• Embed Doc
  • Copy Link
  • Readcast
  • Collections
  • CommentGo Back
 
Draft
 
3.0
 
concept
 
note
 
1
The
 
Subprime
 
Crisis
 
and
 
its
 
Implications
 
for
 
the
 
Microcredit 
 
Market 
 
Sahba
 
Sobhani,
 
Programme
 
Manager,
 
and 
 
Suba
 
Sivakumaran,
 
Research
 
 Associate,
 
Growing
 
Inclusive
 
Markets
 
Initiative,
 
UNDP*
 
M
ICROCREDIT
 
O
VERVIEW
 
The microcredit market today has advanced by leaps andbounds from its early conception, from the evolution of itsfunding profile (i.e. from being funded by just deposits to nowbeing additionally funded through cross-border securitization),to the expansion of its outreach to those previously excluded,to its product innovations that enable clients to mitigateshocks and smooth consumption and income in more andmore sophisticated ways, and lastly, to its regulation bothdomestically and internationally. Today, the exponentialincrease in lending to low-income clients, coupled with theexplosion of the subprime bubble, warrants an investigationinto whether relevant lessons can be learnt from the latter.Figure 4 shows the most recent data on evolving MFIcapital structures by region. The expansion of commercial borrowings (including securitized portfoliosas well as plain-vanilla loans), while representingsignificant opportunities for increased reach to thefinancially excluded, also represents increased leveragein the system. While these systems remain underregulated, this remains a source for concern due to itspotential for inadequate consumer protection.
R
ELEVANT
 
C
AUSES
 
OF
 
THE
 
S
UBPRIME
 
C
RISIS
 
TO
 
THE
 
M
ICROFINANCE
 
M
ARKET
 
The subprime crisis in the United States mortgagelending sector lends itself to a comparison analysis withthe current microcredit sector in the developing world. Research
1
from the World Bank on thiscomparison, as well as other sources indicate the following pressing concerns. While this analysis isfocused purely on the negative implications of subprime lending and microcredit lending, it is importantto remember that both practices extend financial access to the financially excluded, and when executedproperly, can improve welfare.
*
 
The
 
views
 
expressed
 
in
 
this
 
paper
 
are
 
the
 
authors’
 
and
 
do
 
not
 
represent
 
those
 
of 
 
the
 
United
 
Nations
 
Development
 
Programme.
 
1
 
Gwinner,
 
William
 
B.
 
and
 
Saunders,
 
Anthony,
 
“The
 
Sub
 
Prime
 
Crisis:
 
Implications
 
for
 
Emerging
 
Markets”,
 
September
 
2008,
 
The
 
World
 
Bank,
 
Policy
 
Research
 
Working
 
Paper
 
4726
 
Box 
 
1:
 
Definition
 
and 
 
Concepts
 
Microcredit:
 
The
 
lending
 
of 
 
small 
 
capital 
 
amounts,
 
usually 
 
unsecured,
 
to
 
individual 
 
borrowers
 
 for 
 
the
 
short 
 
to
 
medium
 
term.
 
Borrowers
 
are
 
sometimes
 
organized 
 
into
 
 joint 
‐
lending
 
groups
 
with
 
social 
 
cooperation
 
and 
 
trust 
 
mechanisms
 
underpinning
 
borrowing
 
and 
 
repayment.
 
Figure
 
1:
 
Evolving
 
MFI
 
Capital
 
Structures
 
by
 
Region
 
Draft
 
3.0
 
concept
 
note
 
2Microfinance
 
Institutions
 
(MFIs):
 
Fall 
 
into
 
 five
 
categories,
 
traditional 
 
banks,
 
credit 
 
unions,
 
non
‐
bank 
 
 financial 
 
institutions
 
(NBFIs),
 
non
‐
governmental 
 
organizations
 
(NGOs),
 
and 
 
rural 
 
banks.
 
Of 
 
these,
 
some
 
are
 
allowed 
 
to
 
take
 
in
 
savings
 
deposit 
 
whilst 
 
others
 
are
 
mandated 
 
only 
 
to
 
 provide
 
credit 
 
and 
 
credit 
‐
related 
 
 products.
 
The use of credit scores
Lending in both the subprime market as well as many microcredit markets is predicated on credit scoresand default models that are frequently outdated, or inappropriate
2
to the particular market.a)
 
In the case of subprime lending, default models have not kept up with the evolving market, and sosubprime default rates have surprised investors and lenders
3
.b)
 
In the case of microfinance, as Kate McKee from the Consultative Group to Assist the Poor (CGAP)at the World Bank points out: in microfinance there tends to be an over reliance on cheap-to-obtaincredit scores, vs. better analyses that incorporate extended affordability analysis, income verificationand savings profiles
4
.
Claims that lending has provided access to those previously excluded need to be examined carefully.
a)
 
Subprime lending has provided only limited access to finance
5
.More than half of subprime loans inthe United States have been for refinancing existing mortgages rather than purchasing a house
6
.b)
 
In microcredit markets, the claims that microcredit has increased access to finance by the poor arealso in doubt. Jonathan Murdoch cites studies completed as part of legislation mandated by the USCongress that show that in Peru, Kazakhstan and Uganda, roughly, only 15% of microfinancecustomers were among the ‘poorest half’ of the poor, as defined by the official poverty line in theircountries
7
. In addition, borrowers are also susceptible to debt traps (for example using one source of micro loans to pay off another source), that may mask the true reach of microcredit.
Moral hazards involved in the “originate and distribute” model of securitization
8
.
a)
 
The traditional bank model (one followed by most banks in emerging markets) is one wherebanks originate and hold the loans in their portfolios, fund them with deposits and retain thedefault risk 
9
. Between 2001 and 2006, between 60 and 80% of subprime loans were bundled intomortgage backed securities and sold to investors in capital markets
10
. This led to a moral hazardin that those ‘originating’ the loans did not have to hold them on their balance sheet, and couldoriginate riskier loans.
2
 
Ibid.
 
3
 
Ibid.
 
4
 
McKee,
 
Kate,
 
“Meditations
 
on
 
the
 
US
 
Sub
‐
prime
 
crisis:
 
Implications
 
for
 
International
 
Microfinance”,
 
May
 
19,
 
2008,
 
Consultative
 
Group
 
to
 
Assist
 
the
 
Poor,
 
World
 
Bank.
 
Presentation
 
for
 
the
 
Silicon
 
Valley
 
Microfinance
 
Network
 
5
 
Gwinner,
 
William
 
B.
 
and
 
Saunders,
 
Anthony,
 
“The
 
Sub
 
Prime
 
Crisis:
 
Implications
 
for
 
Emerging
 
Markets”,
 
September
 
2008,
 
The
 
World
 
Bank,
 
Policy
 
Research
 
Working
 
Paper
 
4726
 
6
 
Ibid.
 
7
 
Morduch,
 
Jonathan,
 
“Smart
 
Subsidy
 
for
 
SUSTAINABLE
 
MICROFINANCE”,
 
Finance
 
for
 
the
 
Poor,
 
December
 
2005,
 
Volume
 
6
 
Number
 
4,
 
Asian
 
Development
 
Bank.
 
8
 
Gwinner,
 
William
 
B.
 
and
 
Saunders,
 
Anthony,
 
“The
 
Sub
 
Prime
 
Crisis:
 
Implications
 
for
 
Emerging
 
Markets”,
 
September
 
2008,
 
The
 
World
 
Bank,
 
Policy
 
Research
 
Working
 
Paper
 
4726
 
9
 
Ibid.
 
10
 
Ibid.
 
 
Draft
 
3.0
 
concept
 
note
 
3
b)
 
The comparison in the microfinance sector is the increasing use of securitization of microcreditloan portfolios. This suggests a potential misalignment in incentives for those who originate theloan to ensure creditworthiness. While there are mechanisms to mitigate these (ICICI Bank forexample, ensured that originators of securitized microfinance loans were also subject to a firstloss default guarantee (FLDG)), they are limited in scope.c)
 
Besides securitization, there also exist potential incentive misalignments in loan origination thatutilizes a principal-agent method on the ground, when brokers originate loans which are kept onanother institution’s balance sheet.
Lending has increased indebtedness and leverage for consumption purposes instead of investmentpurposes.
a)
 
The availability of cheap credit for subprime clients led to reckless refinancing as house pricesrose, for the purposes of consumption rather than investment.b)
 
In microfinance, the claims that loans are fed to enterprises or income-generating activities ratherthan consumption-smoothing or income-smoothing activities may be overstated. Thesusceptibility of such clients towards debt traps needs to be carefully examined.
Disparate regulation for banks, non-bank financial institutions, mortgage-agents etc
11
leads to lackof appropriate oversight.
a)
 
For example, the US financial regulatory system permits mortgage lenders to move risk to wherecapital charges are lowest and regulatory scrutiny is lightest
12
.b)
 
The opacity and disparity of regulation also exist in microcredit markets where banks, and non-bank financial lenders that originate similar loans are regulated differently in domestic markets.The global market for investors that invest in microfinance institutions are largely self-regulatedat the moment, though there is movement towards adopting a common set of principles (seePocantico Declaration.)
Consumer protection is limited
 a)
 
Predatory subprime lenders in the US have misled borrowers and convinced them to take outloans that they did not understand or that carried inappropriate risks. Subprime borrowers arepredominantly minority, lower income, less well financially educated and less likely to search forthe best interest rates and terms for their mortgage loans
13
.b)
 
These characteristics, particularly regarding financial literacy is true in microcredit markets. Inaddition a commonly cited practice has been fee packing, where excessive processing fees areincluded in the balance of the new loan. In microcredit, while many countries have pushed tohave transparency regarding
effective
interest rates (i.e. including fees etc.), more can be done toensure that the consumer is fully informed about loans.
R
ECOMMENDATIONS
 
FOR
 
M
ICROCREDIT
 
MARKETS
 
11
 
Ibid.
 
12
 
Ibid.
 
13
 
Ibid.
 
of 00

Leave a Comment

You must be to leave a comment.
Submit
Characters: ...
You must be to leave a comment.
Submit
Characters: ...