Sunday, January 09, 2011

Grameen Bank Hits Wall

For decades The Grameen Bank in Bangledesh was held out as sort of an anarcho-capitalist dream: small groups lending and monitoring borrowers, and making money too boot. Banks are usually big, controlled by wealthy parties, but here was a case where the decision makers were little people, and historically loss rates were pretty low. Most loans were for little amounts like $100, and made to women involved in little home businesses.

Although each borrower must belong to a five-member group, there is no form of joint liability. However, in practice the group members would contribute the defaulted amount with an intention of collecting the money from the defaulted member at a later time. There was a great deal of invasive monitoring, cajoling, and often physical intimidation, but when done informally by friends, was not considered oppressive. This clearly would not scale.

The bank has grown a lot in the past 10 years, and the founder, Muhammad Yunus, won a Nobel Peace Prize in 2006 for this idea. The problem with banking is that when borrowers can't pay, there's a political incentive to paint the lender as the bad guy and repudiate the debt. The bigger Grameen got, the greater the political incentive treat them like a regular bank, as the Bangledeshi Prime Minister recently denounced the bank as “sucking blood from the poor in the name of poverty alleviation.”

Elsewhere, imitators have seem similar ends. Nicaragua’s president, Daniel Ortega, for example, supported the no-pay movement, which was started in 2008 by farmers after some borrowers could not pay their debts. Partly as a result of that campaign, a judge recently ordered the liquidation of one of the country’s leading microlenders, Banco del Exito.

Banks should not be thought of as cookie jars full of money, but rather things that manage the savings-investment nexus. They evaluate borrower's creditworthiness, and repossess pledged collateral if payments are not made. If banks simply wrote-off every bad loan as opposed to seizing collateral per the original contract, recovery rates would be so low the whole industry would have to change, and interest rates would rise several fold in anticipation of the higher expected loss rates. Every so often the great idea comes up: why not just stop paying the banks? Borrowers are invariably more numerous and have less net wealth than the savers. Thus, we had the expropriation of the Knights Templar in 1307, several Jewish expulsions in the middle ages (Jews specialized as money-lenders), and various communist takeovers such when the Khmer Rouge took over Cambodia. In every case, this had disastrous effects on the economy.

Surely, if you can't pay back a debt there should be a way to avoid slavery, and we have that now, it is called bankruptcy. To simply repudiate loans, as with the whole 'robo-signer' pretext, is a naive, populist remedy that has always been regretted. The basic problem is, by getting rid of debt you get rid of savings, and without savings, you have no investment.


Dave said...

Good points. I blogged about another objection to micro finance a couple of years ago ("Questioning the Conventional Wisdom about the Benefits of Microfinance and Encouraging Entrepreneurship"), one raised by Prof. Milford Bateman: that micro finance siphons capital away from more productive SMEs in favor of subsistence businesses like rickshaws, etc.

Anonymous said...

Microlending has always seemed like an obvious scam to me. Poor people aren't helped by debt. (Should we give a Nobel prize to Visa and Mastercard?) What they need are (better) jobs, provided by real companies.

Salem said...

It's not true that without savings you have no investment, but without savings investment becomes a lot more difficult. Also, by getting rid of debt and savings you massively contract the money supply.

Patrick R. Sullivan said...

'Banco del Exito.' Perfect.

Anonymous said...

"Banco del Exito" means "Bank of Success".

zby said...

Maybe the model is not that bad - just got overhyped like all the other bubbles? Think internet a few years ago - lots of people qualified all internet business as scam back then.