by Hassan del Campo
Is social collateral, as it pertains to reducing loan default risk, more effective in developed countries or developing countries?
The reason I pose this question is because I work for a nonprofit CDFI (Community Development Financial Institution) in South Los Angeles that for years has been offering a micro-business program Capital Partners based off the micro lending platform originated by Muhammad Yunus of Grameen Bank. Our program starts participants off with a loan of $500 at the first level. Once that loan is paid in full one can receive a loan amount of $1,000. It continues this way till a max out at $5,000. Participants must work in a group of three to five and attend mandatory workshops, in addition to other activities. We don’t check credit history and only require that the participant have a photo ID and proof of address.Though very popular in our communities and among our partners we’ve always suffered from high loan defaults. My role in the organization is with financial literacy, but recently I’ve taken up an interest in this program and addressing those challenges.
To the best of my knowledge we are the only organization on the West Coast offering a graduated loan, peer-orientated program. There is an “expansion initiative” in San Francisco and some other cities scattered across the east coast, according to GrameenAmerica.com. There are several organizations offering programs for first-time business owners, but none that I’ve seen (in California) rely on the element of social collateral as the sole determiner in a borrower’s pledge to pay back the loan. I’ve read of the successes worldwide of this model used in other countries and with Grameen Bank in New York, which is what prompted me to look at how our program’s performance pales in comparison.
The first thing I did was visit the Grameen Bank, USA website and worked through their listed requirements for the program and two things stood out: 1.) “Participants must be a permanent resident of the community” and 2.) “Live close to your group members”. I looked through our organization’s requirements for the program and these two concepts were missing completely.
Social collateral in developing countries, in my opinion, make sense for a variety of reasons. First, having the opportunity to switch out ‘hard’ collateral for something abstract benefits those who don’t own property, have cash or any other thing of value to secure an obligation.
Second, social collateral is a concept that is probably more everyday in the lives of the extreme poor. In fact, informal financial arrangements that are made daily between neighbors, family members, and small businesses are all effective because there is this general notion that the ‘social cost’ of not meeting one’s obligations is greater then the monetary one.
Third, it seems in many places of the world the social connect is much more intimate then, say, the U.S. I live in a building downtown and have several neighbors on my floor yet we barely see each other in passing because each one has their own work schedule (a stronger economy, better/more job options). Our area is also served by several businesses. I have yet to bump into a neighbor at our local grocery store. And some of us own cars, so we’re not sitting next to each other on public transportation. These are small examples, and I’ve overlooked things, but what I hint at is that developing countries are better at creating the space for social connections like these to exist. Lack of infrastructure can isolate a town or village converting it into an island where very few manage to leave. Some communities even thrive on the mutual participation of its residents – there is a shared investment. And culturally, the “every man for himself, even if they’re blood” mentality would not bode well like in the U.S. where it seems at least marginally acceptable.
Fourth, because the poor of developed countries are on average do better financially then the poor of developing countries there exist an opportunity to follow market norms or social norms. Essentially, if something that usually carries a market cost (a price of a parking ticket) has an alternative social cost (your tires are painted yellow for a parking violation – embarrassment) you give a person a choice to opt out of one and choose the other. In our case and in the Grameen model the market cost has been replaced with a social one. You don’t pay your loan you must face the embarrassment from your peers AND know that you are directly impeding the members in your group from obtaining loans.
In our case we attempt to create the same environment but lack the “infrastructure” to enforce it. As a born and raised Los Angelino I can echo the sentiments that we are not necessarily a community-orientated city. Our participants probably spend more time driving to our offices then they do to their grocery store. There is a disconnect. And since our loans may end up going to people in neighboring cities or neighborhoods instead of those on our street we rarely, if ever, feel/see the social impact.
My suggestion is that instead of taking our program city or county-wide, we instead focus on a specific community (either ours or through a satellite center). As much I would love for us to offer this program to everyone I just see us running into the same issues. Granted, we should also look at our screening process.