Sunday, October 12, 2008

Lessons from Micro-Finance

Big financial institutions of all sorts are in dire straits across the globe. But one category remains unaffected - micro-finance.
Even as the global financial system freezes and giants like Lehman Brothers,AIG,Morgan Stanley collapse, micro-finance institutions (MFIs) are expanding unfazed. Famous financiers face defaults big enough to wipe them out, but MFIs report virtually zero default.

This is extraordinary. The Big and mighty financiers lend against collateral, a back-up if their borrower defaults. But micro-finance institutions lend with no collateral at all. Big guys lend to the most creditworthy corporations.

MFIs lend to poor women whom nobody in history considered creditworthy before. Yet, the secured loans to big corporations are bombing, while unsecured loans to poor women are being repaid in full.

Why is that- The basic difference sound counter intuitive. Big institutions lend against collateral and micro-finance does not look at collateral. Looking at collateral blinds the institution from looking at the repaying capacity of the borrowers. US big institutions gave mortgages for 100% of the house value as collateral to people who do not have any capacity to take loans of that amount and you know what has happened because of that.
In the micro-finance area, the repayment capacity plays the most important factor in providing loans. I presume the big banks have learnt something from this.

Leverage can only take you up a certain level, if you try to exploit it, it is going to bite you. Ouch It hurts.

Banks wake up.