ABELLO: Trust is all the collateral needed

Oscar Abello

Microfinancing is a profitable business venture. Typical portfolio-at-risk ratios for microfinancing institutions hover around 2 percent – in other words, only one out of 50 micro-loans report delinquent repayments. Consider the current plight of the sub-prime mortgage market: more than one of 10 sub-prime mortgages report delinquent payments – that’s one out of 20 total mortgages overall. Suddenly that one of 50 seems like a far-fetched dream of financial security.

Targeted almost strictly at the world’s poorest, microfinancing is a safe and sustainable enterprise, as evidenced by the now-famous Grameen Bank, established by Nobel Laureate Muhammad Yunus. Grameen reported a profit of $7 million in 2004 and profited $15 million in 2005.

Over $6 billion has been disbursed to a network of seven million borrowers, who are organized into 75,950 villages, with 2,381 locally controlled bank branches, all in Bangladesh. Zero collateral is required for a loan. Instead, a five-member committee is formed of village members to help the borrower maximize the potential of each loan, which is paid back with interest rates from 5 to 20 percent depending on the type of loan. A few loans are even disbursed at zero interest, to the absolute poorest of the poor.

This deep level of trust is strengthened by the policy of encouraging women to participate in economic activity, so that 97 percent of borrowers are women, assuming they are more likely to use these funds productively than men.

The result of trusting fellow human beings? All those profits and only 1.51 percent of loans have defaulted. Sixty-four percent of borrower families have lifted themselves out of poverty, with the rest on the way. As for the icing on the cake, the bank ultimately resembles a standard credit union, with 94 percent of equity owned by the borrowers themselves – the poor and the formerly poor.

Meanwhile, homeownership is threatened in America. Alan Greenspan made famous the concept of irrational exuberance. The sub-prime mortgage market had been subject to this phenomenon due to low interest rates and rising home prices in the earlier part of the decade, and now we shall all bear the cost of trusting only the math of the market instead of trusting also in people. The market ran itself into a corner by over-financing homeownership.

If instead the market were more prone to microfinancing small business for the poor, it would see the Wal-Marts of our world as the nightmares they are. Wal-Marts today are given almost free reign to expand as they please, bringing us a fantasy of higher living standards – in the same way the low-interest lending binge brought many a fantasy of housing they couldn’t afford. Wal-Mart appears to be a good thing, instantly lowering the cost of living in an immediate area, but Wal-Mart also crowds out small businesses in the same area. Small business is the lifeblood of any community, and the focus of a successful microfinancing scheme. It comes down to this: we might pay less at Wal-Mart, but it will cost us in the end, just as paying less for housing costs us the sub-prime market implosion. It’s irrational exuberance.

The fact is, we must also trust people, not just markets, to make decisions for society. Zero collateral microfinancing is an ultimate display of trust in people first, markets second. In monetary terms, the average micro-loans for small businesses are small and within reach of a small business to pay back, unlike a hefty home mortgage to a poor family. But the funds signify more than just financial aid; they’re a symbol of trust between people. As the women of Bangladesh demonstrate, the market profits and society benefits from this trust.

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Oscar Abello is a junior economics major from Philadelphia, Pa. He can be reached at [email protected]