NOTE 9: (CONTINUED)

NOTE 9: ON MICROCREDITS (Continued):

Continuing with the theme on Microcredit, upon which much has been written, I would like to add my general concept of credit risk linked to the credit in general terms, which includes the Microcredit. We suffered a worrying global recession, in which we have already 7 years of crisis. Countries show a varied response to the crisis, with few countries with a trend towards recovery, many under worse conditions than in 2008, which led me to wonder: What caused the credit bubble crisis?. There is no single answer to explain it, but having given it track before the crisis, there are four elements that stand out as potential generators of this situation: (1) initially it happened in developed countries and then it had a domino effect in the rest of the World; (2) it was caused when there was an effort to try to massify credit, calculating risk based on statistical models, (3) Automating  the approval process, and (4) it was assumed that on rising rates of riskier loans, the total risk was compensated, In short: Countries with a mature financial markets, complex mathematical-statistical models, the application of a risk-rate equation and automation of the credit approval. I am a psychologist, perhaps by my training and work in marketing and sales of financial services, I am a "financial Psychologist" and learned from my beginnings in this profession how difficult, perhaps impossible it is to predict theoretically, the human behaviour, an issue that Stephen Hawking raised years back in Black Holes and Baby Universes and Other Essays – 1993, quote: " The real reason why we cannot predict human behaviour is that it is just too difficult" and "So although we know the fundamental equations that govern the brain, we are quite unable to use them to predict human behaviour ". Credit is a situation in which the financial risk must be predict based on the human behaviour that produces it (To pay or not the instalments), so it is very difficult to determine a priori, what will be the future payment behaviour of any debtor. It is known that 70% of delays can occur during the life of the loan and 30% of it in qualifying. I am a believer of statistics and in the information and communications technology, but I seriously doubt if this can bring a lot of light to the future behaviour of an individual debtor.

I wondered which was the basis by which bankers of Florence in 1379 lent their money. Evidently they had neither the mathematical knowledge nor technology of today: However, they assumed, as today, the same risks for the recovery of the loans as we do today. But other aspects have changed that make the credit risk a critical issue nowadays: Today banks and chartered social financial institutions lend the money of the deposits from the public, but that money, unlike the days of the Medici, is not of the property of the financial institutions, so both the financial and moral responsibility for the institutions is complete.

I ask myself: Why it was assumed the use of mathematics to develop theoretical models for the prediction of human financial behaviour?. Perhaps it was because: (1) The financial aspect of it, is the actuarial science; but actuaries predict what is basically the probability of global risks based on consistent laws; some are natural laws (Life expectancy), others on collective behaviour (accidents, fires, etc.) that serve to determine the individual cost of insurance premiums; but in any case these do not refer to predicting patterns of individual behaviour; (2) In the science of the economy, here things are significantly more complicated because economic theories do not always apply to the micro level, as was observed with the failure of Long-term Capital Management LP (LTCM) in 1998. (3) The momentum of the great development in information and communications has us spellbound and it seems to be the answer to all our problems in our day to day. This led to the creation of tools that came to replace the traditional authority of the Credit Officer and were not able to detect NINJAS (no job/no income). These automatically and in many cases by phone granted loans based only on the data in the Credit Bureaus and using "Credit Scoring" systems. The support with mortgage guarantees, which finally did not, were as warrantable as it was considered. The aim of all this ideas was to give credit massively, automating a product that is by definition selective. It seems that the combination of increasing income by pricing rates according to the risk and massively spreading the credit, was the norm in 2007 and back, and unfortunately, is still done today, but this led to the credit bubble in 2008 which many countries have not yet recovered.

How do I think it should be a sound loan portfolio?: I do not think the statistical analysis is the answer. I believe in the information and communications technologies (ICT): In fact I am using it in an innovatively way: The last year and a half I have been developing training and consulting models using the Internet, you will receive more information on this issue. But I do not think that ICT are the best, much less the only answer to all problems, these must be used wisely to be effective. The fact that these facilitate and accelerate statistical calculations and manage information does not mean that the results are realistic. To me a healthy and productive credit portfolio, is nothing else but the sum of well awarded and monitored loans which are constantly observed and react fast to paying delays: This has always been the focus of Microcredit in Latin America where very important MFIs; such as BancoSol (Gross loan portfolio USD1.106 millions, underperforming loans 1.06% - 6/2015) and Banco FIE (Gross loan portfolio USD 1.048 millions, underperforming loans 1.46% - 6/2015) have shown undoubtedly, that MFIs can operate in the sector with a low risk level of underperforming loans.

But; To the end, what is a credit?: A credit is nothing more than an act of confidence in a debtor by a creditor: Can you statistically measure trust in a person?. The obvious answer would be that the Credit Bureaus are for that purpose; but is that really, can we consider today, that anyone who has paid very well before will do so in the future?. The crisis has shown us that excellent payers stopped being so with the world recession.

All this has led me to try to address the credit risk issue from a psychological perspective; because after all, a credit is nothing more than an agreement between people: A debtor and one or more representatives of a financial institution.
Based on these ideas, there are some points that I recommended in my consultancies and I hope it will also be useful to you:

1.      It is important to give empowerment to the Loan Officers to assume the consequences of a bad credit granted. That is usual in Microfinance by punishing the production bonuses of the Loan Officers according to the level of underperformance of their credit portfolio; this has not been the case in traditional banks. This reduces the moral risk of passing to others (Collection departments) who become responsible for recovering loans that the latter did not approve.

2.      Practice has proved that it should be assume that all loan applicants may be potential defaulters. If their payment behaviour is correct, nothing happens and if they show a pattern of improper payment the institution will be ready to act in time to control it. In fact, the crisis demonstrated that defaults near to 100% can happen.

3.      The situation of a credit application is something punctual that reflects the financial realities of the applicant at the moment, so it is essential to monitor and observe the behaviour of the payments during the term of the loan, reacting fast and firm to the slightest delay to prevent It getting worse. Each delay in payment is casuistic and must be solved individually; I hardly found a common denominator or solution to all the defaulters in a credit portfolio other than going to Court, which is the end of the road.

4.      A credit applicant who is distrusted by a Credit Officer should not have the loan approved. This would imply a high moral risk for the financial institution and a source of future conflicts.

5.      The loans have two distinct phases, in which the borrowers show different patterns of behaviour: (a) The application phase: In it, the applicant is willing to give and gives all the information requested and (b) The payout phase: At this stage if the debtor defaults payments, stays away from the financial institution even evading it. Given this, it must be ensured in the first phase that all the information needed to press the debtor to come forward and/or take the case to Court has been collected, if the need arises. Again, too much information does not cause any harm to a good payer.

6.      The Credit Bureaus are important filters to detect "professional debtors" as those are present on a regular and systematic basis in them. This "professional" debtor wants to have access to a lifestyle that can not pay, so tries that be paid by the financial institution. This behaviour must be acknowledged and prevented.

7.      I cannot conceive of the approval of credit without interviewing the applicant personally, this comes in conflict with the mass given credit, which has been the practice for many years back, with the consequences we know. Credit interviews are ideal to detect inconsistencies and contradictions in the information of applicants. The differences between what an applicant says in the contacts with the Loan Officer in various moments and the documents can be an indicator of lack of transparency and therefore a warning of caution.

8.      No one can approve a loan based only on papers, either being given by a person or company, because this last is managed by people. There is a tendency to turn to the risk departments to revise, approve or veto the loans, without seeing personally the applicants, which is a riskier practice than the possible mistake of Credit Officer. Risk Departments should design and promote policies that reduce risks but cannot take executive decisions based on papers, this is the job of those who deal with applicants and must assume the primary responsibility of the credits and hence their recovery.

9.      Trust is very critical, because half of trust implies another half of distrust. The problem is that no one knows for sure which of the two will be applied to the financial institution. Trust is a yes or a no situation, not halfway. When in doubt it is better not to risk approval, because of the financial implications and conflicts that can be generated.

10.  Only the observation of a trained person is able to detect what the credit applicant thinks and how it thinks, there are no statistical methods to determine the sincerity; this can only be perceived by observing the behaviour of the person. The interview is an art and a science; it must be learned and mastered by the Loan Officers.

11.  As you have to sell the credit professionally, to show to the potential debtors that the financial institution is their best choice against the competition, it must also de sold to the debtor the idea that the payment delay can result in a limitation to enjoy future benefits and loans from the financial institution where the loan was made.

12.  It is the duty of any financial institution to give financial education to the debtors, to show them what their responsibilities and consequences are in a loan. Very few institutions do it. Debtors usually see themselves as the weakest link against the institutions, largely because they ignore where the money lent comes from in the financial intermediation equation. They assume that the money is a property of the institution itself and not from depositors, that give it in trust and/or creditors that lend it to the institution. Ask yourself: How many debtor read the loan contract?.

Many have asked me: Is it possible to mass sell the credit?, it is a marketing issue and the answer is yes, but not in the way that was been done and is being done today. The problem of mass credit lies in the saturation of branches, but if  the applicants are filtered using mass media (Call Center and/or Web sites), determining its presence in the Credit Bureaus and the net repayment capacity, this eliminates over 80% of applicants, because either they not qualify for being in the Credit Bureaus or are not interested in the maximum amount of credit that can receive based on their paying capacity and if all of them were been attended in offices, it would be a lost of time and money due to those that do not qualify. By filtering the applicants, it is easier to meet the 20% who qualify; either because these do not appear in the Credit Bureaus or have accepted a loan amount according to their paying capacity. Obviously, those who pass the filter must be sent to a Branch and will have to present all the documentation required to process the loan request as required by the financial institution.

José Linares Fontela

jlinaresf@gmail.com