TCS Daily


How Evil Capitalists Can Save the World... and Just Might

By Tim Worstall - February 2, 2005 12:00 AM

Recently I wrote two pieces here, the first essentially arguing that throwing money at thieves was perhaps not the best method of reducing global poverty, the second that perhaps capitalists might do a better job. It is with a certain amount of shame that I have to admit to an error. I did not use the most obvious example of exactly how us evil capitalistic money grubbers could most efficiently do this. My thanks therefore go to reader and commenter Michael who reminded me of Grameen Bank and the micro credit movement.

The essential idea here is that the very poorest, those least well served by the financial system, are precisely those who benefit most from access to capital. The sums are tiny, $50 here, $300 there for a house, and the general agreement is that the system works, works better than anything else that has been tried. Even the United Nations, as this recent speech indicates, agrees:

        Experience of the Least Developed Countries (LDCs) show that micro 
        credit and micro finance are effective tools of poverty eradication 
        and empowerment of people, particularly women.


While the rest of the speech given to the General Assembly goes on to describe the usual round of necessary meetings, summits and so on, the UN agrees with this idea so strongly that it has declared 2005 the International Year of Microcredit. Now that the international heavyweights are on the job everything will be OK, yes? Or is there still a case for the private sector being able to do it better?

Grameen was the beginning of micro credit, all subsequent organizations owing their genesis to one man, Professor Muhammad Yunus of Chittagong University. He's a fine example of an academic economist actually changing the world with action rather than just words. Just why the bank is different can be found in the Professor's comments here, but the most important point is this:

        Grameen Bank methodology is almost the reverse of the conventional 
        banking methodology. Conventional banking is based on the principle 
        that the more you have, the more you can get. In other words, if you 
        have little or nothing, you get nothing. As a result, more than half the 
        population of the world is deprived of the financial services of the conventional 
        banks. Conventional banking is based on collateral, Grameen system 
        is collateral- free.

My apologies to the good Professor who wrote those words but he's not actually correct. What he has managed to do is replace the conventional forms of collateral with those of peer pressure.

Borrowers are organized into groups and only a subset of the group can have loans outstanding at any one time. There is therefore considerable pressure from neighbors and such other group members to make sure that the loan is repaid so that the next person can get a loan and start the slow and hard climb out of destitution. It should also be noted that Grameen charges full interest (although without compounding) and that it is profitable. Yes, it's a non-profit organization but it receives back more than it lends out, the extra being added to reserves to increase future lending.

What does all this have to do with free market solutions? After all, we have a profitable business, one that everyone agrees should be supported -- why aren't the world's bankers beating down the doors to lend to it? Michael puts it this way:

        Technocrats in places like ExImBank and the World Bank will pay brief lip 
        service to the micro banking concept, but never bother with these 
        small potatoes as they offer no opportunities for first-class jet travel to 
        exotic locales, or dinners with the Shah.

That might be a touch too cynical even for me but there is indeed something of a problem here. Why are such programs not getting the support they could use? Alas, as far as the free markets are concerned the problem is one of scale. Grameen is by far the largest of the micro lenders and it has total assets of around $4.5 billion. This simply isn't big enough for the global markets to sit up and take notice. All of the other, smaller, such lenders face an even more extreme version of the same problem. Professor Yunus notes the problem himself:

        Although, the growth of micro credit to the poor is encouraging, there is 
        still a number of constraints to the expansion of micro credit. Bangladesh 
        is still the only country where micro credit outreach is over 75% of the 
        poor families. In most of the countries it has not even reached 10% of 
        the poor families. To reach...100 million [families], each country must reach 
        out to 50% of the poor families within that country. Therefore, there is a 
        lot of catching up to do. Why is this not happening yet? Donors explain that 
        there is not enough capacity on the ground to build a higher outreach. 
        Micro credit organizations complain that they are stuck with unutilized 
        capacity, but no money, grant money or soft loan or market money, is 
        available to them.

Note that last: No market money is available to them. There are those who would insist that a profitable business being unable to find loans for expansion is a market failure and if you insist on calling it that it won't bother me. I would describe it as an absence of a market, not a failure of one, and that therefore our task is to design a market that will take care of this problem.

Let's set out the problem as seen from the financial market's perspective. There's a group of potentially profitable loans to be made but the cost of actually checking the borrowers is too high....in other words while the interest and capital might be repaid, they won't cover the set up costs and the monitoring. Too many small borrowers, each of high risk and expense to check, but taken as a group, with those monitoring costs pooled over the group, and so with the risk, an attractive place to go and lend money. If you could square that circle, Wall Street and The City would love it, another set of bonds to sell to investors, more commissions to be made, options, futures, swaps, slicing and dicing the debt to generate more money and profits. What's not to like?

The odd thing is we do actually know how to do that. Over the past 30 years since the liberalization of the mortgage market this is exactly what has happened with the help of Fannie Mae and Freddie Mac (yes, I know about the current problems but then is anyone really surprised about aged politicians dipping their ladle in the gravy?). Instead of a Savings and Loan taking on a mortgage, lending the money and collecting the repayments over the term of the loan, that S&L now issues the mortgage and sells it to the wholesale markets, spreading the risk as it is pooled with millions of others into bonds attractive to a whole variety of investors.

Could we not do something similar for loans to micro credit banks? Lock a few banking types in a room (those in their 30's and early 40's, Managing Director level at Goldman, Morgan, Chase, Rothschild) and not let them out until they had agreed the structure? It might be necessary for there to be an element of subsidy to such a market. It might need the rich governments to guarantee the bonds, might need an interest rate subsidy. Then again it might not, for if Grameen can turn a profit on the use of market price money then so should others. It might also be true that the market itself would provide the subsidy: think of what the "ethical" investment funds would make of a new class of bonds guaranteed to be helping the poorest and most destitute across the world. Think of the 401k plans of those who opine and campaign on behalf of those very people. Such details would be for our bankers to sort out of course but I wouldn't be all that surprised to see prices being bid up to where such bonds yield less than Treasuries.

Think too of the benefit to those desperately poor people across the world that the whole process is aiming to help. Access, in $50 and $100 lumps, to the trillions of dollars washing around the rich world's financial system. Opinions can differ on such matters of course, perhaps it really would be better for aid to be doled out through the usual channels, for there to be a few more conferences on the subject, for the International Year of Micro Credit to be a method, a process, by which we can explore the subject.

Anyone know anyone on Wall Street?

Tim Worstall is a TCS contributor. You can find more of his writing at www.timworstall.com.

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