rejected by other lenders. Purple Shoots can ensure that the loan is something that will genuinely help rather than hinder the individual. There is some work to do after the meeting, but generally Purple Shoots comes back to the client quickly with a response, whether it is a “yes” or “no”. This approach is appreciated by borrowers who are not comfortable with online systems, many of them without access to a computer or the internet, and who feel that on paper or via a scoring system they would stand no chance (invariably true).

Community spirit

Since starting to lend in January 2014, Purple Shoots, with one member of staff, has made 210 loans, investing a total of £465,000, helping more than 170 people out of unemployment and starting or supporting almost 200 small businesses (some clients have had follow-on loans). All loans are for £3,000 or less. The economic impact, according to a recognized tool for calculating, is over £4m. Popularity is escalating and Purple Shoots currently has a pipeline five times the size of that which the original plan envisaged, and so the focus now is on raising more capital in order to meet this unmet need.

So does it work? In terms of attracting clients and fulfilling an unmet need, there is no doubt that it does. One of the big reasons why the small businesses supported succeed is the nature of the Welsh culture and communities. There is a great pride in being Welsh and a great loyalty both to Wales and to whichever community an individual comes from – as a result a local boy or girl starting up a small business in their community is likely to receive huge support from people within that community as well as benefitting from the support of an extended family network which is likely to live nearby.

This factor is particularly strong in the old coal mining communities of the South Wales valleys, where a lot of poverty and deprivation exists and where Purple Shoots has done the bulk of its lending. Because these businesses are rooted in their communities, they are also less likely to give up (approaching in some way the Grameen group collateral idea) and are in a position to know what is needed and what will work much better than outside help that has been catapulted, which has been the pattern in the past.

Challenging times

However, Purple Shoots cannot pretend that it has the amazingly low default rates experienced by Grameen and some of its successful followers. However, given the vulnerability of the client group served, the results are good. Write off figures for the first two years were an average of 15% of the loan book each year. In addition to that, there were a number of loans technically classed as in default – either because they have missed one or two (or more) payments or because they are repaying lower amounts than originally agreed.

Because of capital constraints, at present the maximum loan term for a Purple Shoots loan is two years which is quite an aggressive repayment schedule for a new business which might struggle in its early months, hence longer terms sometimes have to be accepted. Current thinking within the microfinance world is that if a microfinance institution does not have high losses, it is not serving the most disadvantaged members of society – so there is a difficult path for Purple Shoots to walk between continuing to support those it was set up to help, and keeping to at least a break even position.

The experience so far suggests that Wales... seems to be a good place for microfinance to succeed

The risk with borrowers at this end of the market is that there are no resources to fall back on if anything goes wrong – no savings, no property etc. Purple Shoots mitigates this with the small size of its loans and the wide spread – so that if a business does go wrong, the individual should still be able to repay, and this has been the case with a number of them. Some reasons for failure are unavoidable – an illness, an accident, a bereavement, for example.

However, a bigger issue is the interface with the benefits system. Anyone who has been on benefits for any length of time would have drained away any savings they might have had (only a minimal amount of savings is permitted in order to receive benefits). Starting a business means immediately signing off Job Seekers Allowance so that income will stop immediately. For those not on the “Work Programme” i.e. unemployed for less than a year, they can switch to New Enterprise Allowance which is almost the same as Job Seekers for three months and then drops to half of that for a further three months. This is supposed to ease someone into self-employment – but still puts pressure on a business to deliver an income sufficient to sustain an individual far too soon. If the individual is a woman with children or a married man with children, the household at the moment can keep any housing benefit it has been receiving until the new business delivers a reasonable level of income, and there will be child benefit and tax credits. Some single people can also get working tax credits. These all make a difference and can give more breathing space to allow a business to become established before an income has to be drawn from it. If the borrower is disabled in any way and in receipt of ESA (Employment Support Allowance) or PIP (Personal Independence Payment), there is permitted work – a limited number of hours and a limited income is allowed without affecting the benefits. However these people are subject to frequent review and benefits hard won are sometimes lost as a result. The results of all this are:

• The majority of the Purple Shoots defaults and bad debts are young single men – there could be other factors at play here but a number of them have said that they have simply had to give up because they couldn’t make their businesses deliver an income in time before the benefits stopped. Those coming off the Works Programme have an even bigger problem.
• After leaving the benefits system, it takes a long time to get re-enter which means cautious people are reluctant to risk trying self-employment as a long gap without income leaves them with no option but payday lenders in order to survive – a downward spiral. This is stifling entrepreneurship and wasting talent.
• People with disabilities have much more support to lose and some are afraid to do anything that might trigger a review by the DWP of their circumstances. They have often had a long fight to get their money which may have left them in debt and so do not want to risk going through that again. This prevents them testing out business ideas – and once again their considerable talents are wasted as a result.

In helping people out of the benefits system, Purple Shoots is saving the Government significant funds and so there is an argument that some support should be provided either to Purple Shoots or to its borrowers to offset some of the negative impacts of the benefits system.

Purple Shoots has survived as a unique Welsh microfinance institution for three years so far, and if it is successful in raising more capital, it will continue to grow and will expand its reach across Wales. Every day Purple Shoots encounters talented people with viable business ideas who have been rejected by all other funders as “high risk” or “bad risk” and decides to fund them. Purple Shoots can now point at a growing list of these supposed bad risks who have created successful businesses and made every repayment of their loan.  

The experience so far suggests that Wales, with its large numbers of small isolated communities and its strong community spirit, seems to be a good place for microfinance to succeed.

Photo credit: Stuart Madden