Recession-Resistant Microfinance

Storm clouds are gathering in Eastern Europe.  Ukraine, Hungary, and Iceland share the news headlines as the wold’s foremost victims of the global financial crisis.   Political infighting and tensions with Russia, along with a severely declining steel industry have deepened the effects across Ukraine.   There is a silver lining, but more on that later.    

In the western world, “political tensions” essentially mean that 24-hour cable networks switch to all politics, all the time.  In Ukraine, due to “political tensions” between local officials, last week many districts of the capital city of Kiev lost heat and hot water.  These are government-controlled commodities – the local goverment can literally shut off your apartment building’s gas heating at a whim.  In sub-zero temperatures and bitter continental winter conditions, losing heat for a week is a hardship to pale at.  People couldn’t even wash dishes, because the water was literally freezing out of the tap.  Even now, three days after the heat was turned back on by these same officials, radiators are merely lukewarm, homes are still freezing, and people are sick with colds and flu.

In addition, the value of the UAH (or “grivna”) has fallen from 5.05gr to $1 on October 1 to 9.45 to $1 on December 17 – a loss of nearly 50% of its value in two and a half months.  This has a direct impact on many citizens, since half of all bank loans and most rents are denominated in either dollars or euro, but most people get paid in grivnas.  Imagine that your rent was 2,525 grivnas ($500) per month on October 1.  At current exchange rates, your rent due on January 1 is now 4,725 grivnas.

Banks are feeling the crunch most keenly, since most of their own debts are denominated in foreign currency as well.  Informal reports from Kiev state that it is nearly impossible for individuals or businesses to get dollars out of ATMs or money changers – banks are holding on to all foreign currency reserves and refusing to sell them.  One source attempted to find USD from over 20 different ATMs and exchange kiosks, with no luck.  

Add to the mix the near-collapse of Prominvest Bank, one of the largest in Ukraine, earlier this fall.  To prevent a bank run, they froze all depositor accounts until at least January.  People and companies can see their money sitting in their account, but cannot withdraw it, and cannot use the bank to transfer funds or make payments.  As of December 16 a Russian bank has been in negotiations to buy the troubled bank.  Many Ukrainians view this nervously as Russian attempt at economic, rather than military, takeover of their country.  Ukraine is in a vulnerable position, as its GDP is expected to decline by up to 10% in 2009.  Consider that the predicted 3.4% decline in the US is considered a deep recession, while a generally accepted definition of a “depression” is a GDP decline of more than 10%.

This is particularly hard on financial institutions – like Kiva’s field partners.  

Kiva’s business model is more complex than it appears at first glance.  When a lender sends $25 through Kiva to an entrepreneur, that money is received and disbursed by our field partner in that country – in this case, HOPE Ukraine.  The field partner is a microfinance bank which is authorized as a financial institution in that country.  They do the leg-work of finding clients, performing due diligence to ensure the borrower is solvent, writing profiles, and handling the transactions between Kiva’s lending community and the local entrepreneur.  Critically, they also handle foreign exchange risk.  

When Kiva sends $300 to an entrepreneur, it’s exactly that: $300.  So we’re expecting that same $300 back, regardless of the value of the local currency.  Imagine that HOPE Ukraine had raised $300 on Kiva on October 17 for an entrepreneur named Tanya.  They would have converted it into grivnas at 5.05, and given Tanya 1,515 grivnas on a 10-month term.  Her principle payments are 152 grivnas, which is what she gives to HOPE Ukraine each month, and HOPE Ukraine promises to convert it and send it back as $30.  However, when HOPE Ukraine converted Tanya’s monthly payment back into dollars on December 17, that 152 grivnas is no longer worth $30 – now it’s worth only $16.  HOPE Ukraine must then pay $14 out of its own pocket in order to send Kiva lenders a $30 repayment.

That sounds pretty grim for HOPE Ukraine, doesn’t it?  But we promised you a silver lining, and here it is:

Due to the crisis, none of the big traditional banks will give out loans anymore, so everyone is coming to HOPE Ukraine.  They have as much business as they can handle, and more.  And because the grivna is worth less, they can lend out in higher amounts.  Since Kiva has a $1200 per entrepreneur loan cap, back in October no Kiva clients could borrow more than 6,060 grivnas.  Today that $1200 loan cap is worth 11,340 grivnas – so they can service clients who have a greater range of financial need.  And they can use the extra income they’re generating on all these new loans to pay that $14 on Tanya’s loan.    

Microfinance institutions in these circumstances begin to seem, if not recession-proof, at least recession resistant.  Even as the value of their loan portfolio declines on international markets, the volume of loans they service can increase, because traditional banks tighten their lending habits.  This is particularly true for loan-only microfinance banks like HOPE Ukraine.  Because they don’t take deposits, only give out loans, they did not have money sitting idly in their coffers to be used for foreign investments.  They stayed out of the mortgage-backed securities and the short selling, and were thus insulated from many of the shocks that traditional financial institutions suffered.    

Conditions on the ground, particularly for the poor, are still harsh and uncertain.  Unemployment is skyrocketing, inflation is at 25% and rising, and the government is deadlocked in political infighting.  Tanya, and everyone else in Ukraine, may or may not have hot water, or a job, or a savings account tomorrow.   But despite the gloom and instability, and in some cases because of it, Kiva’s field partners are standing strong.  


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