At the core of the recent global financial crisis is a lack of trust between banks due to dodgy lending practices. As governments worldwide are debating how to bail out their financial industries, microfinance may offer solutions to unfreezing credit and preventing a future crisis.
Although microfinance won't solve every financial problem in wealthier nations, big banks could learn from its concepts of building trust between lenders and borrowers, said Muhammad Yunus, Nobel Peace Prize laureate and founder of Bangladesh-based Grameen Bank, at a Feb. 4 event organized by the World Affairs Council of Washington D.C.
Before the crisis unfolded, Yunus and a group of American partners launched Grameen America, a nonprofit microlender in New York City, to prove that microfinance could serve the needs of the poor in the developed world.
So far, Grameen America has made 500 loans with a 99 percent repayment rate, which is in line with Grameen Bank's repayment record in Bangladesh. With massive amounts of defaulted loans in the U.S. and Europe in recent months, microfinance - which once seemed an unrealistic import to the West - is looking more attractive.
The U.S. mortgage industry used a perverse set of incentives that rewarded bankers for short-term gains and letting borrowers take out to much debt. But Grameen aligns the goals of bank branches and loan officers to the short- and long-term "success" of borrowers as measured by improvement in their living conditions and rate of repayments.
When a Grameen branch opens in a village, its lending capital comes from deposits of poor clients and not from Grameen Bank's headquarters in Dhaka, Bangladesh. This bottom-up approach to capitalizing a bank insulated Grameen from the global financial crisis, as it did not need to seek money from global markets to fund its growth.
Although this method of raising capital has its limitations, banks in the U.S. could start rebuilding their reserves through depositor savings. Some financial institutions-like former investment bank Goldman Sachs-have already turned to depositor savings to stay afloat.
First-time borrowers at Grameen must first prove they can pay off small loans before taking on higher amounts of debt. This process, which is referred to as "graduating" clients, could be used to avoid plunging first-time home buyers into overwhelming debt.
In contrast, first-time home buyers in the U.S. with no credit histories got themselves into too much debt with the help of lenders, but graduating American borrowers from auto-loans or small business loans can build a path to purchasing an affordable home.
In a telling sign that microfinance concepts are being noticed by big U.S. banks, Wells Fargo and Citigroup are sponsoring a conference on May 29, which focuses on how to reach California's poor with micro-credit.