What the poor can teach the rich at G-20

Microfinance lessons for a macrofinance mess.

Opinion

This week's G-20 summit is essentially an echo chamber for the world's wealthy to talk macrofinance. The world economy might rebound more quickly if they listen to what the poor have to say about microfinance.

Indeed, just as the global financial system is imploding, the micro-financial sector is expanding. It is ironic that the poor – who have been chronically ignored, or at least underserved – seem more adept at keeping financial institutions healthy at a time when global giants are struggling to hold their ground even with billions in bailouts. Maybe the behemoths in the market (and those now wishing to save them) could learn a thing or two from the "little people."

How is it possible that microfinance institutions (MFIs), from famous operations, such as the Grameen Bank in Bangladesh, to smaller ones in Nicaragua and Nigeria are actually faring well amid such strain? It is an issue of assets. While major players prioritized the creation of complex investment schemes that led to toxic assets, MFIs stayed focused on a more reliable asset class: their clients.

Largely, MFIs depend on the health of the local economy and thus the health of individual workers. These institutions aren't leveraging complex derivative markets and hedge funds at 30 to 1 to keep their profits rising. They depend on the ability of the poor to faithfully repay their loans – and about 98 percent of them do.

MFIs most insulated from the crisis are those that depend on their client's savings for their liquidity, instead of weakening capital markets. These savings not only help the institutions hedge against liquidity risks, but provide a safe, accessible place for the poor to build their own safety nets. This is especially crucial at a time when bailouts are seemingly doled out to everyone but the poor. In fact, numerous unregulated or under-regulated MFIs are now scrambling to become deposit-taking institutions.

The trend to prioritize deposit mobilization might seem counter-intuitive at a time of global economic recession. But now more than ever, institutions cannot afford to ignore the vast demand for adequate savings services among their clients, on the one hand, and the critical fiscal need to build those resources internally, on the other.

But what lessons can G-20 leaders draw from the continued resilience of the microfinance system?

First, get back to the basics. Support institutions that can stand and grow on the health of its clients, not on the health of opaque and necessarily volatile markets. Two of my colleagues at the New America Foundation, Ellen Seidman and Phillip Longman, have made the bold case for Americans to return to small banks and "relationship banking" from the "transactional banking" that came to permeate modern financial life.

Just like the microfinance industry in developing countries, small-scale financial institutions in the United States avoided getting their hands dirty in the derivative market and subprime lending mess. These institutions are in comparatively good shape today. It's not as lucrative a proposition as bundling securities and selling them off into the financial market without regard to the consequences, but such "relationship banking" is what is keeping the majority of the microfinance sector on track.

A healthy global financial system will depend on our global leaders' ability to accept and indeed embrace this reality. The irony of course is that Treasury Secretary Timothy Geithner's plan, if successful, will probably erode local and regional banks (whether in the US or the developing world) because it disproportionately subsidizes the irresponsible players. With the huge government subsidies they have, big Wall Street banks are now able to offer higher deposit rates and lower interest rates than are local banks. The great danger is that these banks will eventually eat up global market share and threaten the growth of players who have kept their hands clean.

A second lesson is to ensure repayment through responsibility sharing that restores accountability. Microfinance lenders achieve such extraordinary repayment rates in part through careful monitoring and group-oriented incentives. Big global lenders, on the other hand, are experiencing the hard way what happens when they promote excessive risk-taking that undermines the overall system's health. Global leaders must work to create and maintain oversight systems that allow and encourage regulators to prevent future financial catastrophes that are the result of the selfish irresponsibility of a powerful few.

A system of peer pressure, like the one commonly used in microfinance, in which an individual's success depends on the responsible behavior of the overall group could prove useful for the global financial system. Had such interdependence existed earlier, the financial community might have prevented a few bad actors from poisoning the well with exotic instruments and ludicrous leverage.

Now the leaders of the industrialized world are convening yet again to seek out solutions to the macroeconomic mess in which the world uncomfortably finds itself. They would serve themselves well by taking some cues from what is actually still working in financial markets.

Jamie Zimmerman is deputy director of the Global Assets Project, a joint venture of the Center for Social Development at Washington University in St. Louis and the Asset Building Program of the New America Foundation.