Cultural Aspects of Credit Risk Management

By Ahsan, Rahnuma | The CPA Journal, August 2011 | Go to article overview

Cultural Aspects of Credit Risk Management


Ahsan, Rahnuma, The CPA Journal


A Lesson from the Microfinance Industry

With a 9.2% unemployment rate and increasing default rates, credit risk management has become more difficult than ever. In October 2009, Bloomberg reported mat the number of U.S. lenders with a 20% default rate is at an 18year high. For commercial real estate mortgages, the default rate during the first quarter of 2010 (4.17%) was at its highest level since 1992, and this figure does not include bank-held mortgages on apartment buildings. In February 2009, the Obama administration launched a Home Affordable Modification Program (HAMP) to assist defaulting real estate borrowers. In June 2010, the Wall Street Journal reported that the redefault rate within one year under HAMP, predicted by Rtch Ratings Ltd., would be 65% to 75%. These disparate perspectives of the credit crisis draw a challenging picture for overall credit risk management.

In contrast, Grameen America, a nonprofit microfinance institute and affiliate of Bangladeshi microfinance institute Grameen Bank, reported a 99% loan repayment rate from 2008 to 2010. The difference in the repayment rate of Grameen America compared to other lenders may be attributed to Grameen's lending methods, as well as the size and types of loans. Grameen America lends to high-risk borrowers who generally earn less than $1 1,000 annually, do not have any collateral, do not have a prior credit history, and have been ignored by commercial and retail banks.

Grameen America's high repayment record with these borrowers has been attributed to its group-lending or peerlending methodology. Peer lending is one of the major contributions of the original Grameen Bank model, which was designed after trial and error in the villages of Bangladesh in the 1970s. Under the initial Grameen model, which was used until 2001, borrowers formed their own groups (social collateral), elected a group leader, and were responsible for each group member's loan amount (joint and individual liability). In case of default by one borrower, each member of the group was responsible for repayment. After the full loan was repaid on time, the group could apply for a higher amount (repayment incentives). If one member of the group defaulted, none of the group members could apply for any future loans (lowers strategic default). Since 2001, Grameen has implemented a modified peer-lending model whereby the borrowers still form their own groups and must continue to support each other's projects, but are no longer jointly hable for each other's payments. As the borrowers receive the loan as a group, however, this modified peer-lending approach still enforces and establishes social collateral conditions. Under this model, Grameen Bank has reported a 95% to 99% loan repayment rate since 1976.

Peer Lending in the United States

During the 1980s and 1990s, the peerlending model was replicated in the United States with mixed results. According to a 1999 report by Michael Conlin, the default rate for mese projects ranged from 3% to 40%, and some of the projects were unsustainable and failed to reach their goals completely ("Peer Group Micro-Lending Programs in Canada and the United States," Journal of Development Economics, vol. 60, no. 1, October 1999, pp. 249-269). For instance, the Good Faith Fund of Southern Development Bancorporation in Arkansas had a 40% default rate in the first two years and after modification of its lending method, the default rate decreased to 3% in the third year. The Women's Self Employment Project (WESP), a nonprofit affiliate of South Shore Bank in Chicago, had a loan default rate of 5% but spent more on overhead and administrative costs man it loaned. The Women's Economic Development Company (WEDCo) in Minneapolis, Minnesota, and the South Madison Neighborhood Housing Service in Madison, Wisconsin, terminated their programs within a few years due to limited success.

In 2008, Grameen Bank opened the nonprofit entity Grameen America in Queens, N. …

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