Tuesday, August 18, 2009

Microfinance experience vs. credit union -- Grameen I

I am reading a good book that gives details on the institutional history, structure, and experience of Grameen and Grameen II. The book is Asif Dowla and Dipal Barua's The Poor Always Pay Back: The Grameen II Story, Kumarian Press, 2006. A number of interesting thoughts came to my mind, especially in relation to my thought of using RoSCA-JAK hybrid structures to generate credit unions organically using the existing institutions in Egypt. The notes in this post relate to Chapter 2 of Dowla and Barua's book, which focused on the original Grameen model and its evolution. Quotations from the book will be in quotation marks, followed by my comments/thoughts:
  • Interestingly, Grameen itself has a mutual structure, with all members forced to save with the bank, and part of those savings are shares in the bank itself (on which, at least as of 2005, the shareholders did not receive dividends; they received 8.5% interest on their deposits). This begs the question why Grameen was not set up at the outset as a non-profit credit union (more on that later).
  • One potential answer is the following: "A major reason for the prior failure of credit cooperatives in Bangladesh was that the groups were too big and consisted of people with varied economic backgrounds... more affluent members captured the organization" (p.18). This suggests, perhaps, that those cooperatives were structured more like mutual savings banks (one share = one vote) rather than credit unions, which are much more democratic in nature (one shareholder = one vote).
  • Grameen used presaving to qualify for loans, which I did not know from reading secondary and tertiary sources: "To receive a loan, borrowers were required to save ... [in the form of] deposit[ing] a fixed amount weekly... [in addition to] a 5% deduction from the loan... [as a] group tax. The compulsory weekly savings and loan deductions were used to create a group fund, and the borrowers were paid 8.5% on their deposits." (p.19) This is somewhat reminiscent of JAK structure, except that interest was paid on deposits and charged on loans (mostly at 20% for general loans).
  • Branches borrowed from the main office at 12% and lent at 20%, eventually covering their costs and making a profit after three to four years of operation. (p.30) Why is sustainability always associated with profitability? A nonprofit credit union can be more sustainable than a profit-maximizing bank.
  • The structure is standard banking practice: the poor had to save and deposit with the bank, earning 8.5% on deposits and 0% on shares; then the bank lends funds at 12%, and the branches lend them on to the poor at 20%. The miracle of Grameen is that it was very successful in growing, mainly by providing credit to those whom the banks did not consider creditworthy or sufficiently lucrative. However, that is not nearly sufficient to suggest Grameen over a credit-union structure, where all deposits were shares earning dividends, and where loans are made at the lowest possible interest rate to avoid losses (without necessarily resorting to the weak argument that at least the interest rate is lower than what loan sharks would charge).

Thursday, August 13, 2009

Microcredit and usury

Today's Wall Street Journal online has an interesting article about a microloan credit bubble. Is this not the very definition of usury:

Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more.

"I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for $209, another for $293, and then $356.

At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams."

Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.

As with every other type of credit, when it can be extended for profit, the incentive to overfinancialize can be impossible to overcome. I have made the argument more than once, in part based on works in classical Islamic jurisprudence and legal theory, that profiting from the act of credit extension is the essence of forbidden usury/riba. The approach through non-profit mutuals, credit-union style, is vastly superior, and agrees with the spirit of early experiments in Islamic finance in Egypt and the Subcontinent.

Unfortunately, people's good intentions have been subverted in Islamic finance toward serving the interest of profit-maximizing multinational banks that have, de facto, rewritten modern Islamic jurisprudence to maximize their profitable arbitrage opportunities. Likewise, this article shows how the very essence of microfinance has been subverted by rent seekers to enrich themselves at the expense of the poor debtors (who may benefit briefly, but will ultimately suffer when the bubble bursts).