How to Transport a Sand Castle

Last month I blogged an interesting article by Daniel Rozas and Vinod Kothari in Microfinance Focus about the potentially illusory quality of securitized microloans. If you don't know what I mean by that, read my (short) earlier post. Microfinance portfolios, as I put it, are sand castles, delicately held together by relationships between borrowers and credit officers. Try to pick them up and move them and they fall apart. That is, when an MFI defaults, so do its borrowers.Rozas and Kothari have just written a follow-up in which they pivot from critics to playwrights. They propose four ways to shore up(!) the sand castles.Two of the solutions are essentially cosmetic, for rather than reducing the risk that Rozas and Kothari identified, the solutions use financial markets to transfer risk or diversify it away. Issuers of securities can add to their bundles of microcredit loans a kind of insurance to cover some or all of the risk that the MFI will go bankrupt. And they can bundle loans from different MFIs, perhaps even different countries, for diversification.The other two solutions go deeper. One is to establish a credit bureau, a standard recommendation for making credit markets work better. This will give borrowers an incentive to repay their loans after the original issuer has disappeared---at least if the borrowers are aware of and understand the credit bureaus. The other deep solution, more novel, is to create an institution like the U.S. Federal Deposit Insurance Corporation (FDIC) which can quickly take over MFIs that teeter. This overseer's job would be to stabilize the sand castle and prepare it for transport. The overseer could fire senior managers, but would probably retain most loan officers in order to preserve relationships with borrowers. Crucially, it would need to keep disbursing new loans to existing customers in order to retain another key incentive for repaying old ones, continued access to credit. Once the situation was stabilized the overseer could arrange for another MFI to take over the portfolio. The transfer could be deliberate and gradual, allowing time to educate borrowers about how one microcredit brand would be substituting for another.Intriguing. The premise is that it will sometimes be in the interest of creditors---the ones who buy those securitized microloans---to send fresh money to the microborrowers even if that temporarily comes at the expense of sending money in the promised amounts to the creditors. I wonder who would have the guts to make that call. The situation would be even more nervous-making if corruption among loan officers, enabled by lax management, is seen as a potential factor behind the MFI's demise. Who then to entrust with making new loans and who to fire? The fundamentally distinctive character of microcredit portfolios, which Rozas and Kothari have spotlighted, translates into a fundamentally distinctive challenge for an overseer trying to do as Rozas and Kothari envision.