The global economic slowdown all began with a credit bubble.  The over-simplified version of what happened is that too much credit (loans, etc) was given out while spreading the risk over many players.  As a result, no one had a clear understanding of the cumulative risk across the system.  This lead to an increase in delinquency rates because too many bad loans had been approved.  As more people stopped repaying their loans, banks felt pressure because they had less money to repay their own debt.  The entire ordeal was much more nuanced than I describe, but essentially a rise in loan defaults was one of the first signals of the financial collapse.  Banks across the world were all connected to the crisis in some way, but somehow the microfinance industry remained unscathed.  Despite the economic downturn, the world’s poorest continued to generate an excellent track record and repay their loans.

Recently, however, there has been some speculation that there is in fact a credit bubble looming in the microfinance industry (at least in Bangladesh).  Grameen Bank, which was founded by Nobel Peace Prize winner Muhammad Yunus, is one of the few microfinance institutions (MFIs) that openly shares data on its holdings (something which more MFIs should do).  A few days ago, David Roodman, a well known writer about microfinance wrote a very detailed and interesting piece about the potential bubble here.  Taking a glance at Chart A below, you can see that Grameen’s repayment rate decreased significantly as 2009 went on.  At the end of 2009, the rate was hovering just above 95%, which is a tenuous position for banks.   Grameen is not new to these challenges and they have found ways to move past them in the past (usually by growing the lender base to gain more flexibility), but rapidly falling repayment rates could spell  looming disaster.

Chart A: Grameen Bank Loan Repayment Rates

Implications
The extent of the problem is not well understood, so there could be a variety of possible implications.  On one hand, this could be the result of borrowers taking on debt in order to pay off other loans, thus becoming trapped in a cycle of debt.  If that is the case, those borrowers are likely to start defaulting at an increasing rate and this could be the beginning of a very tumultuous time for MFIs in Bangladesh (and potentially other parts of the world).  On a more positive note, this could be the result of the tail end of the global crisis and could be merely temporary.  The drop in repayment rates could in fact indicate a pop in a microcredit bubble, but its possible that the ramifications of that pop are minimal.  The only way to know is to understand how systemic the problem is, which is impossible without more data.

Microfinance has dramatically changed the opportunity set for poor and disadvantaged in developing countries; the last thing we should do is turn our back on it in a time of crisis.  Whether or not MFIs around the world are on the brink of a major down turn, I would encourage the industry to set up standards that allow for more data sharing between banks and the public.  Since most MFI borrowers do not have established credit, MFIs have no way of knowing whether or not that borrower has significant debt with other institutions.  Public financial disclosure would greatly alleviate risk in the space.

-  Bryan