Pyramid Schemes vs. Microfinance

> Posted by Sergio Guzman
colombian-flag1During the past few months, the Colombian economic media have kept a close eye on the current financial crisis, but many people’s attention has been captured by a company with a mysterious money-making scheme called DMG, founded by David Murcia Guzmán, a twenty-something, who in 2003 started his company in a small town close to the Ecuadorian border. The company claims to pay clients for “personalized advertising” which really means client referrals. According to Dinero magazine, clients invest in pre-paid cards with which they buy goods from company stores. They are obligated to refer three people and in exchange the company pays them cash or merchandise honoraria in company stores.
A similar scheme, DRFE (Spanish for “Easy Money, Fast Cash”), collapsed last week. The government shut it down and is forcing it to return its “investors’” money. (Click here to read a Washington Post article on the riots caused by DRFE.)
DMG claims that it has more than 70 thousand active members and that over 200 thousand people have participated in the scheme. The model is a grave concern for the banking authorities, tax collection agencies, and even the prosecutor general’s office. Many have signaled the operation to be an elaborate Ponzi scheme. There have been reports by president Uribe that police officers and even some senators have invested in the scheme. The government intervened DMG on Monday citing illegal deposit-taking.
According to Maria Cristina Cortez, a senior director for Global Programs at ACCION International, some people have borrowed from microfinance institutions and cooperatives in order to invest that money in the pyramid schemes. Some savers have been tempted to take their savings elsewhere because of the juicy returns, which in turn dries up deposits.
The collapse of the pyramids could create serious consequences for microfinance. As Elisabeth Rhyne, managing director of the Center for Financial Inclusion says, “the big risk of pyramid schemes is that they cause serious and often long lasting damage to people’s willingness to trust financial institutions or in this case electronic cards as a means of exchange.” She adds that “a pyramid scheme collapse can also makes regulators more suspicious of new financial sector entrants, which can result in regulators raising higher barriers to entry.”
It is no surprise that poor people are investing in DMG. The trust in financial organizations, according to the Custumer Value Index as reported in Portafolio, has fallen. “In part due to the lack of transparency and compliance of banks, who make promises to clients and then fail to live up to their commitments.” Some clients complain that banks do not provide them the treatment they deserve and turn to organizations like DMG who seem to make a greater commitment to their growth and development.
Responses to the pyramid schemes include financial literacy to educate clients about how to recognize pyramid schemes and avoid offers that seem too good to be true. This episode is a wake-up call for financial institutions to step up their game in consumer protection initiatives in order to maintain client confidence in the financial sector.