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From sub-prime lending to micro-credit: poverty lending and new asset classes Presented by John From sub-prime lending to micro-credit: poverty lending and new asset classes Presented by John Conroy At the Workshop Re-embedding the market: crisis and re-invention? Melbourne & Harvard Universities 4 December 2009 1

has micro-credit become another kind of subprime lending? Is this a case of ‘disembedded’ has micro-credit become another kind of subprime lending? Is this a case of ‘disembedded’ finance? • if the ‘self-regulating’ market economy has become ‘disembedded’, with negative outcomes • then we need to consider how to ‘re-embed’ market processes in our societies and cultures • processes of disembedding, & negative outcomes, are evident in many aspects of economic life • after recent events, this is nowhere more evident than in the growth in reach and pervasiveness of financial markets • the impact of ‘financialization’ (‘the act of making something sellable or tradable that didn't use to be’) • here we look at a very specialized corner of the financial markets: the micro-credit ‘industry’ and its growing financialization 2

An introduction to micro-credit and microfinance • micro-credit: regarded by some as the greatest An introduction to micro-credit and microfinance • micro-credit: regarded by some as the greatest innovation in ‘development’ over the past quarter century • essentially, the provision of micro-loans to unleash the presumed entrepreneurial capacities of the very poor • associated with Mhd Yunus and Grameen Bank (GB), which shared the Nobel Peace Prize in 2006 • challenged conventional wisdom: the poor ARE ‘bankable’ • but GB required very high interest rates to cover costs • in earlier years GB lacked transparency and needed very large donor subsidies to continue functioning • critics pointed to this lack of sustainability, and the neglect of client savings (and other financial services for the poor) • nonetheless, GB and other institutional micro-credit ‘models’ made many innovations in service provision 3

microfinance: a much broader approach to the financial service needs of the poor • microfinance: a much broader approach to the financial service needs of the poor • micro-credit continues to rule the popular imagination, but by the 1990 s professionals had a broader understanding • the microfinance approach: emphasizing the value to the poor of a range of services: savings, payments and remittances, & (micro)insurance, as well as credit • this opens the road for ‘MFIs’ to become financial intermediaries, within the broader financial system • any financial institution can ‘do’ microfinance (publicprivate, for-profit/not-for-profit, regulated/informal) • many banks, especially those embedded in local communities, have learned to ‘do’ microfinance • but micro-credit continues, as the vulgar face of microfinance (and as the major element in the ‘industry’) 4

the neglect of savings • the micro-credit industry neglects the need of the poor the neglect of savings • the micro-credit industry neglects the need of the poor for savings and deposit services • access to savings facilities brings great benefits to the poor • and, in fact, the poor have the capacity to save, if offered safe, liquid and convenient deposit services • mobilising their savings contributes to financial deepening, builds institutional capacity for financial intermediation and supports financial system development • but the micro-credit industry finds it easier and cheaper to rely on external resources (donor funds, loans, investors) than to mobilise the savings of the poor 5

investing in micro-credit: cross-border capital flows • foreign capital commitments totalled $14. 8 bn investing in micro-credit: cross-border capital flows • foreign capital commitments totalled $14. 8 bn at end-08 (donors 48%, investors 52%) • grants 17%, debt 63%, equity 17%, guarantees 5% • disbursements in ’ 08 about $3 bn (two-thirds by investors) • almost all flows support retail MFIs directly or indirectly (retail 61%, wholesale 33%) • now >100 Microfinance Investment Vehicles (MIVs) in operation: funds under management $6. 6 bn at end-’ 08 • asset growth: ’ 07 72%, ’ 08 31%, ’ 09 (est’d) 29% • fixed income is 75%; equity is growing (r/g in ’ 08, 47%) 6

the ‘financialization’ of micro-credit • financial technology applied to microcredit: MIVs, securitization, CDOs and the ‘financialization’ of micro-credit • financial technology applied to microcredit: MIVs, securitization, CDOs and structured finance, credit wraps/guarantees, loan syndications, hedging mechanisms, ratings agencies, IPOs • initiated by IFIs and social investors but with a growing ‘for-profit’ element, including MIVs, venture capitalists and private equity funds, even mobile network operators • profitability of MFIs in many developing economies has stimulated investment: MIX data show higher ROA for MFIs than for commercial banks in many countries • about 75% of MIVs deal entirely or mainly in fixed interest investments; some are ‘socially focussed’ and accept lower returns; others offer ‘structured’ products with a range of risk/return options. Others (eg, private equity funds) take equity stakes in MFIs • average gross yield on debt held by MIVs was 9. 5% (‘ 08) 7

Scandals and bubbles: ‘the pinstripes are chasing the poor’ • the infamous Banco Compartamos Scandals and bubbles: ‘the pinstripes are chasing the poor’ • the infamous Banco Compartamos IPO • Sequoia Capital buys into SKS (a ‘for-profit’ MFI in South India: currently the scene of a ‘micro-credit bubble’) • both Citi & HSBC now plan to ‘mainstream’ micro-credit • but are ‘the pinstripes’ likely to be interested in targeting the poor or in mobilising their savings? • will new players behave differently? : Telcos and retail chains (eg, Walmart in Mexico) • will the Compartamos fiasco prove useful (ultimately) by attracting competition and professionalism into the field? 8

Subprime mortgage lending and micro-credit: some curious parallels • both flourished due to laudable Subprime mortgage lending and micro-credit: some curious parallels • both flourished due to laudable government efforts to provide credit for the ‘unbankable’ • for subprime mortgages: the CRA introduced and the Clinton administration accelerated the process • for micro-credit: Yunus was taken up as the ‘darling’ of the donors; official development assistance (ODA) promulgated and funded the industry • in both cases financial innovation was crucial to growth • both were seen as new asset classes, attracting the attention of aggressive, ‘non-traditional’, lenders and intermediaries 9

how has micro-credit become a new ‘asset class’? and what lies behind its growing how has micro-credit become a new ‘asset class’? and what lies behind its growing financialization? • foreign philanthropy and ‘socially responsible’ investment helped build the industry • new forces at work in the new century: rising international ‘imbalances’ between the US and the ‘surplus’ economies • the ‘wall of money’ flowing into major financial markets • the need for more investment propositions to deploy funds • the attraction of a new asset class offering benchmark returns • fashionable concerns (bottom of the pyramid, ethical and socially responsible investing) • the application to micro-credit loan portfolios of the mechanisms of financial engineering • an enthusiastic international cheer squad: World Bank, CGAP (the microfinance donor club), driven by the highly effective Micro. Credit Summit propaganda machine 10

commercialization and foreign investment: some necessary clarifications • neither commercialization nor foreign investment is commercialization and foreign investment: some necessary clarifications • neither commercialization nor foreign investment is necessarily liable to ‘disembed’ financial services • indeed, commercialization is a necessary condition for building sustainable grassroots financial services • both domestic and foreign financial institutions are investing in micro-credit and this should be welcome (to a degree) since capital shortage is a defining feature of underdevelopment • BUT, if micro-credit becomes merely a vent for surplus foreign capital and if cross-border capital flows actively suppress domestic savings mobilisation, and cause ‘mission drift’, financial systems will be neither embedded nor inclusive 11

the financialization of micro-credit is ironic in the extreme • Mhd Yunus: famously antagonistic the financialization of micro-credit is ironic in the extreme • Mhd Yunus: famously antagonistic to the financial system • GB: a reaction to ‘market failure’ in B’desh banking • GB is an instance of Polanyi’s ‘double movement’: a protective reaction to a financial system disembedded from the prevailing context of poverty and financial exclusion, and marked by corruption and ill-governance • GB is an attempt to ameliorate a socially dysfunctional situation & to embed a credit mechanism in a poor society • but (even in its new & reformed shape) how far is GB sustainable? Does it really help the poor? Does it lead to greater financial inclusion? 12

financial inclusion • after micro-credit, and then microfinance, comes a new emphasis, on financial financial inclusion • after micro-credit, and then microfinance, comes a new emphasis, on financial inclusion • financial inclusion, defined as access for all to formal financial services • levels of financial inclusion: PNG 8% (ie. , 92% excluded), Vietnam 30%, Indonesia 40%, Singapore 98% • has financial inclusion superseded microfinance? • NO! Financial inclusion is the policy goal and microfinance is the policy instrument (for now, at least) • financial inclusion is a source of distributional equity & social cohesion • financial inclusion is a necessary condition for creating an embedded financial system 13

modern ‘drivers’ of financial inclusion • • agent banking mobile phone banking greater diversity modern ‘drivers’ of financial inclusion • • agent banking mobile phone banking greater diversity of MF service providers governance and management of state banks financial identity regulations protection of consumer & creditor rights BUT, will these prove to be compatible with embedded financial systems? 14

Conclusion • • 1) 2) • • a striking feature of the microfinance industry Conclusion • • 1) 2) • • a striking feature of the microfinance industry is its internationalisation, especially in terms of diffusion of ideas and technology more problematic is its internationalisation in terms of capital flows, to the extent that this may tend to diminish the incentive to mobilise domestic resources in countries where many are denied access to deposit services to cause ‘mission drift’ in funded institutions such a trend would jeopardize the financial inclusion of the poor, who would otherwise benefit greatly from a financial development strategy founded on extending deposit and other services to low-income households the poor need services delivered by a ‘distributed’ financial system: a system embedded in local communities, powered by technological change 15