Hats off for microfinance

“LENDING to get a student through college is a far better way to fight poverty than making small-business loans,” says Ganhuyag Ch. Hutagt, until recently boss of XacBank, a Mongolian microfinance lender. Graduates are more likely to take jobs that lift them into a far higher income bracket—which is why, five years ago, XacBank started offering higher-education loans, typically between $700 and $900, to the country's more than 160,000 students.

Finding new ways to fund poor students in emerging markets has become a hotbed of innovation. Vittana, founded three years ago by Kushal Chakrabarti, a former software developer at Amazon, is raising loans for students in five countries, with more soon to follow, through “peer-to-peer” online lending, mostly by people from rich countries. Qifang, founded three years ago, is doing much the same in China, raising money online for Chinese students from Chinese lenders. Vittana is growing at over 30% a month; and Qifang has already lent over $1.3m.

Both have much in common with the best-known peer-to-peer lending website, Kiva, founded in 2005. Kiva has raised nearly $160m in microfinance loans to small entrepreneurs in poor countries, and is expected to enter the student-loan market shortly, perhaps within weeks.

Microfinance for students presents two specific problems. Micro-entrepreneurs tend to be from families embedded in communities that can exert strong peer pressure to repay. By contrast “students come from remote villages, no one knows them, they have no reputation to lose,” says Mr Hutagt. Student loans are also much longer-term—up to five years—than the one-year maximum of traditional microfinance business loans. This makes them riskier, especially as microlenders generally rely on short-term funding. As a result, XacBank tends to lend to second-year students, who at least have some record of attendance. Part of the Vittana model is to lend to the children of existing microfinance clients, targeting students in their final year at vocational schools, says Mr Chakrabarti.

The innovations are not limited to lending. Take Lumni, which was set up in 2002 and has funded students from Mexico, Chile, Colombia and America to the tune of $14m. Investors make an equity-like investment, which pays a set percentage of whatever the student earns in a predefined number of years of employment after graduating. “When the student does well, so do the investors. When the student fails, the investors bear the risk,” says Felipe Vergara, Lumni's co-founder. Enzi, another start-up, has just put students from India and Iran through Stanford University; they are paying investors up to 6% of their income for five years. The big challenge is to come up with enforceable contracts, says Ashni Mohnot, Enzi's founder. Millions of poor would-be students could benefit.