The global financial crisis originated in the US sub-prime mortgage market, where banks had gradually relaxed their screening and monitoring standards (Keys et al., 2010). In a recent working paper, Neeltje van Horen (Dutch central bank) and myself analyse whether, when sub-prime losses materialised in the autumn of 2007, banks reassessed their screening and monitoring standards (De Haas and Van Horen, 2010). To answer this question we study changes in the syndicated loan market. This market is particularly well-suited to assess changes in screening and monitoring because the structure of lending syndicates reflects the importance that banks attach to the screening and monitoring of borrowers (Sufi, 2007). A short primer on syndications will make this clear.

Syndicated lending and “skin in the game”

Syndicated loans are provided by a group of financial institutions – the syndicate – to a single borrower. A typical syndicate consists of two tiers: arrangers and participants. The arrangers comprise the senior tier and negotiate the lending terms with the borrower. Arrangers usually allocate a substantial part of a loan to a junior tier of syndicate members, the participants. Participants have a more passive role: they buy a portion of the loan but are neither involved in its organisation nor in the screening and monitoring of the borrower.

Participants use arrangers as delegated monitors (Diamond, 1984). A downside of this functional division is that arranging banks have a reduced incentive to screen and monitor. To resolve this agency problem arrangers can retain a large enough loan portion on their own balance sheet (retention rate). Such “skin in the game” is an efficient mechanism to ensure that arrangers sufficiently screen and monitor (Pennacchi, 1988). We consequently argue that if participant banks became more concerned about screening and monitoring at the start of the crisis – a wake-up call – this should be reflected in a significant increase in retention rates.

By syndicating part of the loans they structure, arrangers free up space on their balance sheet. This allows them to originate additional loans and earn fee income. When arrangers only need to retain a small portion of each loan, they can originate many syndicated loans and the supply of lending is high. Conversely, when capital-constrained arrangers are required to retain a large loan portion, they can syndicate fewer loans and the supply of syndicated credit is lower. Fluctuations in retention rates may thus be inversely related to the supply of syndicated lending. Indeed, Chart 1 shows how at the onset of the crisis in mid-2007 a sharp increase in retention rates was accompanied by a steep decline in syndicated lending.#

  Graph 1. Retention rate and syndicated lending volume (click to expand)

Main findings

The econometric analysis in our paper shows that – even when we control for changes in inter-bank liquidity and borrower risk – the outbreak of the crisis led to a significant and robust increase in arrangers’ retention rates. This increase materialised during the early phase of the crisis – before the collapse of Lehman Brothers and the ensuing sharp output decline – and persisted over time.

In a next step we test whether loan retention increased in particular when information asymmetries between the syndicate and the borrower were large. Lenders likely became most concerned about adequate screening and borrowing in the case of such opaque loans. Similarly we expect that when information asymmetries were large within a syndicate – that is: between participants and arrangers – retention rates increased more as well. To analyse both layers of agency problems – between lenders and borrowers and among lenders – we exploit detailed information on market, borrower and lender heterogeneity.

As expected, we find that retention rates increased significantly more – both in statistical and economic terms – when information asymmetries were high. Table 1 shows the economic magnitude of some of the significant differences we document in the working paper. While the retention rate for loans to first-time borrowers increased by almost 11 per cent, arrangers of syndicated loans to borrowers with average borrowing experience (two and a half loans) only needed to increase their retention rate by 7.6 per cent. The necessary increase in loan retention was even much smaller in case either the arrangers or the participants themselves had previously lent to a specific borrower (or in case they had substantial prior experience in lending to a borrowers’ industry or country). Finally we find that experienced arrangers needed to increase their retention rates much less than less experienced arrangers. Reputation limited the crisis-related increase in agency problems within lending syndicates.

Chart 1. Economic significance of crisis impact on retention rates (click to expand)

Policy implications

We find that more transparent borrowers, more experienced participants, and more reputable arrangers all helped to contain the crisis-related correction in screening and monitoring intensity and thus in retention rates. This strong link between the severity of information asymmetries and the increase in retention rates further underlines that the overall increase in retention rates at the onset of the crisis, and the subsequent decline in syndicated lending, was at least partially caused by stricter screening and monitoring. To the extent that this reflects a reversal of the pre-crisis loosening of lending standards, banks’ continuing reluctance to lend may prove to be quite persistent even when banks’ own funding constraints would gradually become less binding.

Our findings also bear on the current regulatory debate about minimum “skin in the game” retention rates for originating banks. In July 2009 the European Parliament amended the Capital Requirements Directive by including a 5 per cent retention requirement for securitisations, while in May 2010 the US Senate passed the Financial Reform Bill which announces the introduction of similar regulations. Earlier plans to let minimum retention requirements not only apply to securitisations but also to syndicated loans have (at least for the time being) been shelved. At first sight our results confirm that regulatory retention requirements may indeed not be necessary for syndicated loans. After all, we document a strong, broad-based but market-driven increase in retention rates among syndicate arrangers. Participants, concerned about arrangers’ lax screening and monitoring, were in many cases able to take corrective action without regulatory intervention. Although syndicated lending declined sharply, the market did not break down. This stands in contrast to the securitisation market, where the link between the originator and the ultimate investors was too severed to make any corrective (and collective) action possible.

However, when the market for syndicated lending will expand again, and financial institutions once more start to compete heavily to participate in (oversubscribed) syndicated loans, the pressure on arrangers to retain loan portions that are high enough to guarantee sufficient screening and monitoring may gradually erode. Without the introduction of some form of mandatory retention rates for syndicated loans, the risk exists that old practices will soon return. This may in particular be the case if the secondary market for syndicated loans, where both arrangers and participants can offload their loan stakes, revives again. One way to reduce such a negative impact of subsequent loan sales is to require arrangers to hold on to the loan portion they retained at origination. Although such a requirement could be introduced through legislation, participants themselves could also more often demand that restrictions on subsequent loan sales by arrangers are included in loan contracts.

References

De Haas, R.T.A. and N. Van Horen (2010), The crisis as a wake-up call. Do banks tighten screening and monitoring during a financial crisis? EBRD Working Paper No. 117, London.

Keys, B.J., Mukherjee, T., Seru, A. and V. Vig (2010), “Did securitization lead to lax screening? Evidence from subprime loans”, Quarterly Journal of Economics 125, 307-362.

Pennacchi, G. (1988), “Loan sales and the cost of bank capital”, Journal of Finance 43, 375-396.

Sufi, A. (2007), “Information asymmetry and financing arrangements: Evidence from syndicated loans”, Journal of Finance 62, 629-668.

Private sector credit growth continues to be subdued in most of EBRD’s countries of operation (COOs), despite a gradual recovery of trade, industrial production and capital inflows in the second quarter of 2010.

Two groups of countries stand out among the EBRD’s COOs:

• In some countries, deleveraging continues and private credit continues to shrink or stagnate. This group includes the Baltic countries and several countries in South-Eastern Europe (Montenegro, Croatia, Bosnia and Herzegovina, Bulgaria), but also Kazakhstan and—because of the household lending segment—Russia. In Kazakhstan, credit is stagnant as banks remain cut-off from foreign funding. In Ukraine, too, credit shrank until the presidential elections in February 2010, after which capital inflows returned and credit began to expand again.
• In others, the recovery is clearly underway and credit started to grow already in 2009. This group includes commodity exporters (Armenia, Azerbaijan) and those with state-directed or state–subsidized lending (Belarus, Serbia) or lending to state-owned enterprises (Slovenia). The recovery in Turkish credit growth benefited from strong capital inflows.

To isolate the key factors that differentiate countries, we run an OLS regression of the growth in private sector credit to date in 2010 on measures of pre-crisis banking system structures, macroeconomic vulnerabilities, and institutional environment. In addition, we add the size of the preceding credit collapse to control for any rebound effects, and the rise in unemployment during 2009 as a measure of the cyclical downturn that may affect credit demand today (using 2009 GDP growth instead leads to similar results). We limit the sample to the EBRD region.

Table 1: Dependent Variable Credit Growth in 2010 /1. Click on image to view full size.

As expected, the cyclical positions of countries at end 2009 help predict recent credit growth, and so does a rebound effect (where credit dropped most precipitously during the crisis, it is recovering faster). In addition, recent credit growth appears to be explained by at least three structural factors:

• Banking systems that were better capitalized before the crisis (2007/08) show stronger post-crisis (2010) credit growth (see chart. 1.1).
• Post-crisis credit growth is lower in countries that experienced larger pre-crisis credit booms (see chart 1.3).
• In the same vein, more financially integrated countries are experiencing slower recovery of credit (see chart 1.2.). Interestingly, this effect is present over and above the effect of pre-crisis credit booms.

All these effects are robust to the inclusion of institutional controls, such as cost of contract enforcement.

 In a simple correlation, the recovery in credit growth appears to be lower in countries with a higher stock of foreign currency loans (see chart 1.4), higher external debt to GDP, higher loans-to-deposit ratios, or bigger presence of foreign banks. These correlations, however, becomes insignificant once controlled for the cyclical positions of countries at end 2009 and level of financial integration before the crisis.

Click on image to view full size

“Financial dollarisation” – domestic borrowing and lending in foreign currency (FX), even when the borrower’s income is in domestic currency – is back on the policy agenda. Unlike the 1990s, the victims of financial dollarisation are not longer mainly in Asia – which suffered particularly in its 1997-98 crisis – or even in Latin America.  Instead, “currency mismatches” (another expression for unhedged borrowing in FX) struck most harshly in emerging Europe. They aggravated the 2008-09 crisis in countries with large currency depreciations (Ukraine), complicated the crisis response and monetary policy effectiveness in many countries with significant FX exposures, and induced highly contractionary macroeconomic policies in countries that defended their pegs (Latvia).

As a result, the question of how these economies can “de-dollarise” (or in some countries, “de-euroise”) is receiving much policy attention: particularly, in the form of tougher regulation and even bans on foreign exchange borrowing. For example, in December 2009, Hungary adopted new regulations that require higher household debt servicing capacity and lower loan-to-value ratios for consumer and mortgage borrowing denominated in foreign exchange. In June 2010 the new Hungarian government went further: it announced a ban on the registration of FX-denominated mortgage loans. Some other transition countries also are moving in the same direction in the area of regulation.                                                                                                                                         

But is tough regulation necessarily the right answer? In a recently published EBRD Working paper, we argue that if emerging European policy makers want to get the policy response right, they would do well to look at the international experience on dollarisation, reflected in a large literature on the subject, which was written largely in the decade between the 1997-98 Asian and the 2008-09 European crisis. This literature, combined with our own evidence on emerging Europe and Central Asia, leads to three main conclusions.

First, financial dollarisation is primarily, if not exclusively, a macroeconomic phenomenon. This is most obvious today in the less developed countries of Eastern Europe and Central Asia, which suffer from high inflation volatility. In such countries, writing long-term financial contracts using local currency units simply does not make sense, because the future real value of interest and principal payments in local currency is very uncertain. As a result, long term FX borrowing may actually be safer than local currency borrowing over the same maturity – even if it exposes borrowers to the threat of insolvency in the (comparatively rare) event of a large depreciation.

What about the highly “euroised” countries further west, where inflation had been much lower and quite stable since the late 1990s? Here, the link between macroeconomic policies and FX borrowing was more subtle. Notwithstanding low inflation, local currency lending rates in these countries tended to be much higher than FX lending rates. In part, this reflected a lack of monetary policy credibility: while inflation was relatively low, and currencies were generally expected to appreciate, this could not be taken for granted. At the same time, pegged or heavily managed exchange rates gave FX borrowers a false sense of security, particularly in EU countries, which viewed themselves on a straight path to euro adoption. In such countries, the temptation to borrow much more cheaply in FX was simply overwhelming.

Second, while weak macroeconomic policies and institutions were an important factor in fostering dollarisation in emerging Europe, they were not the only factor. It would otherwise be impossible to explain why, for example, FX lending as a share of total bank lending doubled in Hungary between 2004 and 2008 (see chart), a period in which macroeconomic policies (particularly monetary policy, but after 2006 also fiscal policy) generally improved. The driving factor here (and in other of more financially integrated emerging European economies in the Baltic region, and in south-eastern Europe) was a foreign-financed credit boom (for a comprehensive documentation, see a recent IMF working paper). In their rush to expand credit, banks relied largely on cheap FX funding either from parent banks, or borrowed in international capital markets, rather than by building their local deposit base. To avoid currency mismatches on their own balance sheets, the preferred lending currency was also foreign. Hence, rising euroisation was a by-product of the 2004-2008 lending boom, which turned out more extreme in emerging Europe than in any other region of the world.  

Source: EBRD, Transition Report 2009 based on data from national authorities. Click on image to view full-size.

Third, domestic capital market development is a critical component of de-dollarisation policy, particularly in countries that already have reasonable macro stability. From what has been said so far, this is not entirely obvious: a country with credibly low and stable inflation, a floating exchange, and macro prudential tools that dampen credit booms and discourage their financing in FX should not have a dollarisation problem, regardless of whether it has well-functioning capital market. However, capital market development is nonetheless important, for two reasons. For one, longer-dated bonds are a bellwether of macro credibility. Their yield is reflection of faith in the governments’ ability to keep inflation low and stable, and an incentive to maintain stabilisation on track. Most importantly, domestic capital markets help overcome the shortage of domestic currency long term funding that biased emerging Europe’s lending booms in the direction of FX. Banks that wish to expand their lending are less likely to resort to FX funding if there is a domestic investor base – for example, pension funds and insurances – that is interested in longer dated debt instruments,  and if there is a market that makes these instruments liquid and easy to price.

With this in mind, is the current focus on regulatory responses to financial dollarisation a good idea or not? The answer depends in part on the country. In countries in which inflation volatility continues to be a problem, making FX lending illegal (or prohibitively expensive) is downright counterproductive: it may destroy longer term lending altogether. However, more subtle forms of regulation can play a useful role, particularly in more advanced countries, and particularly when they complement good macro policies, and are embedded in a more general set of macro prudential instruments. For example, these could include risk weights and reserve requirements on banks that are higher for FX loans and FX funding, respectively; and setting maximum payment-to-income and loan-to-value ratios that guard against household overborrowing, particularly in FX. While regulation need to be country-specific, its coordination is essential in order to limit regulatory arbitrage. Such coordination is taking place, for example, under the European Bank Coordination (“Vienna”) Initiative.

In sum, our analysis suggests that the fight against emerging Europe’s addiction to FX needs to be country-specific and multipronged. Regulation may be justified, particularly in the more financially integrated countries. But it should never carry the sole burden of the fight against addiction to FX. Depending on the country, the main focus of de-dollarisation could be to stabilise and reform macroeconomic institutions; or it could be a combination of regulation, macroeconomic credibility-building, building the legal and institutional underpinnings of local currency money and bond markets, and developing the demand side of these markets and making them more liquid.

In recognition of these links and complementarities, the EBRD has recently launched a new Local Currency and Local Capital Market Development Initiative. In the next 12 months, at the request of country authorities, the EBRD will conduct country-by-country diagnoses of the causes of financial dollarisation in many of its countries of operation, jointly with other IFIs such as the IMF and the World Bank, as well as private sector associations. All key factors will be considered: macroeconomic volatility and credibility; FX regulatory conditions; local currency market development; and associated legal, regulatory, and infrastructural requirements. Based on these diagnoses, the EBRD will support the development of local capital markets by using the lending and funding instruments at its disposal, in coordination with other investing IFIs; and through technical cooperation.

The crisis has put financial dollarisation at the centre of attention in emerging Europe. That is a good thing. Ten years ago, emerging Asia and Latin America were in a similar situation. By and large, they drew the right consequences, and today, financial dollarisation is no longer the first-order problem in these regions that it once was. There is no reason why emerging European countries should not follow their example. The political will to do something about the problem is there, and macroeconomic conditions are favourable. But in order to make the most of their historic opportunity, they will need to be patient, avoid quick fixes and focus on the hard work of improving macroeconomic policies and institutions and developing local capital markets.

We’ve just published our latest update on Emerging Europe and Central Asia’s economic outlook which indicates that the recovery in the transition economies is progressing with important exceptions, and highlights the key factors behind this diverse picture.In many countries economic activity was strong in the first half of the year, but the outlook is dimmer, due to the short-term negative demand impact of fiscal austerity  packages and/or global exiting from crisis-related macro policy loosening: (i) in advanced EU countries (main export markets for emerging Europe), (ii) in transition countries themselves  (dampening domestic demand); and (ii) globally, as the rest of the world exits from crisis-related expansionary macro economic policies, weakening global demand for natural ressources and commodities.  Balance sheet pressures on banks active in the region also weigh on credit growth. Significant uncertainty remains both on the downside and upside; however, the balance of risks has shifted to the downside since May.

As a result, the growth forecast for the EBRD’s region of operations has been revised downward by 0.2 percentage points since the last EBRD forecasts in May to 3.5 per cent in 2010, and by 0.1 percentage point to 3.9 percent in 2011:

• The downward revision is most pronounced in both years for South-Eastern Europe where the recession appears to be lingering.
• In Central-Eastern Europe, stronger than projected recent growth, while lifting 2010 growth, is expected to fade in 2011. Some Central European countries have recently witnessed stronger than expected growth, which may spill into 2011; at the same time policy uncertainty can also affect investor confidence in cases such as Hungary.
• Central Asia is expected to grow somewhat more than previously projected on the back of good prospects for commodity exports.

A recovery appears to be underway in the second quarter of 2010, although with notable exceptions. On the back of a global recovery in trade, growth in industrial production and exports increased in most countries in the second quarter. In the largest emerging market countries of the region (Russia, Turkey and, since the presidential election, Ukraine), a return of capital inflows has also contributed to growth. Strong commodity prices, despite some market volatility, have benefited commodity exporters (Russia, Kazakhstan, Armenia and Mongolia).

In contrast, output growth continues to be near zero or negative in most countries of south-eastern Europe, and neighbouring Croatia and Slovenia. Here, recovering exports were offset by weak domestic demand, and financial systems suffered some pressure from the turmoil in Southern European sovereign debt markets. In several countries, net capital inflows remain subdued and credit to the private sector contracted or stagnated. In addition, flood damage reduced GDP in some countries. Another exception to regional recovery is the Kyrgyz Republic where political turmoil has disrupted economic activity.

Inflation pressures continued to subside across the region. In those countries where inflation has picked up since end-2009, the increase was caused by hikes in administered energy prices (FYR Macedonia, Kazakhstan, Moldova and Slovenia), VAT and excise tax rises (Bosnia and Herzegovina, Bulgaria and Estonia), or sharp depreciations (Georgia).

Source: CEIC database and national statistical offices.

The outlook for the remainder of 2010 and for 2011 is generally weaker than recent economic activity suggests. Central and Eastern European countries depend heavily on trade and financial links with the EU. Given the weakening outlook for the Eurozone – as fiscal austerity programmes are implemented and financial markets are likely to remain volatile – the external environment may be less benign than previously projected. Credit growth is expected to remain weak as long as banks’ balance sheets remain under pressure, regulatory uncertainty lingers, and the cost of capital are elevated. In addition, country-specific developments will constrain growth. Several countries have announced additional fiscal tightening measures (e.g., Lithuania, Romania and Serbia). Resource-rich countries in the Caucasus and Central Asia will be affected by a slowdown in commodity prices resulting from shrinking demand from Asia.

Downside risks, mostly due to the external environment, have intensified. The “fan chart” below, which is estimated for EU member states in the transition region plus Croatia, illustrates how the risks have become increasingly tilted to the downside. Fiscal consolidation in Europe and monetary tightening in China may still trigger a sharper slowdown in global growth than currently projected. In this downside scenario, trading partner growth could turn negative in the second half of 2010 and remain negative in 2011. This could be compounded by further deleveraging in the financial sector if capital and liquidity remain scarce and risk aversion rises. Financial market volatility could rise significantly. In addition, if market nervousness over fiscal sustainability intensifies, several countries may require austerity packages to convince markets of the sustainability of public finances. While expenditure-based fiscal consolidation may benefit competitiveness in the medium-term, it would dampen growth in the short-term.

At the same time, prospects for fiscal sustainability are better than in many advanced economies and may result in upside risks. Compared with advanced economies and other emerging markets, public debt-to-GDP ratios in the region are generally low. Many countries are implementing significant fiscal consolidation programmes which, if focussed on expenditure cuts that typically produce more lasting improvements in fiscal balances than revenue increases, should improve fiscal sustainability as well as competitiveness. In addition, medium-term growth prospects are typically stronger than in advanced countries which are planning to implement austerity programmes. As a result, capital flows in search of yield may be attracted to debt markets in the EBRD’s region of operations, helping to push growth in the whole region possibly above 4 per cent this year and closer to 5 per cent next year.

We’ve entirely rebuilt ebrd.com from the ground up, with a fresh visual design, new structure, additional features and improved content. The aim was to make everything within the site more accessible, useful and compelling for our clients and contacts around the globe.

In developing the site, we asked hundreds of our website visitors for their views and requirements and created what we hope will meet the needs of existing and new audiences much more effectively than ever before.

Did we get it right? Have a look and send us your feedback.

]]> http://www.ebrdblog.com/wordpress/2010/07/981/feed/ 0 http://www.ebrdblog.com/wordpress/2010/05/born-in-89-update/ http://www.ebrdblog.com/wordpress/2010/05/born-in-89-update/#comments Sat, 15 May 2010 06:54:56 +0000 James Bregman Web Manager http://www.ebrdblog.com/?p=971 The EBRD received hundreds of entries for its “Born in ‘89″ essay competition, which invited people from the EBRD region to share their experiences of growing up in the years after the fall of the Berlin wall.

Finalists…

The Dom Tuškanac is a residence funded by the Croatian Ministry of Health and Social Welfare. With a dedicated and caring staff, it provides a home for children and young adults with a variety of mental disabilities, helping them to integrate into society while looking after their special needs.

The home’s current heating and hot water system is outdated, inefficient and costly. Together with environmental partner ‘City Center one’, the EBRD will contribute to help install a system of modular, highly efficient boilers that will save energy and reduce carbon emissions.

This investment in energy efficiency will bring real savings to this worthy institution. More importantly though it will make life a little more pleasant for a group of special young people.

Today, on the eve of the opening of the EBRD’s Nineteenth Annual Meeting, EBRD President, Board members, staff and meeting participants visited Dom Tuškanac. Read more

Participants will be able to assess the latest political, economic and social changes and business opportunities in the country and across our region of operations, as well as a chance to network and to enjoy the host country’s cultural programme.

The Bank’s shareholders will be making important decisions about the strategy of the EBRD for the coming years and how it can be best equipped to carry out its role. The Board of Governors’ sessions will be chaired by the EBRD Governor for France Christine Lagarde, who is also France’s Minister of Economy, Industry and Employment.

A further 19 country presentations will give the Bank’s countries of operations a chance to articulate current investment opportunities. In parallel with the official AM programme, the EBRD and Croatia will co-host an informal meeting of heads of government of South-Eastern Europe on 14 May. The meeting is held in the format of the South East Europe Cooperation Process, which includes Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Greece, Moldova, Montenegro, Romania, Serbia, and Turkey.

The volcano was symbolic perhaps, reflecting my mental state, since the height of the eruption occurred in parallel with April 15th, a key day in the calendar of Americans around the globe, the last day to file US income taxes. Volcanos, taxes, whatever, there is some kind of poetic justice here. As the impact of both became clearer, my sleep became more and more fitful. I woke up every morning at three to watch live photos of billowing smoke. No information was to be had online or by phone from Air Canada (nor, for that matter, from the Internal Revenue Service) and my departure date came and went as the realisation sunk in that I might be in here for the long haul.

How long? That was what was (actually still is) the issue, though it now appears that I am booked (THANK YOU, EBRD TRAVEL OFFICE) on tonight’s 6.15pm flight to Heathrow. The past few days have been strange as I began to make extensive use of the hotel’s laundry services and shop for undergarments at that North American paragon of value, Sears, a stone’s throw from my room. Barriers imposed by the hotel’s business centre sent me to “Best Buy” to buy a laptop (we needed one anyway) and set up shop.

I have now adjusted to life in 412 on day 3 after my planned departure and day 7 of life in Canada. The representatives from the IMF and World who also attended the conference are long gone (Washington!), and I have started sussing out the pros and cons of the three food courts and shopping malls which surround my hotel, planning the logistics of a longer, even indefinite stay.

Who knows if I’ll actually leave? Another plume, another cloud of ash might change everything. I anticipate utter chaos at Lester B. Pearson International Airport, where I will stock up on maple syrup, baseball caps and relentless Canadian friendliness and optimism while praying that I actually take off. In any case, I consider myself lucky. I might have gone on mission to Zagreb with our colleagues from the Bank. After days of waiting, they apparently spent 26 hours on a bus and, I hear, are in the UK as I type these lines. They no doubt hated that bus by the end; I, on the contrary, have come to love 412.

Wednesday 21st April update: A Room with a View

Funny how crisis drives one to literary allusions. Anyway, though the reservation was confirmed and the BBC announced that UK airspace would re-open, I arrived at the Toronto airport to find any flight to London inexplicably cancelled. (I immediately regretted joking with the taxi driver about seeing him again soon.) And there I was again at the mercy of the Marriott lady, whose voice I know so well and who took me back at the same preferential rate, this in spite of a meeting of the Funeral Service Association of Canada (Association Funeraire du Canada) — meaning that the entire hotel is now inhabited by undertakers, many of whom wear black suits even when “off duty”, and all of whom seem quite jolly, in the lifts and especially at the bar. Needless to say, philosophical, even existential thoughts have begun to intrude onto what has become a surreal routine, with surreal encounters punctuated by live shots of billowing smoke wherever I go.

In the film version of E. M. Forster’s 1908 novel “A Room with a View”, the rooms have lovely views of Brunelleschi’s masterful cathedral in Florence and of idyllic English countryside. I too asked the endlessly accomodating Canadian staff of the Marriott for a room with a view. I was assigned room 1506, eleven stories above the fabled 412 (see yesterday’s entry), which paradoxically has exactly the same view as 412, i.e., of the parking structure next door from a much higher angle (no hint of Lake Ontario). I have set up shop again and am happily working via a remote connection (THANK YOU, EBRD IT HELPDESK), and have had words of encouragement from across the Bank, including sage words from the IT director on how to penetrate the anti-Citrix barriers in business centres around the world: “Download the Java client,” he writes. No need to do this now, since all is well, but in my now perverted mind, I associate “Java” with Krakatoa and am superstitious enough to not dare to tempt the gods by even trying something like this at this point in my life.

I return to my parting lines of yesterday: “Who knows if I’ll actually leave? Another plume, another cloud of ash …” Will I? Find out tomorrow. I am though much more relaxed, for at least now I have solid routine: arise at 6.38, drink coffee in Eaton shopping centre, work via EBRDremote, check BBC, check out, cab to airport, note flight cancellation, call Marriott, return to hotel, consider fast food options, avoid undertakers, ponder meaning of life. Repeat.

Ger – a portable, felt-covered dwelling – in rural Mongolia

Although microfinance has grown rapidly over recent years, hard evidence on its socio-economic impact is only emerging slowly. To what extent does microfinance lift people out of poverty by allowing them to generate income from small-scale enterprises? And is group lending (‘joint-liability’) or individual lending the best way to reach out to borrowers? These are questions that XacBank, a leading microfinance institution in Mongolia, has been grappling with as well. The bank wanted to expand its outreach to indigent rural borrowers, in particular female ones, who hitherto had only limited access to financial services. But what is the best way to expand lending to such ‘difficult’ customers?

On the one hand, individual loans may be more suitable in a country in which the nomadic lifestyle may have limited the build up of social capital outside of the family structure. On the other hand, group lending may work well if the looser ties within groups reduce the risk of collusive behaviour. Moreover, since monitoring costs are particularly high – loan officers have to travel extremely large distances to reach remote clients – the reduction of such costs through a group lending structure may be particularly valuable.

To help XacBank with its strategic decision making and to assess empirically the impact of access to microfinance on small business development and poverty reduction, a project team at the EBRD (Ralph De Haas and Heike Harmgart) and the Institute for Fiscal Studies (Orazio Attanasio, Britta Augsburg and Emla Fitzsimons) designed a so-called randomised field experiment. The design entails an experimental set up involving 40 soums (villages) across 5 aimags (provinces). Together with the Mongolian Women’s Federation (MWF) a list was drawn up in each village with the names of relatively poor women who were interested in a XacBank loan to expand or set up a small business. These women were also asked to form preliminary borrowing groups. All 1,148 of them were then interviewed by a survey company in March 2008 (the baseline survey).

Session of MWF representatives involved in the field experiment

The 40 soums were then randomly divided into 10 ‘control soums’, 15 ‘group lending soums’ and 15 ‘individual lending soums’. Information from the baseline survey confirmed that the randomisation worked well: the participating women in all three types of villages were on average very similar across a wide range of observable characteristics.

In a next step, all women in group-lending soums were visited by a XacBank loan officer and groups that were deemed credit-worthy were offered a group loan. In the individual lending soums, women were offered an individual loan, while in the control soums XacBank delayed the roll-out of lending for the duration of the experiment. Importantly, when the women signed up to the project it was carefully explained to them that they would only have a 75 per cent change of actually obtaining a loan during the first year (since XacBank would delay the introduction of lending in 10 out of 40 villages).

A follow-up survey was conducted in October/November 2009, about 20 months after the baseline survey. Four interview teams re-interviewed 982 of the initial respondents; a re-interview rate of 86 per cent. This means that for 982 respondents we have detailed information from both the baseline and follow-up surveys on income, consumption and saving patterns, asset ownership, (in)formal enterprises, and exposure to shocks. Respondents were also asked about their income expectations and attitudes towards risk. Finally, novel questions were asked to gauge how well group members knew their co-borrowers, with the aim of allowing us to make inferences about the ‘information asymmetries’ within joint-liability groups. Detailed information was also gathered on the characteristics of villages and loan officers that participated in the experiment, while XacBank provided the project team with comprehensive repayment data on all loans.

Respondent being interviewed. The stones are used to answer questions about the respondent’s own expectations about her future income.

The project team is currently combining and analysing all of these data. This should allow us to compare how the respondents in the control soums (no loans offered) and the treatment soums have developed over time. Since the women in the treatment and the control villages were on average very similar before the experiment, differences in their subsequent development and outcomes will only be related to whether or not they received a loan.

This comparative analysis is of particular interest given the global financial crisis, the impact of which was felt in rural Mongolia in the period between the two survey rounds. Cashmere prices dropped by more than one third over a short period of time, adversely affecting many herder families. We hope that our results shed light on the question of whether the availability of microfinance has alleviated – or maybe even increased – rural households’ financial vulnerability during the crisis. Complete results are expected to be available in June of this year and will be summarised on this blog. For now, the data collected during the baseline survey already provide some insights into the state of rural microfinance in Mongolia. Three observations stand out:
First, we find that only 44 per cent of respondents had no outstanding debt at the time of the first interview while 46 per cent already had a loan. Almost ten per cent of respondents even had two or thee loans. Contrary to popular perception, penetration of microcredit was already quite advanced across rural Mongolia, even among our sample of relatively poor women who were selected because of their supposedly limited access to finance.

Second, virtually all respondents with a loan took out that loan in 2007 or 2008. Almost half of the respondents had not had another loan (whether repaid or not) in the last five years. Competition for rural customers – in particular between Khan Bank, XacBank and Mongol Postbank – had intensified in recent years. In our sample, Khan Bank has by far the largest market share: we find that just over one half of those with an outstanding debt owe it to Khan Bank.

Third, we find that between 70 and 80 per cent of the debt outstanding at the start of the experiment was used for consumption purposes and not for financing micro-entrepreneurial activities. This is an important finding since it shows that even though microfinance in rural Mongolia has advanced rapidly in recent years, the vast majority of loans has been used for consumption rather than income-generation. That is not to say that these loans have not been ‘useful’: the ability to smooth consumption is particularly important at low income levels. But it will be interesting to see whether the crisis has impacted households with varying debt levels differently. Moreover, it will be of interest to find out to what extent the individual and group loans disbursed during our experiment, which were intended to finance businesses, have indeed been used for such income generating purposes.

Stay tuned for more…

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