NEWS WIRE: India: Microfinance Raises Fresh Sub-prime Fears

Source: Times Online.

Original article available here.

MUMBAI, July 14 – Leading bankers fear another potential sub-prime scandal in poverty hotspots across the world with the advent of microfinance, where lenders make tiny loans to impoverished borrowers.

Microfinance is supposed to offer a “double bottom line”: the financiers make profits while helping some of the world’s poorest people, from Mexico’s villages to the townships of South Africa, improve their lives.

As new lenders flood the sector, however, concerns are mounting that a new breed of “microloan sharks” are helping only themselves. Leading bankers fear another sub-prime-type scandal – where poor American homebuyers were sold loans they couldn’t pay – is brewing.

In the 32 years since Grameen Bank, the first microlender, opened for business in Bangladesh, poor borrowers have proven astonishingly creditworthy. Microloan repayments typically top 97 percent, far higher than conventional lending.

Hopes are high: Muhammad Yunus, the Nobel Peace Prize-winning “godfather of microcredit” who founded Grameen, talks of a future in which people visit “poverty museums”. Asad Mahmood, who heads Deutsche Bank‘s microfinance arm, envisages a time when “a Dar Es Salaam becomes a Frankfurt”. Such is the potential power, they argue, of loans of as little as GBP 5 advanced to help, say, Venezuelan villagers buy dairy cows or Ugandan co-operatives purchase sewing machines.

Some of the world’s savviest investors are buying in: Sequoia, the venture capital group that backed Google, recently took a stake in SKS, India’s largest microfinancier. With estimates suggesting that demand for microcredit stands at about USD 250 billion, ten times the amount lent so far, Citigroup and HSBC plan to make it a mainstream business. As Time magazine put it: “the pinstripes are chasing the poor”.

Not all is well, however. When Compartamos Banco, Mexico’s largest microlender with more than 840,000 customers, went public last year, it raised USD 450 million for a group of backers that had originally invested just USD 6 million. It emerged that the bank routinely charges annual percentage rates (APR) of interest of more than 100 percent – about treble the global microfinance average. Its return on equity is more than three times the 15 percent delivered by Mexico’s conventional lenders.

A paper written for a Stanford University review said: “The Compartamos IPO raises a red flag: There is something decidedly unseemly about profit-maximizing investors backing an [microfinancier] that charges 100 percent interest, compounded annually, to the world’s poorest people.”

In South Africa experts say loans are being misused to buy television sets and the like. In Bolivia there are fears microfinance will go the way of pawnbroking, a pariah among financial services.

According to Larry Reed, of the Boulder Institute, a specialist thinktank, the sector “faces a moment of reckoning”. A recent meeting of bankers, academics and development specialists admitted that “rapid growth … is now leading to accusations of aggressive collection or excessive profits”.

Many hear echoes of another recent financial crisis triggered by overzealous lenders. “We want to make sure [microfinance] doesn’t become a subprime case,” Mr Mahmood said.

Microfinanciers are now being called to sign the Pocantico Declaration, a self regulation pact that resembles a kind of Hippocratic oath, the ethics code that states doctors should, above all, “do no harm”. Elizabeth Littlefield, of the Consultative Group to Assist the Poor, one of the groups behind it, said: “Without commercial foundations microfinance cannot become the profitable business it needs to be to survive. But without firm ethical principles and a commitment to benefit poor people’s lives first and foremost, it will no longer be microfinance.”

There are dissenters. Mary Anastasia O’Grady of the Wall Street Journal wrote this week that the outcry over Compartamos occurred because “do-gooders … the poverty industry” had started “losing clients”. She said Compartmanos should charge what the market can bear because competition among lenders would lead to falls in rates.

Bankers agree that competition will lower charges, which are notoriously high because microloans are expensive to service. However, many believe the transition to truly open markets will take generations. “From monopolies you don’t go straight to free competition – you go first to oligopolies,” Mr Mahmood said. “It’ll be 50 years before you get to a free market.”

In the meantime, he argues, microfinanciers must plot a careful course lest they bleed their borrowers dry. “Indulging in unfettered capitalism is like sleeping with an alligator: there’s a very good chance it’s going to bite you.”

How microfinance works

In the classic microfinance deal a poor villager borrows a small sum to buy a cow for milk. The cow gives milk from day one and so repayments can be made immediately. As the micro sector gains traction, however, it is evolving to finance riskier projects that have the potential to deliver huge returns.

Vortex, a Madras-based technology start-up, was funded by a INR 2 million (GBP 24,400) investment from Aavishkaar, a specialist “micro venture capital” (MVC). The company has developed what it hopes will be a revolutionary new cash machine that can solve India’s chronic financial services shortage. The Gramateller ATM costs a tenth of the price of conventional models and is cheap enough to deploy in rural Indian areas where the average transaction is INR 100 (GBP 1.25).

A fingerprint scanner provides an identification system suitable for a country where 70 percent of the population is illiterate. The Gramateller can also take deposits and deal with dirty and crumpled notes – helpful, since villagers are often suspicious that crisp new cash is forged.

Unlike microfinance schemes, MVC funds do not require repayments to be made immediately, which means riskier, younger companies yet to turn profits can be funded. Lakshmimarayan Kannan, the head of Vortex, said: “For us, a small amount of money made a large impact.”

The Gramteller’s potential market is vast. In the US, where credit cards are common, there is a cash machine for every 1,000 people. In India, where cash is still king, there are only about 30,000 machines in the entire county – one for every 43,000 people. ICICI, India’s largest private bank is piloting the technology and Aavishkaar could reap a handsome profit: one of Indonesia’s largest retail banks has told Vortex that if the Gramteller proves itself in field trials it will “buy as many ATMs as the company can build”.

By Rhys Blakely, Times Online

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