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David Roodman's Microfinance Open Book Blog

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My purpose in asking Who Inflated the Microcredit Bubbles?---in naming names---is not to condemn microcredit investors such as the World Bank. But I do want to make the fingered uncomfortable and onlookers curious in order to gain attention for a serious problem and an opportunity to combat it. Creditors have made the recent microcredit crises possible and they need to prevent a repeat.

Laboring with Paolo Abarcar to answer the question of who inflated the bubbles, I realized: almost no one knows. With effort, we gathered information that is incomplete, uncertain in some respects, and at 1--2 years of age, ancient relative to the tempo of hypergrowth. Imagine if it were as hard for banks and bank regulators in a rich country to understand the state of the mortgage business. (Why, we might have a mortgage crisis!)

So a bunch of microcreditors are taking loans from multiple sources. Total credit to microcreditors outstanding is expanding rapidly. The easy credit may hide and exacerbate the very problems it creates since unpayable loans are quickly rolled over. No one is tracking all this activity, much less whether the borrowers can reasonably be expected to handle the debt they have contracted. Does this sound familiar?

That's the story of the retail microcredit markets in the four microcredit crisis countries---and in the wholesale "macrocredit" market for loans to microfinance institutions.

The standard preventative for credit bubbles is the credit bureau. Lenders must share information and heed what they learn, perhaps via rules of thumb analogous to the one that mortgage payments should not exceed a third of income. It seems that we need a credit bureau to collect and share information on the financial obligations of microcreditors.

More broadly, microfinance investors must work together to discipline themselves. Ecological economist Herman Daly has written about the need to move from an "empty world" mentality that treats natural resources as inexhaustible to a "full world" one that accepts limits. In remarkably short order, the world of microfinance finance has swelled from empty to full. In the mid-1990s, Alex Silva struggled to raise a few million dollars for the first microfinance investment vehicle, Profund. (See my chapter 8.) Now microfinance investment managers are struggling to absorb a cascade of millions per day. For the sake of the industry's health, financiers must rapidly adapt to the new reality. Before investing, they now must ask, How much is enough? If they do not institutionalize limits, they may replicate the subprime crisis in a dozen developing nations. Yes that means you, World Bank. And you, KfW. And you, Blue Orchard.

Now, I imagine that if World Bank's International Finance Corporation (IFC) is about to place $10 million with a fast-growing Peruvian MFI, it can obtain a precise, current, complete portrait of the latter's debt stock. To this extent, no credit bureau is needed. But I think a bureau would still serve, and for three reasons. First, as Xavier Reille suggested to me yesterday, the IFC loses leverage for disclosure after it disburses the loan. Yet it would remain keenly interested in the solvency of its borrowers. Second, if the credit bureau is public, posting its data online, then the peers of the IFC, industry groups, and members of the public can more easily hold the IFC accountable for self-discipline. Third, international consensus on what constitutes too much lending to a given MFI could make it easier for investment managers to rebuff the politicians, higher-ups, and citizens who are too eager to pour in more money. The managers could explain that their hands are tied. Rules could also help them combat their own worst tendencies. Here's Damian von Stauffenberg explaining what I mean in January, before Congress:

This proposal for a public credit bureau on microcreditors raises a host of questions. How do you judge whether an MFI has overborrowed (or an investor has overlent)? More precisely, how do you judge how fast an MFI can safely grow? How do you judge the quality of its management, information systems, training, etc.? Since these questions cannot be answered precisely, what conservative rules of thumb would suffice? Relative to such rules, how widespread is overlending today? Then there are questions of process and institutions. By what mechanisms should information be shared and heeded? Xavier suggested a role for loan covenants. That is, in exchange for the IFC's money, the Peruvian MFI would agree to disclose its debt stock on a quarterly basis or risk immediate recall of the IFC's loan. As for a credit bureau, who would fund and run it? Would it arise voluntarily or need a legislative prod? What would be then incentives to participate? How much would public and private investors resist disclosing their dealings? To what extent would this resistance be legitimate and deserve accomodation? (Of course, almost all macrocredit for microcredit is socially motivated, so it would be hard to understand why investors genuinely committed to the public interest would resist bubble-preventing disclosure.) Should some microfinance investment vehicles close, taking in no new money for a time? Should public institutions halt lending to all top-tier microfinance institutions to prevent over-crowding?

I don't have the answers, but I'm confident that they must be sought now. The faster money pours into microfinance, the less time we have to prevent the next bubble. It's better to be in the business of stopping bubbles than popping them.

The signs of surfeit in microfinance also cast an odd light on efforts to pressure the World Bank to invest more in microcredit. One of the campaigners' lines of attack has run through the offices of members of the U.S. Congress, whom they have persuaded to write letters to World Bank president Robert Zoellick. Apparently these campaigners are not satisfied with the response. Here is Susy Cheston of Opportunity International testifying just before Damian von Stauffenberg:

For contrast, reflect on these passages from two documents produced by the bureaucratic machinery of the World Bank. The first, approved in 2003, makes the case for financing a quick extension of microcredit to another half million Pakistanis:

The second, from 2009, notes that Pakistan's microfinance sector had grown as planned, and that it recently contracted---because it grew faster than it developed:

Is it such a good idea to bash the Bank into disgorging more money for microcredit? We have learned in the last year is that microfinance is not immune to the dangers of pushing credit. (Meanwhile, echoing in my head is the longstanding argument that easy outside money undermines the taking of savings.) Rather, bash the Bank (and other microfinance investors) into building ways to ensure that any money is injected safely---or not at all.

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CGD blog posts reflect the views of the authors drawing on prior research and experience in their areas of expertise. CGD does not take institutional positions.