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microcredit and inflation = trouble on the horizon

 

 

 

 

microcredit and inflation = trouble on the horizon

 

Background:  A few years ago, I was entertaining the idea to startup a microcredit organization in Brazil, with the idea of using the principles of peer-to-peer lending (such as Kiva, for example).

 

One fact about the industry that has stuck in my mind was that the business model only works in an era of low inflation.   Microcredit as a business model becomes a money loser if inflation ticks up.

 

Why?  Because if I lend you a $100 dollars, and give you a year to pay me back…and if inflation interferes in the mean time, then unless my loan was indexed to inflation, then you only have to pay me back $100, but that hundred dollars in the future is worth less than it is worth today.  In other words, the lender is harmed by inflation because they get back less “value” than they were anticipating.  Unless they were clever enough to index the loans to inflation (and get back more money than was originally agreed upon), the lender will loose money if inflation gets too high.

 

With todays headlines that inflation is going up around the globe, the alarm bells began ringing in my mind.  It is alarming because inflation has ticked up around the globe at exactly the same moment in time that we see a massive expansion of microcredit facilities available to the poor.  In Brazil, for example, I recently visited Recife, in the Northeast, and I was shocked to see how quickly that the credit markets have been made available to the poor.

Why was there a global expansion of credit to the poor?  In response to the well published success of the Grameen Bank, and the bottom of the pyramid marketing work of professor Prahalad, we saw a microcredit explosion around the globe.

 

The key question to ask is: “Were all of these lending schemes clever enough to index the loans to inflation rates?”  Im afraid that the answer is “Probably not”.   As inflation ticks upward, you should expect to see troubles, maybe even bankruptcies of many of these microcredit lending institutions.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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