Microfinance and Economics

There was an interesting group of articles in today's issue of The Wall Street Journal (WSJ), all dealing with the idea of microfinance or making small loans to poor people (usually in underdeveloped countries) to help them improve their personal economy, which in turn can help the local and then the larger economy develop. I'll get to the stories later, but first some background.

Long-time readers of this blog have read about microfinance, Grameen and Yunis before. There are some excellent summaries of what Yunis is doing with the Grameen Bank on YouTube, and on the Nobel Prize site.

What makes this microfinance story so compelling is the success it has generated. With a 95%+ repayment rate, at interest that many Westerners would consider onerous, Grameen has made a difference in many lives. But what is most interesting is the procedure the Grameen Bank uses. It lends to women, in societies where women are often looked down upon or, at the least, undereducated. It also depends on peer pressure. Borrowers are expected to have sponsors or be part of a group. The group has a role in making sure the borrower makes repayment, on time and in full. And the Bank turns traditional credit on its head. The less the borrower has, the more creditworthy they are. In fact, Yunis himself states in a February, 2008 lecture before the London School of Economics that the approach was to examine what large financial institutions did and to do the opposite.

This brings us to today's WSJ stories (all free at these links at the time of writing). It seems that the success of Grameen Bank has drawn other institutions into the microfinance market, with some success.

One sees the attraction, high rates of return with low default rates. It certainly seems like an attractive business model. But I suspect for the kind of success Grameen has experienced, the full model must be implemented. (Please note Grameen plows profits back into loans. The borrowers are the owners - more of a credit union/co-op model than a commercial bank.)

A second story (which includes a great short video) relates how for-profit investors are noting what may be the early signs of a credit bubble (not unlike the one experienced the West); with borrowers piling loans on loans on loans, often to finance consumption rather than business development. Apparently, the lenders often ignore the real uses or encourage borrowing. This leads to short-term increases in living standards, but not long-term development or financial independence.

Indeed, the article indicates that because the firms did not use the full Grameen model, institutions are now pushing back on the loans. Groups of borrowers and religious organizations are encouraging non-payment. And, as is shown in this accompanying story, some object to the idea of group pressure, despite the fact that the same pressure is part of what makes Grameen successful.

I think the larger issue, offers a lot of possibilities for classroom use. The most obvious ones are related to the topics of banks, credit, capital, production and economic development. But one can also intertwine discussions of economic institutions. After all, what role can traditions or beliefs about of honesty, peer pressure, and gender discrimination have in credit markets? And while the WSJ stories focus on women borrowers, I found myself wondering if, with greater desire to lend, came a loosening of standards - i.e. money was also lent to men, or to people who already had access to capital (other loans). Clearly there were some false statements of intent on the part of some borrowers; and some “looking the other way” by some of the lenders.

I know there's a lot of information here. And I hope you will be able to access all of it. (Sometimes free links get changed to subscriber links.) But I expect you will find the story interesting, and I hope your students will, as well.

I look forward to your comments.