Banking the Poor
Lending Without Collateral
This is a free version of Net Interest, my newsletter on financial sector themes. For additional content and supplementary features, please consider signing up as a paid subscriber.
Banking the Poor
There’s a disconnect that sits at the heart of banking: the people with the highest demand for loans aren’t the ones banks want to lend to. More often than not, it’s because they don’t have collateral – and there’s nothing a bank likes more than collateral. A private bank will lend you as much as you want against the value of your stock portfolio; a mortgage bank will do the same against the value of a house. It’s more difficult if you haven’t got a brokerage account, or any real assets, or even a bank account. Globally, around 1.7 billion adults didn’t have a bank account when the World Bank last did a survey, in 2017.
One of the ways round this, if you want to avoid usurious interest rates, is to find a guarantor.
Jonathan Swift – the author of Gulliver’s Travels – took up a sideline doing this form of lending in his home town of Dublin in the eighteenth century. He set up a small fund to lend to poor but creditworthy tradesmen who had projects that promised high returns on investment but who lacked collateral. Swift required borrowers to present a guarantee from two neighbours, the idea being that any one known by his neighbours to be an honest, sober and industrious man, would readily find such security while the idle would struggle.
In 2005, a company called Amigo Loans was founded in Bournemouth, England on similar principles. It required borrowers to nominate a creditworthy guarantor who would be liable for any missed payments by the borrower. On approval of a loan, funds would be released to the guarantor, who, in turn, would pass them onto the borrower. Guarantors could be neighbours, but in the twenty-first century, they were more likely to be a family member or close friend.
Amigo made loans in average amounts of around £4,000 and charged interest at rates of 49.9% per year on an average term of around 39 months. Although clearly high, these rates were lower than those charged by payday lenders, and were subject to a regulatory cap. Between 2014 and 2018, when the company came to the market in an IPO, the company grew its loan book at a rate of 31% per year. By then, it had 182,000 customers.
Not long after its IPO, though, the business began to unravel. The company spent significantly on advertising in order to increase its reach and, although it initially only approved approximately 15% of applications, it began lending to customers who plainly couldn’t afford it. Impairment charges rose from 21% of revenue in the full year prior to IPO to 36% in the twelve months up to March 2021. In May last year, the UK financial regulator (the FCA) launched an investigation into the way the company conducted its customer creditworthiness checks.
Alongside these credit issues, many customers complained that they were mis-sold. A wall of complaints built up. Amigo proposed a scheme to cap payouts on complaints but this was blocked by the courts and the company was forced to shore up provisions to fund them. As of today, the company estimates it has a backlog of 88,000 complaints, against which it has taken a provision to £345 million. This level of provisions takes Amigo close to the edge. In its latest filing, the company admits that “there remains a material uncertainty in respect of going concern.”
The rise and fall of Amigo reflects the difficulties lending to those who may need the money most. Loans can be used to salve an emergency or to finance a new venture but they can also saddle the borrower with an excessive debt burden.
The issue is particularly relevant in developing countries. Amigo’s customers weren’t technically unbanked, they just couldn’t get credit via the traditional banking sector. Of the 1.7 billion people around the world who are unbanked, half live in seven developing economies: Bangladesh, China, India, Indonesia, Mexico, Nigeria and Pakistan.
The guarantor model is more tricky in these markets because there aren’t enough guarantors to go round. Muhammad Yunus, who famously won the Nobel Peace Prize in 2006 for his work in microcredit, touches on the model in his autobiography, Banker to the Poor. He tells of a meeting he had with a regional bank manager in his hometown of Chittagong, in Bangladesh. He was there to discuss ways the bank could facilitate lending to the poor.
“Now, if you could find a well-to-do person in the village who is willing to act as a guarantor for a borrower, then I think the bank might consider giving a loan to that person without collateral.”
“I can’t do that,” I explained, “what would prevent the guarantor from taking advantage of the person whose loan he was guaranteeing? He could end up a tyrant. He could end up treating that borrower as a slave.”
Yunus raises the possibility of himself becoming a guarantor. The bank manager concedes that could work, but he would have to get clearance from head office. After six months of back and forth, Yunus set up a small scheme whereby he would guarantee loans to the poor of Jobra, a nearby village. Yet it wasn’t particularly scalable; Yunus had to personally sign each and every loan request made to the bank.
It was from these roots that Yunus set up his own bank to focus exclusively on microcredit, Grameen Bank (Grameen means ‘of the village’). He adapted the guarantor model into a group model. Individual loan applicants were required to band together to form groups from different households, putting pressure on members to help each other repay.
The group model solves another problem: the cost of delivering very small loans. On another visit to a bank, the branch manager explained to Yunus, “the little money you say they need to borrow does not even cover the cost of all the loan documents they would have to fill in, and the bank is not going to waste its time on such a pittance.” Shifting the task of initial supervision to the group reduces the work of the loan officer and increases the self-reliance of the group.
As well as group delivery, the model developed by Yunus incorporates several other elements. First, repayment begins immediately, to encourage borrowers to invest in assets with an immediate payback (a cow, a rickshaw, some cloth). Initially, borrowers were required to pay back loans in daily installments, so small they were easily manageable, but that became too unwieldy for Grameen so they switched to weekly. Second, there are no traditional branches; loan officers go out into the community to disburse and collect loans. Finally, there is a very explicit focus on lending to women. Today, over 95% of Grameen’s borrowers are women. According to Yunus:
The more I got involved, the more I realized that credit given to women brought about changes faster than when given to men… Poor women had the vision to see further and were willing to work harder to get out of poverty because they suffered the most. The women paid more attention, prepared their children to have better lives, and were more consistent in their performance than men.
Since its launch 45 years ago, Grameen has grown to a $1.7 billion loan book with 9.4 million borrowers. The average loan size is typically around $230 and the overall book yields around 20%. Impressively, the loan loss rate has remained low. Since the bank was founded, 94% of all funds disbursed have been paid back. Covid has caused repayments to falter in the recent past, but even on the current loan book, only 5.4% of loans are past due.
Yunus compares his experience to the mainstream Bangladesh Industrial Development Bank (BDBL) whose repayment experience had been a lot worse:
I shook my head: “Bankers keep telling me how indispensable collateral is, but in fact it does not protect the banks’ investment. What it really does is push the poor away from the banks.”
Further financial data on Grameen is available to paying subscribers. For this, and other supplementary features, consider taking out a paid subscription to Net Interest.
The Future is Digital
For many years, policymakers lauded the Grameen model as a tool to ease poverty. It was replicated in several other markets including neighbouring India. However, over time, excitement cooled off. In a survey of microcredit programmes published in 2015, a team of economists observed “a consistent pattern of modestly positive, but not transformative, effects.”
As Amigo has demonstrated more recently, the line between debt as a means to fund opportunity and debt as a trap can be a fine one. Over 2008 and 2009, microcredit industries collapsed in a number of countries because of fast growth, global recession, debtor revolts and political backlash. And then, in 2010, a spate of suicides linked to overlending led the regional government of Andhra Pradesh in south-east India to impose restrictive regulations on the industry.
One microlender that performed well during this period was Bandhan Bank of India. Its founder, Chandra Shekhar Ghosh, had seen Grameen in action as a student in Bangladesh. In 2001, he set up Bandhan across the border in West Bengal.
Today, Bandhan has a leading market share in Indian microfinance, with 18.4 million customers. Average loan sizes are higher than in Bangladesh, at around $600; the interest rate is similar, currently around 19%. The bank distributes loans via ‘doorstep centres’ located close to customers’ homes and funds these loans via deposits it attracts from the urban middle class.
Unlike Grameen Bank, which is owned by its borrowers and the Bangladeshi Government, Bandhan Bank is public, having come to the market in an IPO in 2018. But its stock performance has been poor. Three and half years on, it trades 20% below its IPO price. One reason is that the bank’s credit has been negatively impacted by Covid. Non-performing loans are currently running at 8.5% of the loan book.
Another reason, however, may be that the underlying model of lending to the poor is shifting again – from guarantors, to groups and now to digital. Last week, we looked at the success of M-Pesa in Kenya, which began as a payments provider and has since begun to offer lending products to its mobile customers. Back in Bangladesh, bKash has been equally successful as a mobile money business and, like M-Pesa, its penetration has grown through the pandemic. As of July 2021, bKash is used by 54 million people in Bangladesh, up from 38 million at the end of 2019.
There are many similarities between M-Pesa and bKash. Indeed, one of M-Pesa’s founders, Nick Hughes, is a founding board member of bKash. The two operate extensive agent networks to facilitate ‘cash in’ and ‘cash out’. bKash has a network of 272,000 agents. Take rates are very similar – 0.61% in the year ended December 2020 at bKash, the same as it was in the year before Covid at M-Pesa – even though bKash does not charge to add cash to its wallet.
But a fundamental difference is that while M-Pesa is controlled by a mobile telco operator, bKash is controlled by a bank. It is 51% owned by BRAC Bank, which is public. bKash makes up a quarter of the bank’s revenues. (The other shareholders are the founder, who owns 29% via his corporate vehicle Money in Motion, the International Finance Corporation, which owns 10%, and Alipay, which bought 10% in 2018.)
Being bank-owned eases the regulatory burden of pushing credit down its pipes. And for small, uncollateralized loans, digital solves the problems that have confounded lenders for years: it’s low cost, and it comes with payments behaviour that can help to underwrite risk. Last year, bKash launched a “collateral-free digital loan” through its wallet for loans up to around $120 at rates of 9%.
Financial inclusion remains a key area of focus in international development and within that, credit provision is an important part. Over the years, models of lending without collateral have shifted from guarantor to group schemes. The new payments-first digital model could be the future, in which case, bKash is the one to watch.