India: Post 1

Hey All

This is my first post on this blog. I got to India Friday night and have been here for 5 days now.

I promised that this blog would be less narrative and more about my thoughts, but here is a quick summary of whats happened so far.

I'm staying with family for the moment. I think that will change over the weekend, but they've been very helpful. Over the weekend we ate a lot and visited some other family around Chennai. I started work at IFMR Trust on Monday. For the first two days my manager was pretty busy so didn't have time to chat with me... so I spent time reading, browsing, etc... Today I got some reading to do and the next two days are an introduction to the company.

I've only been here for 5 days, so I'm not going to try to draw and broad conclusions about India now. Anything generalities I draw would be premature... so instead I'll talk about what I've learned so far about microfinance. Everything here is from the first 100 or so pages of a book called "The Economics of Microfinance" (http://www.amazon.com/Economics-Microfinance-Beatriz-Armendáriz/dp/0262012162) and some other essays.

What most people know about microfinance comes Grameen's original methodolgy.

• Loans work in 5 people groups. First you loan to two people, whenthey pay back you loan to the next two. When they pay it back you loan to the last person (the leader). If at any point someone doesn't pay, the whole group is "blacklisted." This gives the recipient social preassure to pay and gives the others preassure to help out.
• After these loans are finished, the group can get more (and bigger) loans.
• Loans are given primarily to women.
• Loans are given out only for starting a business.

This was, indeed, the original grameen setup. However, a lot of microfinance loans have given up all of these. Loans are given out individually and still paid back. Why? Because repayement allows the recipient to get bigger loans next time. People realized that even though the recipients were officially women, both men and women spent the money. And, even in the original system the loans were used for other purposed (although they did discourage using this). In fact, even Grameen has started something called Grameen II which abandons a lot of the previous restrictions. Other groups originally copied Grameen but many have found the restrictiosn they put on the loans counterproductive. (Note: I'm not trying to say anything bad about Grameen, they did great stuff and got the movement started).

I mention this because until a few days ago, I thought all microfinance used the group method and that they were primarily given out to women. Pretty neat stuff.

So what am I going to be working on in relation to microfinance loans? One big problem is that the microfinance institutions (MFIs) have trouble getting capital. In addition, most of them focus on one region (and may even narrow down their criteria even more). This is good because it allows them to pick up the necessary local knowledge to decide who should recive loans. But its bad because it exposes the MFIs to a huge "concentration risk." Imagine, for example, there is a drought in an area where some MFI works. This will probably advsersely affect all the loans this MFI has out. What happens? The MFI is pretty much dead.

So whats the fix? Diversification. But thats tough because doing microfinance correctly means gaining a lot of local knowledge. So instead, what IFMR Trust is doing (in addition to other things) is working to securitize the loans. This means buying exposure to the loans, packaging them, and selling them.

So... to you finance people out there (and most other people) you say "but isn't this what caused the subprime crisis?" Well... sort of. The problem is that the banks knew they could sell of the exposure from their loans so they didn't need to do the necessary due-dilligence. To avoid this, two steps are taken.

• The loans are divided into two traunches (essentailly two sets). One traunch is superiod ot the other one in the capital structure (i.e. moneyh that gets paid back goes to that one first).
• The MFI and IFRM Trust both keep exposure to the inferior traunch.

What does this mean? This means that both the MFI and IFRM Trust will be extra careful because they take on the most risk. Its a cool way to give the MFIs funding and still be responsible about it.

Of course, this means that IFMR Trust takes on a lot of risk. Its diversified across MFIs (and therefore across regions, etc...) but it still needs to be monitored. However, the risks aren't well known yet, so I'll be working with them to figure out the risks, model them and create a system around it all. It's going to be a lot of fun since we'll be breaking new ground and starting from scratch.

So far they've only securitized one set of loans (http://www.ifmrtrust.co.in/announcements/ifmr_capital.php) but they've given money to MFIs for a bunch more there is a lot of risk they have.

Note: IFMR Trust is doing a lot of other stuff. If your interested you can take a look at the website.

http://www.ifmrtrust.co.in/

Ok, thats post 1. Nothing new, but hopefully its interesting. More to come!

Hari