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 mortgage-backed 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: 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.
When you reap the benefits, you must pay the cost of your actions as well:
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 home-owners 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 re-sell at a profit. Some can afford to repay but have decided not to, since default attracts no social opprobrium.
By contrast, defaulting home-owners 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 re-sell at a profit. Some can afford to repay but have decided not to, since default attracts no social opprobrium.
But Micro finance is not the financial panacea:
So, the MFI model is small but sound. But don’t lavish excessive praise on it. Western banks lend far too much. But Indian lenders—including MFIs-- lend far too little. Rural studies suggest that poor rural households need Rs 25,000 or credit per year. MFIs provide far less. The balance is made up by borrowing from relatives and moneylenders. The system cries out for more formal credit.
The aim must be to enable capable but capital-starved entrepreneurs to move beyond ownership of buffalos and tea-shops. At an MFI meeting in rural Dehra Dun, I saw an enterprising village woman pleading for a loan of Rs 50,000, saying (rightly) that this was the minimum needed for a decent shop. But the MFI regretted that this was beyond its lending limit.
The aim must be to enable capable but capital-starved entrepreneurs to move beyond ownership of buffalos and tea-shops. At an MFI meeting in rural Dehra Dun, I saw an enterprising village woman pleading for a loan of Rs 50,000, saying (rightly) that this was the minimum needed for a decent shop. But the MFI regretted that this was beyond its lending limit.
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