Sub-prime crisis or solution? PDF Print E-mail
The shaping of policy at UNODC (2002-2010)

 

Money is tight these days. Creditors have been badly burned, and banks are wary of lending to each other or to risky clients. And yet, in many parts of the world, sub-prime lending is exactly what is needed to foster development and reduce vulnerability to drugs and crime.

Lending money to people to help them make ends meet is not a new idea - especially in some of the poorest and most unstable regions of the world. The problem is, it's usually called loan sharking or extortion. This kind of informal money lending deepens poverty and strengthens organized crime.

Informal lending, often under duress, contributes to drugs and crime. For example, in Afghanistan and Colombia farmers are given loans by local strongmen on the condition that they grow illicit crops. And they are threatened if they don't. This makes them dependent on drug cultivation for their survival.

In other parts of the world, poor people are trapped by debts to the point that they themselves become collateral - forced into sweat shops, debt bondage, the sex trade, or other forms of human trafficking. In other cases, debt forces people to flee their homelands and seek better opportunities abroad - falling into the hands of smugglers.

If loan sharking deepens poverty and enriches criminals, than micro finance can help fight crime and eradicate poverty. Experience - for example from the World Bank and the EBRD - shows that even small loans can make a big difference in people's lives, especially those who are among the poorest of the poor.

It raises living standards and alleviates poverty. It enables people (particularly women) to become self-employed. It provides a solid basis to foster financial management, e.g. promoting family savings. It enables inclusion into the financial sector (to access credit, insurance, remittances and savings products), as opposed to coming into contact with the underworld. It smoothes consumption fluctuations caused by seasonal income and employment. Group-based lending can empower communities, enabling them to better stand up to predatory and coercive criminal patrons, and enable greater self-management.

You may ask (especially if you are a banker) isn't it risky to provide credit to people who are so poor? Couldn't this create the next 'subprime' crisis among millions of the world's poorest people? In an EBRD programme in 19 "early transition countries" (Balkans, Caucasus, Central Asia Central Asia), 98% of all loan recipients paid back on time. A World Bank programme in Bangladesh, targeting 450,000 of the poorest of the poor, had only a 5% default rate. These kinds of numbers are the rule rather than the exception in microfinance and compare favourably with default rates for normal loans (which are at least 10-15%).

But aren't the interest rates too high - for example around 25-30% per annum? No, they are not higher than your average credit card rate. And micro-finance rates are pegged at commercial bank rates (in order to be sustainable - this is business not charity). Keep in mind that interest rates in many of the countries concerned can be 10-15% per year. Studies in India, Kenya and the Philippines found that the average return on investments by micro-businesses ranged from 120-850%.

Besides, loan sharks (and other extortionists, which includes some credit card companies) charge at least 10% monthly, usually much more. Payback conditions are often set in a way that makes it hard for customers to escape debt. And the rate is not the only problem. The dangers that one faces through using the black market can cost you more than your money - if you don't repay you may lose your livestock, your car, even your child.

So let us hope that the financial crisis doesn't turn off the tap of micro-credit to the poorest of the poor. Small loans can unleash entrepreneurial spirit and create opportunities for poor and vulnerable people in a way that will liberate them from poverty and the exploitation of criminals. This might actually kick-start a few economies.

 

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Last Updated on Sunday, 04 May 2014 17:13