Macro Microcredit

April 13, 2010 2:46 PM

Big Banks Draw Big Profits From Microloans to Poor Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 percent or more from their impoverished customers. (SLNYT -- use Bugmenot or register with fake information)

Previous discussions of microcredit have focused on its transformative promise, rather than its efficiency for earning money from poor people.

posted by Forktine (24 comments total)

This is excellent news.

Oh hey, what's that "usury" tag doing up there?

Seriously, access to credit markets has the power to massively transform the lives of the world's poor. Interest rates are high because the poorest societies are riddled with insecurities -- to some extent, that's why they're poor. In a developed country, your bank can afford to charge you a low rate of interest because a massively ramified system of protection and social control secures their investment.

Before the development of microloan techniques, banks generally could not afford to charge interest rates low enough that the very poor could afford them -- information problems etc. If banks are now transacting business this way, it's the ultimate ratification of the microloan model, and much more meaningful than a hundred small charities making donations that are technically structured as loans.

Sure it would be better if all subsistence farmers could get mortgages with 5% APRs, but for structural reasons that's currently impossible.
posted by grobstein at 2:58 PM on April 13, 2010 [7 favorites]

Good point, grobstien. I can't really see any danger whatsoever in tapping hitherto untapped credit markets, particularly if the lendees might not have the money to pay back loans. I mean, it's not as though there have been any problems with that sort of thing in the past.
posted by koeselitz at 3:10 PM on April 13, 2010 [4 favorites]

At least these banks are making money by charging interest on loans, rather than securitizing loans that have already been made. I'm with grobstein - what's the problem, exactly? Are our current protections against predatory lending insufficient?
posted by Fraxas at 3:11 PM on April 13, 2010 [1 favorite]

I've been following this closely, as microfinance was just getting big in popular consciousness as I was finishing up my undergrad Econ degree and the seemingly recent turn it's taken has left me, well, disgruntled and disheartened. I don't know enough yet to have a solid assessment either way, but the shift in focus as it's become mainstream feel-good popular advertisement for Big Finance has made me very wary. It's remind me a little of my constant disheartened feeling over the change in the internet in the past 10 years (though that's a lot more privileged and shallow a thing for me, of course).
posted by ifjuly at 3:11 PM on April 13, 2010 [1 favorite]

This strikes me as similar to the payday loan problem. If you assume poor people are stupid, then it makes sense that they don't actually know that they're getting screwed and need to be protected from the lenders. But if you assume that poor people are just as smart as ordinary folks, and understand what they're getting themselves into when they sign up for 900% interest rates, then it makes sense to consider the possibility that they actually need the money badly enough to accept the usurous rates.

“We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks,” Mr. Yunus recently said at a gathering of financial officials at the United Nations. “Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.

The real joke here is that some microloans and all payday loans are actually much more expensive than the rates the old loan sharks charged. The fact that many loans are pooled and collateralized against a whole village rather than an individual owner just means that the person who comes calling when the loan comes due is the grandmother from down the street. As always, it's the social coercion that hurts the worst.
posted by anotherpanacea at 3:19 PM on April 13, 2010

This strikes me as similar to the payday loan problem. If you assume poor people are stupid, then it makes sense that they don't actually know that they're getting screwed and need to be protected from the lenders.

Exactly: except you don't have to assume they're stupid, just know they need the money badly enough to pay the exorbitant rates, and don't have the time to learn more (or even shop around for a better deal).

Yes, these are risky markets, but risky enough to charge 125%?
posted by filthy light thief at 3:25 PM on April 13, 2010 [1 favorite]

In a developed country, your bank can afford to charge you a low rate of interest because a massively ramified system of protection and social control secures their investment

I put it to you that this is somewhat simplistic, as it fails to factor in the reality of competition, consumer access to information and price regulation in developed markets. The article is suggesting that some financial institutions are profit gouging their unsophisticated new clientel in poorly regulated, low competition environments. I respectfully put it to you that it is hardly unprecedented for such institutional behaviour to occur, and hence while I agree that it is good that the poor have access to financial services, it would be surprising if this new extension of the market was already working with maximal "moral efficiency". Hence, I conclude that you are worse than Hitler.
posted by the quidnunc kid at 3:25 PM on April 13, 2010 [3 favorites]

Yeah, microcredit and payday lending provide valuable services to their clients. I know I was hurting for money at one point in my life, and a payday loan kept the lights on. I knew what I was getting into, because everything was disclosed.

In my mind, the fact that so many lenders are in this market means that the benefits of competition will accrue - when you have only a few lenders in a market for charitable reasons, you probably have less than efficient operations.
posted by Pants! at 3:26 PM on April 13, 2010

I am worried that this will mainstream the process in such a way that the system goes back to the status quo- as in, lending to the head-of-household only, etc.

One of the best things about non-profit microlending has been its empowerment of the disenfranchised, especially poor women.
posted by small_ruminant at 3:33 PM on April 13, 2010 [1 favorite]

I just read Portfolios of the Poor, which I think I saw recommended here on MetaFilter. Very interesting. But I remember one small point the author made with regard to some categories of loans that people were accessing was that the rates would seem exorbitant, but the turn-around time on the loans were so short that in some ways it made sense to think of the interest as a fee rather than an annualized rate. I am 97% sure, though, that he was talking about person-to-person loans, more informal things, rather than microfinance loans managed by financial institutions.

Very worthwhile read, that book.
posted by not that girl at 3:37 PM on April 13, 2010

1. Issue millions (billions?) of loans to risky new consumers in previously untapped markets
2. Package new loans into larger tranches of bundled securities and separate them by perceived relative risk level
3. Innovation! Automatically rated as AAA, because they all can't fail at once, right?
4. Sell tranches of new securities to world markets, pension funds, mutual funds, soverigen wealth funds, etc. Innovation is GREAT! AAA!
5. Issue complex CDO and CDS contracts on the back end, betting for and against these products at the same time. Hedging! Innovation!
6. Repeat 1-5. Innovation!
7. ???
8. Bailout. Profit.
posted by T.D. Strange at 3:59 PM on April 13, 2010 [7 favorites]

Awesome! More dark pools of liquidity.
posted by bonobothegreat at 4:00 PM on April 13, 2010

Yes, these are risky markets, but risky enough to charge 125%?

There's one sure way to find out. We're not talking health insurance or cable internet, here; if you want to compete in this game you don't have to be able to cover potential multimillion dollar losses, wade through thousands of pages of regulations, or bribe a fistful of city councilmen for easements; you just need to have a few hundred bucks of savings.

But before you jump in, a couple suggested strategies:

A. Understand both the time value of money and the price of risk. Not going broke requires covering both. For example, charging 3% for the risk of letting someone take your money out of your sight for a day does not mean that you are a usurious monster who charges ((1.03)^365-1)*100 = FIVE MILLION PERCENT INTEREST WHARGARBL!

B. Think of it as a charity instead of an investment. Handing out hundreds of dollars to someone who's desperate enough to benefit from such a small loan is less stressful if you secretly think of it as a donation that might be repaid rather than a gamble with your savings that might be lost.
posted by roystgnr at 4:09 PM on April 13, 2010 [2 favorites]

Think of it as a charity instead of an investment.

Advice to top banking executives: don't try this line at the shareholder meeting.
posted by stammer at 4:27 PM on April 13, 2010

Think of it as a charity instead of an investment.

Making pots of money from microfinance is certainly not illegal. CARE, the Atlanta-based humanitarian organization, was the major force behind a microfinance institution it started in Peru in 1997. The initial investment was around $3.5 million, including $450,000 of American taxpayer money. But last fall, Banco de Credito, one of Peru’s largest banks, bought the business for $96 million, of which CARE pocketed $74 million. The CARE announcement heralding the sale did not mention the price.

Who says you have to choose?
posted by ennui.bz at 5:06 PM on April 13, 2010

There are days when I wonder if banks should be allowed. This is one of them.
posted by sneebler at 6:41 PM on April 13, 2010 [2 favorites]

If I live in a developing country where everyone in my town has to walk 3km to get to the market because there is no refrigeration available in my village to store the fish, getting a loan at 125% interest to allow me to buy a big ice box and trade the fish locally might make me a killing, and easily pay back the loan.
I think the key thing here is that credit has not been available at any price in many of these places, and business opportunities that would have been acted upon decades ago in the west remain untapped.
If I need $200 for two months to buy my village a sewing machine or whatever, and I pay back $275 at the end of that time, but the sewing machine allows me to earn an additional $1000 this year it's a no-brainer.
posted by bystander at 7:39 PM on April 13, 2010 [1 favorite]

Yeah, microcredit and payday lending provide valuable services to their clients. I know I was hurting for money at one point in my life, and a payday loan kept the lights on. I knew what I was getting into, because everything was disclosed.

Yeah, so did my niece, but she still lost her car to a title loan place.

I'm not sure that we need services which by nature prey upon people's ignorance who can least afford to be ripped off. Are you surprised at the idea that many people who get payday and title loans might not understand compounding interest and the real cost of financing? Many states have prohibited their business, and there doesn't seem to be any downside to keeping them out.
posted by krinklyfig at 8:09 PM on April 13, 2010 [1 favorite]

For example, charging 3% for the risk of letting someone take your money out of your sight for a day does not mean that you are a usurious monster

It depends on the terms. If the loan goes unpaid, will it quickly balloon to a ridiculous amount due to ridiculous interest rates, and then property is seized? It can, because this is an unregulated market. That's what the payday loan sharks do here.
posted by krinklyfig at 8:14 PM on April 13, 2010

Awesome! More dark pools of liquidity.
Yeah, because nothing says "liquid" like a $600 loan for a rickshaw.
posted by atrazine at 10:49 PM on April 13, 2010 [1 favorite]

I think it is more than a little naive to think that the thing that has been holding back the world's poor is a lack of access to credit, and that large banks getting into the high interest microloan game in developing countries is necessarily going to be a good thing because of that. Access to credit might be a part of the solution, but lack of it did not cause the problem.

Microloans can have a positive effect, especially when available to women who would otherwise not have many opportunities. But ultimately, high interest foreign loans that facilitate businesses providing local goods and services remove money from the local economy. A lot of factors can offset that, but it does need to be offset.

I've lived in developing countries, and half the non-journalist expats I met were marketing people from international companies learning how to exploit the local markets. This is both good and bad. Coca Cola employs a hell of a lot of people in Africa. (I've heard figures claiming that coke is responsible, directly and indirectly, for 1% of the economy of the continent.) It's not surprising to see banks following the trend. But the lack of regulation is dangerous, as is the gloss of helping the world's poor that discourages criticism.
posted by Nothing at 4:47 AM on April 14, 2010

filthy light thief: “Yes, these are risky markets, but risky enough to charge 125%?”

Well, that's really the rub. There's no really good way of knowing, except by empirical observation of actors in the market, or comparison to similar markets, what the risk premium ought to be. There are a huge number of factors that might go into that interest rate.

We (or rather the authorities in jurisdictions where these loans are being offered) could simply cap interest rates, but then the banks might simply stop offering loans to high-risk borrowers. This was the traditional route in many places that had usury laws, but it tends to have the side-effect of creating a black market for high-interest loans. And even a minimally-regulated but legal market is probably better than a totally-unregulated illegal one. Plus, there's a certain undeniable parentalism about "protect people from themselves" laws that rub a lot of people the wrong way. That's not to say that the market ought to be unregulated, but high interest rates aren't in and of themselves necessarily a sign that anything is wrong.

125% pa seems high, but if the average loan term is measured in days — as might be the case for payday loans — then it might make sense to look at it in terms of a daily or weekly rate instead. And 125% pa works out to 1.57% per week or 0.22% per day, which doesn't seem quite so outrageous. Particularly, if as others have pointed out, you just look at it as a fee: borrowing $100 for a week costs you less than $2. (You run into big problems if you don't pay back the money in the span of time originally anticipated, obviously, but that's a problem with all credit products due to the way compounding interest works. The "fee" doesn't increase linearly with time.)

The best thing that can be done is probably to encourage the development of a strong system of civil law and its associated government bureaucracy, along with things like credit ratings, so that lending is less risky. Keeping an eye on the banks to make sure that nobody manages to monopolize the market would probably also be a good idea; capital markets tend to be fairly efficient but only if they're competitive, and I could see this sort of thing getting pretty warped if there were many barriers to entry.
posted by Kadin2048 at 7:14 AM on April 14, 2010

This raises a concern that I've had for a long while. I don't doubt the good intent of Yunus and others. I'm certain that genuine microloans have already helped a lot of people out of poverty. But, on the other hand, it was only a matter of time until the good old loan sharks jumped onto the bandwagon and repackaged themselves as touchy-feely "microlenders". They've always been doing "God's work", right?

That's the danger of mixing non-profit and for-profit. Ultimately the latter tends to overwhelm the former, often hiding under its allegedly altruistic mantle. There are plenty of cautionary historical examples, such as the transformation of the "philantropic" International African Association into the rather-less-philantropic International Congo Society. Although it may be hugely tempting for non-profits to tap the much bigger resources of for-profit corporations, they should tread very, very carefully.

On a different plane, I find how microlending uses social pressure to ensure payment somewhat disturbing. If you don't pay back your loan (and interest), a loan shark may send Crazy Joe to break your legs. A microlender will get you ostracised from your tight community. I'm not sure about which is worse.
posted by Skeptic at 7:54 AM on April 14, 2010 [1 favorite]

Bah. Humbug.

Microfinance "Bubble" in the Slums

Why financial system must legitimise traditional moneylenders

This dynamic is why some analysts believe the village moneylenders are actually floating the microfinance lenders.

Some Stats About Money Lenders [from India’s Money Lenders – The Colonial Stereotypes]

There are 34,000 money lenders – and they have lent money to more than 2,00,00,000 farmers. They account for nearly 30% of the rural credit flows – and more credit than all the nationalized banks put together. They charge between 18% to 36% p.a. interest generally. Lesser than what most ‘educated’ credit card users pay – and what ‘modern’ banks charge their English speaking customers.

So much about ‘usury’ by money lenders.
posted by infini at 12:00 PM on April 14, 2010