Since Mohammed Yunnis won the Nobel Peace Prize in 2006 for creating the Grameen Bank – a micro-lending institution that has lifted hundreds of thousands of people out of abject poverty - microfinance has increased in popularity. But will micro-lending programs be able to survive throughout the current financial crisis? Microfinance is the act of lending small sums of money to people that would otherwise be ineligible for conventional loans, allowing individuals to purchase capital equipment/ supplies so they can earn a living. The first micro-lending institutions were developed for philanthropic reasons but the industry has increasingly become commercialized. Since microfinance has shifted from charity to more of a business, the industry is more dependent on world capital markets. And because there are two types of institutions, those that are for-profit and those that are non-profit, experts are divided on how microfinance will react to the current economic crisis.
A good place to start this analysis is by looking at history. The most relevant example is to see how well microfinance did during the Asian Financial Crisis? In a report published by The Foundation for Development Cooperation, Paul McGuire and John Conroy make some interesting observations regarding financial crises in general, noting that recession leads to increased unemployment in the formal employment sector, therefore more candidates for microfinance in the informal sector. Sounds good for microfinance but things are not that simple, recession also means people have less purchasing power and more people trying eek out a living on the streets means there is more competition. But what actually occurred?
David Roodman of Center for Global Development notes that in Indonesia “while large companies and rich people defaulted left and right, the 2.6 million micro-credit borrowers of the Bank Rakyat Indonesia hardly skipped a beat.” This is not surprising since many micro-loan programs, like the Grameen Bank, are structured around group lending where there is communal pressure to repay. Although there may have been some problems, micro-credit faired pretty well in this particular instance.
Seeing how micro-finance reacted to the Asian Financial Crisis is a good barometer for how things might turn out but current circumstances are unique. For instance, the Asian Financial Crisis was relegated to emerging markets compared to the current economic crisis which stems from problems in US financial system. So the debate really comes from the unique nature of the current crisis and how the micro-credit industry has evolved since the last crisis.
There are people on both sides of the debate, Muhammad Yunus is a vocal advocate of the micro-credit industry and publicly announced “The financial crisis has not hit the microfinance system” and that “in the middle of all these bad news: microfinance still works.” Bill Clinton believes investors should look to microfinance saying “consider the poor of developing nations as viable investment alternatives to today’s turbulent markets.”
Besides believing celebrity advocates like Dr. Yunus and Bill Clinton, there are structural reasons why one could be optimistic about the future of microfinance. David Roodman points to the fact that most foreign investment still comes from those who are motivated by charity and willing to accept the risks involved with lending to the poor. Others like Benjamin Kahn and Tor Jansson of The Inter-American Development Bank (IDB) argue that microfinance “will benefit from close ties with their local communities, from knowing their borrowers well, from having an ownership structure that includes shareholders with a strong interest in their well-being, from conforming to local financial regulations and from making good use of local savings.” So once again the structure of the micro-credit industry may insulate it from high default rates. But is that shifting?
There are good reasons to believe microfinance will be resilient; however there are also a variety of reasons to be cautious. True, charitable foundations are willing to take risks but many of the endowments charities rely on have shrunk because of sharp decreases in world stock prices. So they may be willing to take risks but may not have the capital to finance such risky loans. Foreign governments have also been large contributors to development projects but will more than likely be forced to cut international aid budgets because their own economies are at risk of collapse. In addition to philanthropic related problems, the micro-lending industry has become increasingly tied to the conventional financial system.
Sarah Bauele of the University of North Carolina, makes three important observations that could affect repayment and micro-lending’s sustainability during the financial crisis: rising food prices means that individuals have less money once basic needs are taken care of; increasing unemployment in rich countries means that money sent as remittances is declining, cutting off a needed source of capital; the commercialization of microfinance means that the industry is affected by the lack of credit in the global financial system.
Echoing the last point made by Bauele, Fitch's Financial Institutions Group, agrees that microfinance will be affected by its ties to the global financial system but believes that a cool down may not necessarily be a bad thing, stating "In a way, it will be a much-needed "taking of stock" after several years of strong growth."
Kate McKee, a senior fellow at the Consultative Group to Assist the Poor wrote an article reinforcing that sentiment, making interesting parallels with the US sub-prime mess and potential problems with micro-finance if it were allowed to get out of control. McKee notes that micro-lenders, like sub-prime lenders, target barrower that may not be the most credit worthy - but in the case of micro-loans that is kind of the point, lending to people that would otherwise not have access to credit. McKee is an advocate for micro-lending so she does not want to see the practice end but emphasizes that lenders should be cautious and make sure borrowers know their rights and obligations before approving loans. This could be key to making sure the for-profit micro-credit industry is sustainable because as large amounts of money get pumped into microfinance - similar to the sub-prime market - lenders could get over ambitious and lend to people they know can not repay and will subsequently defaulted. She also mentions that the microfinance industry could have taken on another characteristic of the sub-prime market due to the small sums of money involved. Traditional lending institutions or investment houses can’t really be bothered with loans for $50-$100 so they could be bundled into more complex securities like the toxic assets that have plagued the banking industry.
In addition to similarities with the sub-prime industry, the changing dynamic of micro-lending and that it is becoming more like the conventional financial system puts its sustainability in jeopardy, Christoph Kneiding notes that “while 9 out of 10 BRAC-only clients repay their loans regularly, repayment drops to 50% for households with membership in three or more MFIs other than BRAC.” There are two observations that can be made about this statement. Similar to US consumer credit cards, repayment was high when credit was not readily available but when multiple lines of credit were offered, borrowers can become overloaded and not able to repay. The changing dynamic of micro-lending can also affect repayment - traditional micro-lending programs used peer pressure as a mechanism for repayment but as microfinance becomes more like a traditional finance - barrowers are removed and don’t feel quite as obligated to repay, especially since there are no formal credit reporting agencies in many countries. So for these few reasons, it may be a good thing for the micro-lending industry to cool down.
This analysis is by no means a comprehensive study of microfinance but hopefully it presented some interesting ideas and possible influences as the industyr tries to weather through the financial crisis. As you can see there are many things to look at to evaluate the future prospects of microfinance; it is caught between two worlds -- business and charity. Depending on what angle or what context, one can make totally different conclusions. My personal opinion is that it will make it through just fine, it may run into some problems but as the saying goes “what doesn’t kill you makes you stronger.”
A good place to start this analysis is by looking at history. The most relevant example is to see how well microfinance did during the Asian Financial Crisis? In a report published by The Foundation for Development Cooperation, Paul McGuire and John Conroy make some interesting observations regarding financial crises in general, noting that recession leads to increased unemployment in the formal employment sector, therefore more candidates for microfinance in the informal sector. Sounds good for microfinance but things are not that simple, recession also means people have less purchasing power and more people trying eek out a living on the streets means there is more competition. But what actually occurred?
David Roodman of Center for Global Development notes that in Indonesia “while large companies and rich people defaulted left and right, the 2.6 million micro-credit borrowers of the Bank Rakyat Indonesia hardly skipped a beat.” This is not surprising since many micro-loan programs, like the Grameen Bank, are structured around group lending where there is communal pressure to repay. Although there may have been some problems, micro-credit faired pretty well in this particular instance.
Seeing how micro-finance reacted to the Asian Financial Crisis is a good barometer for how things might turn out but current circumstances are unique. For instance, the Asian Financial Crisis was relegated to emerging markets compared to the current economic crisis which stems from problems in US financial system. So the debate really comes from the unique nature of the current crisis and how the micro-credit industry has evolved since the last crisis.
There are people on both sides of the debate, Muhammad Yunus is a vocal advocate of the micro-credit industry and publicly announced “The financial crisis has not hit the microfinance system” and that “in the middle of all these bad news: microfinance still works.” Bill Clinton believes investors should look to microfinance saying “consider the poor of developing nations as viable investment alternatives to today’s turbulent markets.”
Besides believing celebrity advocates like Dr. Yunus and Bill Clinton, there are structural reasons why one could be optimistic about the future of microfinance. David Roodman points to the fact that most foreign investment still comes from those who are motivated by charity and willing to accept the risks involved with lending to the poor. Others like Benjamin Kahn and Tor Jansson of The Inter-American Development Bank (IDB) argue that microfinance “will benefit from close ties with their local communities, from knowing their borrowers well, from having an ownership structure that includes shareholders with a strong interest in their well-being, from conforming to local financial regulations and from making good use of local savings.” So once again the structure of the micro-credit industry may insulate it from high default rates. But is that shifting?
There are good reasons to believe microfinance will be resilient; however there are also a variety of reasons to be cautious. True, charitable foundations are willing to take risks but many of the endowments charities rely on have shrunk because of sharp decreases in world stock prices. So they may be willing to take risks but may not have the capital to finance such risky loans. Foreign governments have also been large contributors to development projects but will more than likely be forced to cut international aid budgets because their own economies are at risk of collapse. In addition to philanthropic related problems, the micro-lending industry has become increasingly tied to the conventional financial system.
Sarah Bauele of the University of North Carolina, makes three important observations that could affect repayment and micro-lending’s sustainability during the financial crisis: rising food prices means that individuals have less money once basic needs are taken care of; increasing unemployment in rich countries means that money sent as remittances is declining, cutting off a needed source of capital; the commercialization of microfinance means that the industry is affected by the lack of credit in the global financial system.
Echoing the last point made by Bauele, Fitch's Financial Institutions Group, agrees that microfinance will be affected by its ties to the global financial system but believes that a cool down may not necessarily be a bad thing, stating "In a way, it will be a much-needed "taking of stock" after several years of strong growth."
Kate McKee, a senior fellow at the Consultative Group to Assist the Poor wrote an article reinforcing that sentiment, making interesting parallels with the US sub-prime mess and potential problems with micro-finance if it were allowed to get out of control. McKee notes that micro-lenders, like sub-prime lenders, target barrower that may not be the most credit worthy - but in the case of micro-loans that is kind of the point, lending to people that would otherwise not have access to credit. McKee is an advocate for micro-lending so she does not want to see the practice end but emphasizes that lenders should be cautious and make sure borrowers know their rights and obligations before approving loans. This could be key to making sure the for-profit micro-credit industry is sustainable because as large amounts of money get pumped into microfinance - similar to the sub-prime market - lenders could get over ambitious and lend to people they know can not repay and will subsequently defaulted. She also mentions that the microfinance industry could have taken on another characteristic of the sub-prime market due to the small sums of money involved. Traditional lending institutions or investment houses can’t really be bothered with loans for $50-$100 so they could be bundled into more complex securities like the toxic assets that have plagued the banking industry.
In addition to similarities with the sub-prime industry, the changing dynamic of micro-lending and that it is becoming more like the conventional financial system puts its sustainability in jeopardy, Christoph Kneiding notes that “while 9 out of 10 BRAC-only clients repay their loans regularly, repayment drops to 50% for households with membership in three or more MFIs other than BRAC.” There are two observations that can be made about this statement. Similar to US consumer credit cards, repayment was high when credit was not readily available but when multiple lines of credit were offered, borrowers can become overloaded and not able to repay. The changing dynamic of micro-lending can also affect repayment - traditional micro-lending programs used peer pressure as a mechanism for repayment but as microfinance becomes more like a traditional finance - barrowers are removed and don’t feel quite as obligated to repay, especially since there are no formal credit reporting agencies in many countries. So for these few reasons, it may be a good thing for the micro-lending industry to cool down.
This analysis is by no means a comprehensive study of microfinance but hopefully it presented some interesting ideas and possible influences as the industyr tries to weather through the financial crisis. As you can see there are many things to look at to evaluate the future prospects of microfinance; it is caught between two worlds -- business and charity. Depending on what angle or what context, one can make totally different conclusions. My personal opinion is that it will make it through just fine, it may run into some problems but as the saying goes “what doesn’t kill you makes you stronger.”
