As India's Micro Finance Institutions (MFI's) Face Catastrophe, MFI's in Bangladesh at Risk of Failing

The recent news that India’s microcredit industry is in dire straits should trouble Bangladeshi policy makers.  Through a combination of credit-overreach and political demagoguery, Indian banks are facing the prospect of a wave of microcredit loan defaults. Given the nearly $4 billion risk exposure that banks have undertaken in entering into the recently booming microcredit industry, default could spell ruin for the Indian banking sector.

The story is much the same in Bangladesh. Though given that the particulars of the tale are somewhat different, the outcome might well be different, a prospect quite likely soothing to many bankers in Bangladesh.  Along with BRAC and Grameen, private banks have entered the muddied field of private microcredit lending.  Borrowers have been paying back their loans with remarkably high interest rates.  Lenders, increasingly private for profit enterprises, have been reaching ever more needy people to help them become cottage entrepreneur.

Indeed, many firms do not inquire about the past income of the borrowers. Many of these borrower-entrepreneurs will not be able to pay back their small sum loans. Realizing this, lenders are using harsher tactics to collect payment, triggering another round of defaults.  These are not sustainable investment or development schemes. Private MFI’s seem to care only for money; these moves are destroying the microcredit lending model.

The remaining question is: when groups of small business owners default in Bangladesh, how soon till individual defaults turn into a collective wave? Then, what shape, peak and curve will fit the contours of  the wave that crashes on Bangladesh’s banking sector?

Fortunately, MFIs in Bangladesh have time.  Though they have more than $2.5 billion sunk into microcredit loans, the market for those loans remains large. There are more customers and there is more demand.  As long as the banks stretch themselves out, but not too thinly, they’ll remain in business.  The problem is that they are likely stretching themselves too thin to too many people with the same income history and income projections.  The market may be large, but it is, just, more of the same. It seems a financial instrument that many saw as a panacea to social and economic development in many poor countries, turned out to be just another engine of corporate profit, one that is now overheating.

Over-wrought over-reaching created a bubble of sorts in microcredit lending.  That explains the expansion, inflation of the market-not the impending deflation. The reasons that microcredit is in shambles has to do with the internal business model and a surge of anger and political moves to boycott high nigh usurer interest rates.  The New York Times reports that if this trend continues:

the industry faces collapse in a state where more than a third of its borrowers live. Lenders are also having trouble making new loans in other states, because banks have slowed lending to them as fears about defaults have grown.

How to replicate this impending disaster in Bangladesh?  Encourage political opportunists to stoke public outrage at the exorbitantly high interest rates.  Move away from a policy fix that encourages borrowers and lenders to renegotiate the terms fo the loan, a move that might do quite a bit of good.  Let the repayment rate dwindle: watch what happens.

I fear that there are political entities in Bangladesh that might seek just that deleterious form of populism to combat what is slowly becoming less a boon that a barricade for individual economic mobility and social growth.