Big financial institutions of all sorts are in dire straits across the globe. But one category remains unaffected — microfinance. Even as the global financial system freezes and giants like Lehman Brothers collapse, microfinance institutions (MFIs) are expanding unfazed. Famous financiers face defaults big enough to wipe them out, but MFIs report virtually zero default.
This is extraordinary. Big financiers lend against collateral, a back-up if their borrower defaults. But MFIs lend with no collateral at all. Big financiers lend to the most creditworthy corporations. MFIs lend to poor women whom nobody in history considered creditworthy before. Yet, the secured loans to big corporations are bombing, while unsecured loans to poor women are being repaid in full.
How so? What lessons does micro-finance have for Wall Street? The big lesson for Wall Street is that lending against collateral, supposedly prudent, can blind you to the need for checking the repayment capacity of borrowers. US banks happily gave mortgages of 100% of the value of houses during the housing bubble, and suffered when house prices fell. So did august institutions buying mortgage derivatives. Some, like Lehman Brothers, borrowed massively to invest in AAA mortgagebacked securities, and went bust when value of these securities plummeted. A trillion-dollar house of cards was built on collateral. When the collateral value fell, the house of cards collapsed.
Lesson Learnt: Don’t just depend on collateral, assess the cash flow of borrowers, and leave a cushion to ensure repayment. The housing bubble induced banks to give NINJA (no verification of income, job or assets) loans, secured just by house value. As house prices rose, their value exceeded the repayment capacity of borrowers. The rest is history.
Microfinance, by contrast, has no collateral at all. MFIs deliberately keep loans small, well within repayment capacity. Some MFIs give first loans of just Rs 5,000 a year. Those who repay qualify for a higher second loan, maybe Rs 7,000, and the third loan can be still higher. But MFIs set an absolute loan limit, ranging from Rs 12,000 to Rs 25,000, depending on local economic opportunities, to guard against over-borrowing. Wall Street needs similar safeguards.
US housing brokers get commissions from banks based on the size and interest rate of loans. This gives them incentives to fiddle documents and data to lend excessive sums at excessive rates of interest, increasing default risk. But MFIs have a fixed interest rate, and fixed ceilings on the first, second and subsequent loans. MFI field agents are trained to ensure that loans do not exceed repayment capacity. Mimo Finance, for instance, gauges the cash flow of borrowers by taking a quick look at the quality of their houses. Wall Street needs similar safeguards.
MFIs lend to groups of poor women. If any borrower defaults, the whole group is barred from credit, so other members put social pressure on the defaulter to repay. This is remarkably effective. By contrast, defaulting homeowners in the US are treated as victims, offered subsidies and write-offs by politicians. Some home-borrowers may have been duped by brokers, but many others over-borrowed on the assumption of ever-rising house prices. Many bought houses to resell at a profit. Some can afford to repay but have decided not to, since default attracts no social opprobrium.
High inflation in India has not caused MFI defaults. MFIs report that worker-borrowers have demanded and got a 20% increase in wage rates, while small-businesses’ borrowers running tea shops have raised their prices from Rs 2 per cup to Rs 3. By contrast, home borrowers (or even giant corporations) in the US are unable to increase their incomes in line with borrowing costs. So, the MFI model is small but sound. The main problem is that western banks lend far too much. But Indian lenders — including MFIs — lend far too little.
Source: Report published in Mumbai Mirror
Good site I “Stumbledupon” it today and gave it a stumble for you.. looking forward to seeing what else you have..later
anybody here know of a good site to find more info on small loan? I’ve got this site bookmarked and im gonna keep checking it out, but i still would like to find a site that covers small loan a little more thoroughly..thanks
Why do you think things have always to go that way?
Very usefull post.
Thanks.
P.S. I like your writing style.
First of all congratulation for such a great site. I learned a lot reading article here today. I will make sure i visit this site once a day so i can learn more.
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Thanks for good post
Hi Johnny, Thanks for visiting my site. I am glad that you liked the post. You may also choose to subscribe to the RSS feeds of my site…
Hello How Microfinance Institutions Are Surviving Financial Crisis was very well written. Good job.
Thanks for excellent article. I like your blog too. I will visit your blog frequently
Great! Thank you very much!
I always wanted to write in my site something like that. Can I take part of your post to my site?
Of course, I will add backlink?
Regards, Timur I. Alhimenkov
Hi Fred, “Financial Institutions”, and Timur,
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Timur: You can always write about this post on your site and link it back to me. Please do so and post the link here!
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I am not sure I totally agree with How Microfinance Institutions Are Surviving Financial Crisis
Really good read, nice to read a good blog at last!