A Subprime Crisis for the Poorest?

I think that this is not a case of bankers being sorely needed and despised. There are plenty of good examples of microfinance institutions providing financial services to the lowest income segment in a sustainable way. See “banco postales” in Brazil; “opportunidades” in Mexico; SMART Partnerships in Philippines; M-Pesa in Kenya. All these partnerships provide financial services to those most desperately in need of them.

The issue here was a common issue to the sub-prime crisis. There was a lack of education and awareness amongst consumers and lenders. There is a need to build up sustainable institutions by having in place the right infrastructure, which many attribute to a mixed role of public and private partners (such as in the aforementioned partnerships). This means providing consumers with the tools and resources (this include knowledge) to enable them to go through the appropriate channels for redressing complaints and increasing transparency (see Bank Negara Malaysia) and by working with Banks to provide this (see SBS Peru).

The point is not that giving loans to the poor or enabling places for thme to save is not “a silver bullet”, or even looking for such “silver bullets” is a good idea. It is that institutions matter! Short-term fixes, such as what has happened in Andhra Pradesh, is not going to provide a sustainable outcome for the microfinance industry. Rather creating or reforming the appropriate institutions to enable them to handle such problems will be more sustainable. This can be done by learning from other successful experiences or learning from mistakes in bad experiences.

Also, it is important to remember that microfinance is not the only area of financial services to the poor. There is also the mobilizing of savings, consumer protection, agent banking, mobile financial services. Microfinance acts as a way to access finance from loans, but moving towards savings may provide a more sustainable option for this, especially in rural areas (see GSMA activities in the Philippines). Also, payment systems are extremely important, being able to send remittances back to rural areas.

I think the overall message, is bloggers as well as media sources have the responsibility to do their homework so they do not shift something like this current crisis in India, to a worldwide crisis. By being able to explain why this infrastructure was weak and why other infrastructures have been stronger. And, how microfinance is not the only option for low income segments of the population, but other channels and products have and are being developed to reach those most in need.

I think this definitely needs to be discussed, but in a way in which policymakers can learn from India’s challenges and ensure that they incorporate them in their policy. And, obviously lending is profitable, and someone may have to profit from that, but it is how these profits are used. If they are used to increase loan portfolio sizes and reach more people then that this is good. I think you would agree Dr. Easterly, its not how you do it that is always as important (this will differ per circumstance), whether for-profit or non-for-profit, as long as the intended impact happens.

I think that is good point. I guess I would only respond by encouraging you to be aware of the types of “politicians” in charge of regulating this industry. For the most part this is central banks, ministries of finance, and supervisory institutions. They do have to go through a parliamentary process in some countries for large-scale legislation. But circulars and guidelines have also been used to expedite the process.

My point is this is not the work of every President, Prime Minister or Minister of Parliament; this is the work of financial policymaking and regulatory bodies that are yes, subject to the evaluation of President, Prime Minister or Minister of Parliament, but are not as subject to the discontent of the public as the Fed Reserve or the ECB is in the the US and Europe.

See the case of M-Pesa in Kenya and you will see the Central Bank was accountable to the Ministry of Finance Kenya, but still went forward with the risky M-Pesa model.

And also, I think that the “heroin users” are now simply not paying their drug dealers back for the heroin they already bought, but previously they paid on time as high as 98% of the time (I don’t know much about heroin addicts, but I assume thats good).

I also think you need to be careful with the term “unrestricted finance”. I would be pretty comfortable saying that India did not have “unrestricted finance” (lack of deposit taking non-bank financial institutions) and that actually greater diversity and access to a range of financial services (not just microfinance) has the potential to make such an industry more beneficial.

For example, allowing some banks to take deposits, will increase the equity level of non-bank financial institutions and they will not have to rely so much on making profits off the underwriting of loans as the key feature of their business model.

“Can micro-lending be both for-profit and sustainable for development?”

That must be easy to answer. Just point to all those undeveloped countries that became rich and developed thanks to their micro-finance institutions….

mr. kristof had an excellent piece on the onerous management of several charities just the other day. i think microfinancing falls in the same category. the message is loud and clear: beware of the middle-man…

@Alex: right. The situation would be so much better if only individuals were making direct loans to poor rural women in AP.

@AidWatch: Writing about AP and not citing David Roodman’s excellent work to chase down the real details underlying the story is a grievous omission.

If you had, you would have written more about the political conflicts, the agricultural shock, multiple loans, overindebtedness, and the fact that default rates of MFIs aren’t particularly useful here since the borrowers were first defaulting on their SHG loans (organized by the government).

@Tim, thanks for your comment, we are working on a more in-depth post that will touch on the some of the issues you mention as well as other questions raised in the comments here, and will definitely rely on Roodman’s reports from AP. Best, Laura

Since anecdotal evidence built microfinance’s previously towering reputation, it should not surprise us that anecdotal evidence now subverts that reputation.

However, Tom’s citation above of the recent Centre for Microfinance survey fascinates me and raises some vital questions for research. Eleven percent of Andhra Pradesh residents have MFI loans while vastly more—eighty-two percent—have informal loans averaging four times bigger than the MFI loans. But what else do we know about the relationship between MFI and informal lending? How do informal interest rates compare with MFI rates? Can we verify the claim often made in defense of MFI that its lenders preempt unsustainable resort to loan sharks by the poorest people? Or does the high visibility of MFI generate excitement around borrowing and therefore multiply the volume of informal lending?

And so on. Anyway, I hope somebody is researching these and related questions.

@rob, just a final comment. if this crisis proves anything is that the moment some innovative initiative goes for profit needs to get regulated by the government, in order to safeguard the incentives of the original effort. and the indian government is not very well known for its efficiency or visionary action, hence the appearance of the unsustainable loop.

There is more question than answer with Micro Credit in particular and finance in general in poor countries. Outsourcing finance to Aid agencies would not address it, like many other sectors the fundamental problem of why the credit market is not working is not answered i.e. to galvanize ‘indigenous’ saving to finance sustainable productive activities.

The Aid agencies are searching for anything to sustain the flow of foreign aid without making governments accountable for failing to transform the indigenous market to function on its own.

What is finance on its own if the system is not reformed to have continuity and transparency to evolve in to sustainable development, and if there is no ownership of the stakeholders to see their long term interest depends on it?

The failure of governance is sustained by a patch work of micro finance and the like funded by foreign Aid for too long. If the objective is to sustain poverty to justify Aid flows administered by remote control they are on the right track. If the objective is to reform the credit market for sustainable development, then finance by its own, especially external finance on the poor disguised as development is not going to do it. In fact, it would have an adverse effect to further destabilize the existing formal or informal credit market that partially works.

It is fascinating how Aid agencies’ decision makers are one dimensional-picking and choosing the sector to their liking.

Can the discussion be elevated to the flaws of governance at the institutional level than Micro Finance or one or another fad?

The fundamental flaws of governance that made billions of people poor and pawns for corrupt governments, Aid agencies and part-time development adventurist in-and out of universities must be challenged in the open, at a higher level.