I see the moon…

Since arriving, I’ve read three short books on microfinance.

Principled Practices in Microfinance

Microfinance and Poverty Reduction

The Poor and Their Money

When he gave me the books, my mentor suggested I return with questions from the reading. On page 53 of the first book, regarding the principle Plan for Permanence, it says:

Disbursing a loan is the beginning of a long-term relationship. … We tell the borrower that if s/he fulfills her/his part of the bargain, s/he may rely indefinitely on our financial services. It is a promise without end.

To honor this promise, we, together with our partners, have sought ways to serve clients over the long term. While we know that a very few clients may move on to other credit sources, most will never be attractive to a commercial bank. Their loan sizes are simply too small and the transaction costs too high. So what do we do about the many clients who will never qualify for commercial funds?

The answer provided by Catholic Relief Services is “by transforming viable microfinance service providers into permanent financial institutions.” But I question an earlier assumption: that most clients will never be attractive to a commercial bank. I think small loan sizes and transaction costs are problems that can be managed with proper interest rates, technology and scale. As I see it, the real remaining problem is one of information.

Commercial banks lend at the level of individuals, whereas Microcredit often works through some form of social collateral. Here’s a simple example. Groups of people agree to save regularly, and, after successfully saving for a few months, one of the group members gets a loan from the group’s savings. When that loan is repaid on time, the next person in the group gets a loan. After a pattern of repayment, an NGO may step in and provide additional loan capital to increase the size of the loans. But, suppose someone in the group doesn’t repay. Then, no further loans are issued in that group until the debt is met. That can mean peer pressure on the defaulter, or the group can chip in from their savings to pay off the loan. This works somewhat naturally (and sometimes exists without NGO involvement) partly because insider knowledge can be used to form the groups. By only entering into groups with people you trust, or people whose livelihood you can monitor, the risk to the lender (a.k.a. fellow borrowers) is reduced.

And while a lot of good has undoubtedly come from these groups – millions have access to credit services, albeit rather inflexible, that were never before available – it struck me as a little unfair. Why should an entire group – sometimes 40 people – have to go without loans or pick up the slack for someone else’s failure to repay? In the United States, we sometimes have social collateral in our lending. A co-signer agrees to repay if the primary borrower can’t. A secured savings loan puts a willing third party’s savings on the line. But, in general, we have progressed beyond collateral based loans. And we’ve made this progress by facilitating the collection and transfer of information about creditworthiness.

The third book mentioned above makes somewhat frequent reference to SafeSave, the author’s project that attempts to extend basic personal financial intermediation to the very poor by presenting the daily opportunity to save or withdraw, or even receive an advance on savings (a loan).

It may occur to you that – with the exception of the doorstep service offered by its Collectors – the financial services SafeSave offers are rather like what is available over the counter to ordinary customers of banks in the rich world. It is a combination of current account, savings account, long-term deposit, and loans.

Should that surprise you?

The more I thought of it, the more I came to the conclusion “No, the poor are dignified people, too. If it’s good enough for the rich world, why can’t the principles be reproduced among the poor? Why shouldn’t they receive the professional quality attention that we seek for own finances?” I think they can and should, but there is a cost.

Microfinance has costs. Right now, much of those costs are being paid by NGOs in terms of volunteer labor to manage and educate. Donors also subsidize operations costs (and sometimes even subsidize loan capital or artificially deflate interest rates). The poor pay costs through having to self-manage their groups or by having a relatively meager selection of services on often inflexible terms. And although the volunteer led, donor subsidized microfinance movement has shown some promise of permanence, sustainability is still unproven. It may yet collapse. Donor funds could dry up. Volunteers could burnout faster than they can be recruited. And if a microfinance provider folds, the people they support may also be harmed financially.

So, we come to my summer research project – the groundwork for world’s first Microcredit Bureau. The vision is that we will adapt the American system of credit scoring to fit the unique situation among the poor in South Asia. We will aggregate credit history – loan amounts, interest rates, repayment rates, etc. – at the individual loan level from as many microfinance providers as possible. We will then score the individuals (with the individuals perhaps having received loans from multiple NGOs) and recommend the best risks to the formal sector of banks. This move attacks the information problem described earlier. Even if technology reduces transaction costs and the interest rate is set adequately high to allow sufficient profit, the banks are still reluctant to deal with the poor because they are viewed individually as particularly risky. The typical “graduation” story out of Microcredit is that the borrower eventually saves enough money to be able to deal with the bank. That is, the individual is no longer poor. But, if we can show that certain (in fact, many) individuals are good re-payers based on their past performance, we can mitigate the risk in the mind of the bank, help set that appropriate interest rate, and graduate more of the poor to the profitable, proven sustainable formal sector more quickly.

In summary, the Microcredit Bureau being proposed would first provide a portable, comprehensive credit history to the poor individual while the Microfinance NGOs are still around (and in case they go belly up). In the spirit of SafeSave, I want to provide this desirable financial service that we enjoy to the poor. Secondly, it would build that credit history more quickly and objectively than simply observing accumulated wealth, which would inform banks of the good risks among the poor. Lastly, it may open a Pandora’s Box of pre-approved credit card offers to the developing world. :-) Such is the price of progress.