Monday, March 29, 2010

NPR: Microlending comes to the US

When I was an undergraduate, I wrote a paper on microlending. Everyone, including me, admires the concept. As practiced in the Global South, it relies on social networks to guarantee credit - microloans are made to groups of women, under the assumption that if one defaults, the others will pressure her to make good on her promise, since they too will be considered in default. I thought microlending would not take off in the US because social norms would not allow for that business model, and the legal system might not support it.

Well, microloans are starting to come to the US, but they aren't guaranteed by the group lending model. National Public Radio has a good story on how non-profits are doing a lot of micro loans in the US, and how they have become a significant source of credit for small businesses in this recession.

Basically, large traditional lenders in the US mainly work with your credit score, which is a summary measure of how well you've repaid your debts (both secured, like mortgages and car loans, and unsecured, like credit cards) in the past. For the big banks, their business model is based on doing a lot of mortgages quickly, which is why they use the credit scores. However, the credit scores miss a lot of new immigrants and a lot of poorer people who haven't been banked in the past. They may also miss small businesses who don't have a track record of credit, but have a good business model and need funds to expand. This describes Ryan Folcher of Arlington, Virginia. A traditional bank was about to extend him a loan before the recession hit - then they pulled their offer. Folcher was nearly forced to liquidate until a local nonprofit microloan corporation (that was incorporated to help Hispanics but extended him credit anyway) worked with him.

The radio segment described that the loan process was quite labor intensive. The loan officer worked with Folcher in detail to understand his financial situation and how much cash flow he was generating. Businesses development assistance is one prominent feature of microlending which is harder to translate to commercial banking because of its labor intensity; Self Help Credit Union is a community development credit union which offers such services (disclosure: I have some money on deposit with them).

When I was an executive VP at a student housing cooperative, we worked with a local for-profit bank. We were refinancing a loan, and our loan officer took the time to understand our unique and quirky business model, and the fact that we could, in a worst case, liquidation scenario, pay the loan off. He said that he'd heard a case of a local businessman working with a larger commercial bank. He, too, had a slightly unusual financial situation. He had always been good on his debts, but some newly-minted MBA loan officer came in, took a look at the documents, and called in his loan. He had to shut his business down, but a loan officer who had taken the time to go through the business would likely not have made that call.

In the US, business opportunities are readily available. I suspect that non-profits will continue to dominate the micro-loan space in normal times; we had a credit glut not so recently, but the big banks are being very careful now. The smaller amounts involved in working with small businesses and the time it takes to offer business development assistance and to work intensively with clients probably rules the big banks out from being major suppliers of small loans. The microloan person interviewed on NPR said that his goal was to eventually be put out of business by the bigger banks, but I still think we will need to rely on nonprofits and smaller community banks to fill this gap in.

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