Jun 10, 2011

The Microfinance Contagion Scenario

From the Conversation (HBR):
Although the situation in AP remains fluid, one thing hasn't changed over the last few months: repayment rates have fallen to about 10%. While these low repayment rates currently are only being seen in AP, they are causing serious problems for the major MFIs in India. The reason is that AP accounts for a large chunk of the total portfolio of the major MFIs in India — the Economic Times of India estimates that AP accounts for 40% of all microfinance loans in the country.
The AP crisis and the virtually certain (at least) nominal debt default sends a message to global capital markets: the debt-to-equity ratios in the microfinance industry were too high. At the prevailing ratios, management failed to act prudentially.
 But we need to be cautious:
Here's where the possibility of a downward cycle kicks in. Based on the admittedly scanty research, it seems likely that a significant factor in microcredit repayment rates is the expectation of clients that more and larger loans will be forthcoming. If capital markets take a breather from funding MFIs waiting for better debt-to-equity ratios, that could impair MFIs ability to make good on this implicit promise to clients. That in turn could cause the MFIs portfolios to deteriorate. Ad because microcredit loans are so short term, a fall of a few points in repayment rates can havemajor implications for the balance sheet, profitability and growth rate of MFIs. This would further scare off lenders and investors and start the cycle again.
One can't but wonder about the similarities between the MFI and the Banking industry crisis (causes such as moral hazard, etc.) This post explores some similarities. One can also think about the application of business cycle theories to the micro-finance industry, say an Austrian approach, a Real Business Cycle approach, etc. It seems like a behavioral economics approach is the most popular currently. 

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