April 14, 2008

Is It a Ripple Effect? The Subprime Crisis Leaks Into the Microfinance Sector

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The U.S. credit market has been flooded with delinquencies and foreclosures. Why? This economic flu we feel can be traced to a blend of deceptively designed sub-prime loan products and devious borrowing strategies. It is the lenders, though, that merit the bulk of the blame.

Lower income borrowers were targeted, and even when those borrowers might have qualified for prime loans with better terms, they were often routed instead into sub-prime loans. States don’t yet require that lenders reveal a consumer’s credit score, and so it’s unsurprising that they would tend to err in their own favor. The problem then intensified as mortgage brokers and lenders would immediately sell off these sub-prime loans or otherwise avoid the costs incurred if borrowers were to default. Loopholes can be tempting, but the abuse in this case has seriously destabilized the market, setting off a frightening ripple effect.

On a basic level, lenders can find the same recipe for quick riches in the microfinance sector. Though microfinance products have generally remained simple in nature, consumer lenders are plowing into the scene. Micro-products are multiplying and there is a threat then, that over-indebtedness could eventually cripple microentrepreneurs.

These lessons to be learned have surely affected behavior among investors, and so the sub-prime experience has likely slowed and curbed the recent bulge in microfinance investment. This could help protect the industry from potential degeneration. Overall though, the sub-prime crisis communicates a caution. Emerging markets are growing rapidly, and as financial services develop for the massive number at the “bottom of the pyramid,” lenders and borrowers alike must be weary.