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David Roodman's Microfinance Open Book Blog

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Today's post by Timothy Ogden for the Harvard Business Review is spreading in the Twittersphere. The idea, simplifying slightly: Spooked by what Sam Daley-Harris called the "near-death experience" in Andhra Pradesh, investors pull back from microcredit in other countries. Short of capital for expansion---reliant solely on the repayment stream to fuel new lending---microfinance institutions can't grow as fast as they used to. In particular, they can't promise bigger loans in return for prompt repayment of current ones. Bereft of that incentive, repayment rates fall, microfinance institutions deplete their equity with write-offs, and the global industry enters a vicious cycle.

It's an interesting idea. But I would think that if events in Andhra Pradesh do reduce investment elsewhere, the more likely vector of contagion would be the social bottom line, not the financial one. I.e., I think socially motivated investors, public and private, who still account for the majority of microfinance investment, will be more turned off by the suicide stories than the near-bankruptcies in Andhra Pradesh. After the global financial crisis popped some microcredit bubbles, microfinance investment companies worried that they would experience a drought of inflows just when microfinance institutions needed capital most. Instead, they got a glut: responsAbility, for one, temporarily closed its funds to new investors.

If the social bottom line rises to the top, that would seem to reduce investment in a way that would not technically constitute "contagion." We probably wouldn't see less funding leading to more suicide stories, leading to less funding.

Maybe that's hairsplitting [or, on reflection, just confusion on my part---contagion just means "spread" not "positive feedback loop," right?]. But other factors will dampen contagion. Microlenders can cut back on two margins: number of clients and lending per client. Only the first causes contagion in Tim's scenario. Also, while Tim is right that the Andhra Pradesh crisis may lead investors to demand higher amounts of risk-absorbing equity per dollar borrowed and on-lent, I would think that many of those investors stand ready to provide the equity rather than walk away for the lack of it.

Of course, I actually want investment in microfinance to slow---but in a trajectory that is orderly and gradual, not fast, chaotic, and crisis-inducing. My concern is that easy money overstimulates microlending even as it kills microsavings with kindness, undermining the interest in this useful service as an alternative source of finance.

In symmetry with Tim's focus on contagion, as he mentions, I would point up moral hazard. If investors step in too quickly to rescue firms that get in trouble, that can cue other microlenders not to worry too much about the downsides of fast, poorly managed growth. Fortunately, that doesn't seem to be happening in India, where the founders of overextended microfinance institutions had to pledge their personal holdings in their companies as collateral for breathing room from their creditors. So a signal is not being sent that if you screw up in leading a microfinance institution, you'll feel no pain.

But moral hazard can strike microfinance investment firms too---and perhaps already has. I'll save that for a separate post.

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CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.