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The following was a brief email exchange between Paul DiLeo, Ira Lieberman and myself. Very lightly edited, but others on the CC thought it worth sharing:
Paul DiLeo: Very nice piece, Daniel; really great and thought provoking. A few comments:
While clearly some and perhaps many MFIs will not survive, I think we have to be alert to the risk of a kind of survival bias: that the stronger MFIs that are targeted for support are not disproportionately those that serve the more profitable clients. Targeting of support need to look through the MFIs themselves and make sure that the full range of end clients are being supported.
While I agree that MFIs are not the ideal channel to provide support to households that have lost income, I wonder in how many countries alternatives exist? In developed countries it seems government are channeling support directly to businesses or through banks to formal businesses with a government backstop. But give the engagement of MFIs with the informal economy, I wonder whether they might be in many countries the only option.
Overall your analysis gives some encouragement about the capacity of many institutions to support staff, meet deposit outflows and maintain debt service. But on the latter, our concern is not that MFIs broadly cannot meet scheduled debt service for some months. It is rather that partial — and somewhat arbitrary — debt service will undermine the principle of equitable burden sharing and make the recap that many institutions will sooner or later need more difficult, time consuming and less successful.
Daniel Rozas: Hi Paul -- thanks for your feedback. Very helpful. I do hope the investor MOU will play a meaningful role in avoiding non-compliant lenders from undermining the rescheduling process. And there may need to be a public shaming component too, for those who play fast and loose. I'm certainly happy to do that if needed.
And also, thanks for the comment on the forum yesterday - discussion activity in the forum is growing, and we hope this will spark further conversation. I'm working on a follow-up piece that looks at credit loss and solvency issues, and how those play out.
A lot going on...
Paul DiLeo: I remember during the AP crisis a rule of thumb was that any MFI with more than 30% of portfolio in AP was likely insolvent unless it serendipitously happened to have an extraordinary low CAR, like SKS, which had just closed a big raise a few months previous. In the current situation, a similar rule of thumb might be extracted: more than 30% in group loans and loans to affordable schools, for example.
I think the MIV MOU is a solid step forward. Aspects where I have concerns are, first, in my view it underestimates the insolvency problem with respect to numbers of MFIs, if not OLP. Many MFIs will disappear. While some stronger MFIs may have sufficient capital to absorb them, there will be a need for fresh money if the industry capacity is to be largely preserved. And left to its own devices, the incidence of consolidation and shrinkage will likely be uneven in terms of which clients are most impacted: understandably it will be the less profitable MFIs, but we are still in thrall to the no-trade-off fiction that asserts that lower profitability is always a mark of inefficiency rather than at times due to serving more challenging clients. A second concern follows on from this underestimation of the solvency issue: the MOU exists in a creditor only silo. I do find it stunning that there is no mention as far as I recall, to shareholders or donors. And yet I don’t see how solvency, consolidation and preserving outreach can be addressed without engaging these stakeholders in the dialogue from the outset. A unilateral creditor led response will require lots of back-filling once these and other stakeholders are — inevitably, I hope — brought into the discussion.
Anyway, I don’t mean to be sniping and I do think it is great that they have moved this quickly.
Daniel Rozas: Good food for thought, Paul. Regarding capital losses -- new capital infusion makes sense, but if losses are large but still survivable (i.e. enough clients still repaying and new lending to be done sustainably) what about haircuts to outstanding creditors up to the level needed to bring capital back to zero? Or forced debt for equity swaps? I know some funds can't hold equity, but they could sell to other shareholders, for example.
It just seems to me that in the present circumstance, the rather arbitrary line of zero equity shouldn't be the mark of the guillotine. I can easily imagine scenarios where an MFI with -10% equity is actually stronger than one with +1% equity. Unlike cash, equity & debt are abstract notions denoting degree of risk. They aren't absolutes.
Paul DiLeo: Two quick points: Zero or negative equity can be fine so long as regulatory requirements are not breached or are relaxed. Extended forbearance less likely for depositories. Second, as soon as you start talking about haircuts, swaps, etc you are implicating shareholders, so they better be at the table sooner or you will have a time-consuming standoff during which more value will be destroyed.
Daniel Rozas: Of course. Both those things go without saying (or maybe they do need to be explicitly said -- and that's the point). And for depositories, regulators need to be in the discussions early on as well. But I likewise imagine most regulators would prefer to take the forbearance route if there's a viable path forward -- shutting down depositories in the middle of a pandemic doesn't help regulators either, with angry crowds of savers in front of branches and ATMs. Plus, having regulators at the table might give investors -- shareholders and lenders alike -- the incentive to find a solution, since the alternative would probably be worse. Maybe we propose the Teddy Roosevelt prize for those best at wielding the big stick quietly...
Ira Lieberman: Don’t know if any of you followed the Argentine crisis in 2001-2004. There was a run on the banks and the central bank imposed a coralito where savers could only withdraw a limited amount each week to cover food, rent etc. It led to massive street protests where citizens many of them pensioners surrounded the central bank and other major banks, best on pots and pans and demanded their money. Leading a World Bank team to Argentina to address the crisis I had to walk through that gauntlet. Scary.
So I worry about eventual pressure on the MFIs from depositors hit by loss of income. I am not sure what a good solution would be.
Daniel Rozas: Yes, the corralito is a case example of what NOT to do. The problem in that case was at heart a declining real currency value with an untenable official rate -- it remains to be seen whether that'll be an issue in today's crisis. But that's really impossible for any financial institution to manage -- once you're facing such a situation, it's really up to the government to get right.
Ira Lieberman: That is right Daniel Argentina had to abandon its currency board and eventually let the pegged peso float. It devalued from 1:1 vs the USD to over 3:1 wiping out bank capital and putting some of the largest companies in difficulty
There is a good chapter in my book In Good Times Prepare for Crisis on Amazon on the Argentine crisis.
Paul DiLeo: Well, I think in the absence of strong, quick, coordinated action by shareholders and creditors the obvious central bank response will be a forced merger, which may not be in the best interests of many clients.
Daniel Rozas: Yes -- that was an outcome with Zakoura's collapse in Morocco, which turned out ok, including for clients. What was interesting is that the new entity (Fondation Banque Populaire) retained many of Zakoura's staff, some of whom are now in very senior positions at FBP. So there was very real integration.
But in today's environment, there may not be strong, well-capitalized institutions to rely on for the merger. I imagine the banks are struggling as much as the MFIs. It's a very unusual scenario... Very hard to predict.
Hi ! Daniel.
In the context of Nepal, Central Bank has issued the circular that Every MFIs should lower the interest rate by 3 percentage points on existing intrest rate of loan portfolio of every borrower for last quarter of this fiscal year and allowed to pay Installment till mid July 2020 without penalty.
Dana Raj Panta
Hi Daniel, I certainly appreciate the effort to try to put some analysis behind what is an unfolding and unprecedented global crisis. We are all in the middle of it, changing day by day. I usually don't respond to posts but feel compelled to respond here. I think we are at a very early stage and there is a risk to underestimate the scale of what we are facing. Having read your analysis, and thinking about conversations I am having with my peers, practitioners who are also managing MFIs and looking at the stress tests and business continuity plans, you do not factor in here the potential snowball effects we are facing, for example impact on CAR, higher provisioning costs and impacts on liquidity, regulator moratoriums for months on repayments, prevention from operating as "non essential business", related covenant breach vis lenders, local lender constraints, severe FX volatility and pressures. There is a certain amount of cash on hand, yes, but expenses are not really going down and the whole landscape is changing - at the regulator/govt, funder/individual client levels. We should not de-emphasize the risks of a shortage of liquidity - if not immediately - then in the long run if we are all victim to a global recession. I would rather us prepare for the worst, line up all our defenses, and then hopefully be proved wrong.