Monday, May 10, 2010

Microfinance ... level of indebtedness

Dear Colleagues

The following three posts are part of a dialog about microfinance and over-indebtedness. For the purpose of this feedback, however, I prefer to think in terms of the level of indebtedness.



Clearly the phrase "over-indebtedness" implies something is wrong ... level of indebtedness starts off with a neutral view, which, I would argue is important.

From the CA perspective whether or not debt reflects "over-indebtedness" depends very much on what the client is getting from the debt. The heart and soul of microfinance in the early Grameen model was lending to people who, according to the mainstream financial bankers, did not have the capacity to borrow, did not have the collateral to borrow, did not have the profile of a good borrower. As it turned out the criteria used by the big bankers were all wrong, and the Grameen model showed that poor people could use money in ways that improved their quality of life.

Frankly ... according to financial criteria ... I might argue, stupid financial criteria ... all poor people are in a state of over-indebtedness. They are being lent way more money than their "credit score" would allow.

Nobody has yet explained to me how mainstream bankers were able to create a multi-trillion dollar disaster on top of all their credit scoring metrics, appraisal systems, legal oversight, regulators, accounting and audit. How could this happen? Yet lending to very poor people with nothing but their own integrity and honor has been able to keep going without terrible crisis ... and has been enormously helpful in humanitarian emergencies after natural disasters of all sorts. Old fashioned MFIs have been doing something right for society ... while the mainstream banking community created a set up for a terrible socio-economic outcome.

I have been of the opinion for a long time that microfinance is not a single silver bullet to move people out of poverty ... other things are needed. But I have observed over and over again that microfinance can make life at the bottom of the pyramid considerably easier, and is a valuable piece of what is needed.

What is the origin of over-indebtedness? With one MFI in the community, the client has to work by the one MFI's rules ... with multiple MFIs in the community, the client has options ... maybe including borrowing from multiple MFIs. If the client is getting value from borrowing in this way ... and if the client can manage to keep to the terms of the loan and its repayment ... this is not a problem. But beware ... simple quantification of the situation might suggest that this is over-indebtedness ... but I don't think so. It is the client making good use of available resources.

There is over-indebtedness when clients are borrowing to do things that do not have value ... and the clients are not in a position to repay according to the agreed loan terms. This can happen ... and this is evidence of over-indebtedness. The question, then, is why do poor clients take out too much loan. Part of the explanation for this is a behavior of MFI's that put their own financial performance ahead of their clients' interest. As observers of the sector have suggested, this will end up putting the portfolio performance at risk ... but that comes later. Staff in MFIs are going to behave like the mainstream folk in the sub-prime mess ... they will do whatever is needed to "make the numbers" and if the numbers are merely financial performance, then there are going to be microfinance industry problems ... include over-indebtedness.

Many ... not all ... of the MFIs have a strong commitment to social performance and are not simply chasing financial performance at all costs. Many of these organizations are doing amazing work, albeit not work that gets honored because of stellar financial performance. Sadly, the prevailing systems for tracking social impact are poor ... but though not well measured and not well reported, these MFIs are doing a lot of socio-economic good.

CA is committed to "management information" about things of socio-economic importance and in due course it is hoped that the social dimension of MFI performance will be reported using the CA methodology. While this approach does not have the rigor of academic statistical analytics, it will serve to help understand the value of MFI work and usefully supplement the financial reporting. My guess is that this management information will show that the socio-economic performance of an individual or family is exceedingly complex ... and the outcome is determined by many critical externalities, many of which are an order or magnitude more powerful than the good news that microfinance brings.

There is a need to bring the resources of the capital markets into play for the benefit of the four billion people on the planet that are poor and hungry. But how this is done will determine whether or not there is a good outcome. History suggests that when capital markets allocate resource it is all about money return and associated risk ... the value to society is not a measure that appears anywhere in the work of the market.

Accumulated capital ... Carnegie, Ford, Rockefeller, Gates, Buffett, and a whole lot more ... may be used to do valuable things ... but these resources are small compared to the capital that is associated with capital markets and money profit organizations ... many of which are earning their profits in ways that make it difficult for society to make socio-economic progress ... many of which are contributing significantly to value destruction for society at large!

The big issue in the microfinance industry is not the level of indebtedness of the clients but the trend for big MFIs to seek profit more than they seek socio-economic value ... and for the capital markets to fund this terrible trend. My goal is for Community Analytics (CA) to help in getting a new paradigm for socio-economic progress and performance metrics in play as soon as possible.

Please let me know if I am completely off base!

Peter Burgess

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