The Hindu Business Line : For realistic lending to the poor

The sub-prime problem in the US has raised the question if unscrupulous lenders pushed such loans disproportionately on the poor who were not aware or could not understand the implications of these special terms. This is unlike the experiences in Bangladesh and Thailand.

The US Congress is getting worried about what is happening at the lower end of the home mortgage loan market, as it well should be. The party is over and the bills are coming due. Estimates suggest that about 13 per cent of sub-prime borrowers are behind on their payments and close to 30 lenders in this market have closed operations. Foreclosures are rising and Congress has begun hearings to find out if the regulators should have done a better job catching the problem at an earlier stage.

The crisis in the sub-prime market is not about to shut the economy down, like the Savings and Loan scandal threatened to in the 1980s. America's mortgage market is huge (the equivalent of about Rs 4,33,70,000 crore) and much of it is humming along quite nicely. But worsening problems at the lower end of lending, combined with a slowing housing market could create a credit crunch and push the economy towards a recession.

Alternative Solution

The sub-prime market is America's private solution to lending money to those whose income is too low, or whose credit history is not too clean, to qualify for the regular mortgage. Owning a home is a dream for all, and the tax policies (such as deduction of mortgage interest) make it more sensible to own rather than rent a home in America over the longer term.

Information recording and sharing in the economy is sophisticated enough that lenders can find out everything they need to about potential borrowers. Thus, those who lend in the sub-prime market do it with their eyes open. They lower qualifying income and asset limits for the borrowers, and cut the need for documentation not because of their altruism, but because they calculate that the rewards exceed the risk.

However, with a sluggish real-estate market, home prices have stagnated or fallen making the loan to market value unfavourable. Moreover, interest schemes such as adjustable rate mortgages are resulting in higher payments that the weaker borrowers can no more afford. Some lenders had indulged in innovative `teaser' loans, wherein after a low rate in the first two-three years, some times even 1 per cent, it would jump to 10-13 per cent. Well, as they say, these lenders made their beds and must lie in it. That's how this market works.

Up the Garden Path?

And when the poor and unfortunate are only a small percentage of society, as in the US, one can hope market solutions will deal with their needs. But the solution is within the boundaries of traditional assumptions.

The problem is that the question of whether conventional rules apply to this segment of society is not often examined. This means some groups in society are hit harder than others. For example, about half the mortgage loans taken by African-Americans the last few years were sub-prime. Also, some are wondering if unscrupulous lenders pushed such loans disproportionately on the poor who were not aware or could not understand the implications of these special terms.

Grameen Bank that serves the needs of the lower end of society manages to thrive as it is based on a very different philosophy of lending. The whole micro-credit movement started by Dr Mohammed Yunus of Bangladesh (interestingly, he was trained as a conventional economist) made loans accessible to those at the lower end based on a premise different from the motivations or the methods of the sub-prime lenders.

Instead of winking at collateral and repayment ability, the basis of the loan was trust and peer-pressure. Whatever be the reasons for taking the loan, these factors ensured high rates of repayment. The formation of a group responsible for the loan was to inculcate a responsibility amongst peers to ensure that there was no default, which would not only affect the credit-worthiness of the group but lower the individual's standing within the group.

In some cultures, when the group is part of an existing in-group in a village, the peer pressure can be stronger than any legal document. The defaulters cannot continue to live in a community when they had made it difficult for their peers to borrow. Thus, this economic system takes advantage of social norms and ensures low default rates.

The needs of those who are ignored by bankers in suits and ties with conventional economic theories in tow led to the Village Fund in Thailand. Mr Thanksin Shinawatra, the ousted Prime Minister of Thailand, formulated a scheme creating a fund of one million baht (Rs 13.5 lakh) for every one of the country's 70,000 villages in 2001. It was to be managed democratically by a committee elected from the village.

The assumption was that the village-level decision-making would take into account local needs and concerns. But the structure seems to have been loaded with all the conventional banking requirements, which the villages were perhaps not capable of dealing with.

Doubts and Controversies

The Thai Village Fund scheme is still swarming with doubts and controversy. Some view it as a weak scheme that is near collapse with high percentage of non-performing loans, while others see it as an innovative way of reaching help to the poor and argue how it has given access to poor farmers beyond the reach of conventional institutions and who are in the clutches of local money-lenders.

The arguments are based on different theoretical premises and can thus not be resolved; should such schemes work on conventional banking principles or not. For example, one question that comes up in the evaluation of such schemes is about how the money is being used. The purists would like to see it go towards revenue-generating expenditure, such as farm equipment, or seeds for the next planting. This is to ensure that the loan is productive, and will generate resources to enable repayment.

But if the farmer wants to buy a washing machine or needs the money for a wedding and is not going to get it from this fund, he is still going to get it elsewhere affecting his ability to repay all his loans from whatever sources. Thus, a more holistic view of a person's borrowing needs would be appropriate for such an institution as a village fund to consider, since it is located closest to the borrower, and for which the conventional bank's rules and philosophies may not be able to deal with.

Mr Shinawatra's village fund scheme, among others, made him very popular in the rural areas and returned him to power in democratic elections, much to the chagrin of the urban elite. Its success will be assured only when the organisers sit down and carefully consider the sociological basis of how and why it is run.

Trying to create a `normal' lending scheme but managed at a village level, yet not grounded in the local power structure, social relations, and the realities of daily life will only add to the problems rather than be a solution.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. He can be reached at cgopinat@suffolk.edu)

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