You open this new book, Microfinance: Emerging Trends and Challenges, by pointing out that the high end of the microfinance ladder has embraced a number of innovations, while the lowest rungs have continued to work largely the same way through the years. What is driving the difference between the high and low rungs?
At the lower end of the spectrum, there are mostly women borrowers, who participate mostly in group lending. The average loan size is fairly small. Big institutions are less interested, because to put together a portfolio of two or three million dollars with an average loan size of 150 dollars, you really need to have thousands of loans. It was not a scalable proposition until very recently.
In the current structure, borrowers still participate in group lending and village banking and are being primarily served by NGOs, which are driven by soft capital. NGOs don’t worry about scaling up the same way banks or other largely profit-driven financial institutions do.
What does the future hold in terms of scalability?
There have been two big developments. One is innovation in information technology. The ability to deliver loans through mobile phones means that if a lender can deliver a thousand-dollar loan from point A to point B separated by thousands of miles, that lender can just as easily deliver a 20-dollar loan. The transaction cost is eliminated, so, suddenly there’s the possibility of delivering loans through mobile phones into kiosks — very much like the system we have for delivering phone cards. That has already happened in the Philippines and has opened up the possibility for scalability for the lower end of spectrum.
The second innovation is happening with BRAC, the Bangladesh securitization project. It’s a Grameen type of system — the loans are very small. Bangladesh is a small country, but it is waterlogged, with a lot of remote corners that are not well connected. BRAC manages by keeping meticulous loan records for every village. The data on loan performance for all these tiny loans were eventually computerized so that they could be aggregated into a fairly large portfolio. That portfolio was then securitized and assured a credit rating, and pension funds and others invested in it. So I think this and similar innovations in financial securitization and information technology hold big hope for scalability.
Given that the credit crisis has been largely driven by securitization and CDOs, that is not exactly comforting. Why should microfinance be any different?
It’s true that these are precisely the strategies and instruments that are seen as the main culprits in the credit crisis. But in microfinance, for most of these borrowers, if they default or if they don’t service the loans, the outside costs of borrowing will become much, much higher. So they are very incentivized to avoid default. They are responsible to their borrowing group, and their reputation is at stake because their entire village will know if they default.
Contrast that with subprime borrowers, who can walk away from their loan, which is a non-recourse loan; the bank can only take over a home (now worth less) but cannot come after personal accounts or other property. The repayment incentives for a microfinance borrower are much more severe, and so the underlying risk for securitized microfinance products is much more reasonable than what we’ve seen with mortgage securitizations and CDOs here.
Also, if mobile-phone technology lives up to its promise, securitization might become less important. A poor borrower in Chennai can take delivery of a loan from a lender in Delhi, hundreds of miles away; as long as her credit history is in the mobile-phone system, the credit history can transmitted to Mumbai or wherever she migrates for another job. She can find job opportunities and continue to service the loan, so it is not even necessary to aggregate these loans. We are still far away, but it could easily develop along these lines.
What political and regulatory roadblocks have delayed the expansion of microfinance innovations?
There were problems getting BRAC running. Politicians delayed the project for different reasons. First, infrastructure: the borrowers were dispersed throughout remote villages without computer records, and by the time the information was aggregated — well, it took forever to go to the credit-rating agencies to share the records, to verify that the borrowers were in good standing and so forth. We take that for granted here — we are able to get a decision in just a few weeks. But the basic infrastructure wasn’t there.
Nationalized banks and rural branches, which tend to not do as good a job as NGOs when it comes to microlending, don’t see the need to spend money to establish infrastructure for NGOs that would allow for improvements in microlending.
Second, the government’s stance could be more helpful. One South Asian bureaucrat asked me why anyone would give microloans to one hundred or two hundred women when chances are only 20 or 30 of them are likely to be entrepreneurs. To his mind, the remaining women were not entrepreneurial and therefore wouldn’t be able to do much with a loan. Now, this business model might not appear to be a very good one at first glance. But a loan might allow borrowers to buy something that morning, go to the local bazaar and sell them at a margin and by the evening they would have made certain amount of money for themselves. These women may not be highly skilled entrepreneurs, but for a hundred-rupee (two-dollar) loan you can’t expect a very high level of entrepreneurial skill. The bureaucrats frame the question as if these women need to have a great deal of skill, but a high level of skill is not really required for the system to work.
Along the same lines, many BRAC investors balked at some of the less-than-standard ways that default and current loans were defined, even though the average default rate was extremely low. Why the resistance despite such impressive results?
A U.S. credit-card company might say if a particular credit-card user is delinquent for one month they might want to write off some part of that loan. But delinquency in microlending is often involuntary. Often, the local lenders know if a borrower is having some genuine problems and know that if she’s given extra time she’ll be able to pay the loan back. So they won’t necessarily flag that as a problem loan.
But the credit-rating agencies (CRAs) won’t necessarily take that position. The CRAs would see these delinquencies as a potential for future default and insolvency, forgetting that these borrowers have a great deal of interest in repaying because if they default there is huge community pressure on them. It is group borrowing; they have to go back and live in their village, neighbors will be watching them and there is great deal of pressure.
In fact, that social pressure is a great loan enforcement mechanism, but it has a social cost. Borrowers have committed suicides in some Indian villages, for example, after years of drought left them unable to repay loans. Is it really worth it to claim that there is a 98 percent payment rate when people for reasons well beyond their control end up defaulting on loans and eventually committing suicide?
Microfinance has been viewed, in its relatively short history, as more or less immune to recessions. Given that the credit crisis underlies the current recession — which is undeniably a global one — might that have a bigger effect on the field than past economic downturns?
There will be serious consequences in the sense that soft capital and soft loans that typically go to NGOs and to the poorest of the poor will probably suffer. But while there could be a dip in the aggregate money that flows into the sector over the next couple of years, in the long run, given the momentum that this field has experienced, I’m very optimistic.
But I also want to point out that while it’s important to consider what microfinance can achieve, we sometimes focus on microfinance and forget that these families operate under very difficult circumstances. The technology they use is rudimentary — wood stoves, for example — and they live in unhealthy environments and lack access, in many cases, even to primary education.
Microfinance lending is properly viewed as part of an overall strategy in which efforts are made to improve primary education, especially for woman and children, healthcare and improving domestic tools used for day-to-day activities. Parallel work is being done in these dimensions, and at some point they will reach a critical mass where it may be possible to coordinate those efforts.
Suresh Sundaresan is the Chase Manhattan Bank Foundation Professor of Financial Institutions in the Finance and Economics Division at Columbia Business School.
M. Suresh Sundaresan
Suresh Sundaresan is the Chase Manhattan Bank Foundation Professor of Financial Institutions at Columbia University. He has published in the areas of Treasury auctions, bidding, default risk, habit formation, term structure of interest rates, asset pricing, investment theory, pension asset allocation, swaps, options, forwards, futures, fixed-income securities markets and risk management. His research papers have appeared in major journals such as the Journal of Finance...
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M. Suresh Sundaresan
"Microfinance: Emerging Trends and Challenges"