The New Credit Paradigm or the Old Playbook?

Bangladesh’s Generation Z revolution, which began on July 1, unfolded dramatically and swept Prime Minister Shaikh Hasina out of office on August 5. Its parallel drama is a story of credit with two wildcard factors, one universal, one unique to Bangladesh.

The Songbook of the Credit Canaries

Credit crunches and protesting youth go together like love and marriage or death and taxes. The usual response of adults is to hear it as noise from the mouths of immature, ignorant, undisciplined children, rather than to perceive the feedback of unemployment, inflation, homelessness, bureaucracy, political alienation and corruption as early warning signals of a system of credit in decline.

Youth protest led to the changing of the guard in Bangladesh and was a factor in Sri Lanka. Aragalaya (2022), Tunisia Dignity Revolutionand The Arab Spring (2011)—countries where ordinary people found it hard to make ends meet because money to repay debts and buy inputs for their small businesses was so hard to come by.

This is creditworthiness in its most basic form.

Local Policy — Global Credit Truths

Observers have not always connected the dots between credit market problems and civil unrest in other places and times.

In the 1980s, China went through periods of prolonged liquidity and credit tightening, which finally ended in the 1990s, when policy shifted to building financial infrastructure to better circulate capital. While English-language coverage of the unrest in the late 1980s focused on political unrest, local newspapers in China, Hong Kong, and Taiwan wrote extensively about a parallel credit crunch. As economist Chu-yuan Cheng wrote, “Economic decline was a direct cause of the 1989 unrest.”

And in the US, the civil unrest of the mid-1960s coincided with credit market tensions from 1965 to 1970, which then-Fed Chairman McChesney Martin called “the wildest inflation since the Civil War.” Of course, credit was not the only driver of unrest—there were social upheavals and an unpopular war in Southeast Asia—but while the policy has been fully explored in public discourse, the underlying causes of credit remain relatively unexamined. Given what happened next in the history of US monetary policy, that history may be worth revisiting.

Leads to credit problems

Core economies are the real source of working capital on which domestic macroeconomies depend. A revolting economic underclass can create a macro-problem for governments, jeopardizing their ability to repay debts and buy critical inputs. The problem can become self-fulfilling if credit rating agencies get involved.

Compared to even large corporations, sovereigns have built-in credit privileges and a long rope. First, they don’t go out of business just because their rating is downgraded or because they default on their debt obligations. But their ability to govern and operate can become severely curtailed. Their reputation with private investors is affected. They may lose their people’s mandate to govern. The recent history of credit in North Africa, the Middle East and South Asia is instructive:

Sri Lanka’s sovereign ratings by Moody’s and Standard & Poor’s have been stable at single-B for many years. Not high, but stable. In the pandemic, the economy contracted sharply. In 2020, the ratings fell to Caa1/CCC+. The youth protests of 2022 catalyzed more widespread protests that crippled the economy. Sri Lanka’s ratings today are still at the bottom of the credit scale: Ca/SD (Selective Default).

The former head of Tunisia, Ben Ali, was a market reformist. Its sovereign rating was investment grade (Baa3/BBB) in the period 1995-2011. But beneath the economic surface lay a profound disconnect between high finance and the daily struggle at the grassroots. In the last days of 2010, a street vendor died by setting himself on fire to protest financial harassment by the municipal authorities. His death sparked protests in North Africa in a movement known as The Arab Spring. Prior to 2013, the autocratic leaders of Tunisia, Zine El Abidine Ben Ali, Libya, Muammar Gaddafi, Egypt, Hosni Mubarak, and Yemen, Ali Abdullah Saleh, had all been forced out of office or assassinated.

Tunisia’s sovereign rating fell below investment grade in 2013 to Ba2/BB. S&P immediately downgraded it to B, then withdrew it. Moody’s downgraded eight notches from Ba3 to now Caa2, telegraphing Moody’s view that default risk has at least doubled, from 33% to 65+%. Other countries’ sovereign ratings followed similar trajectories: Egypt’s rating went from double-B to Caa1/B-. Oil-exporting Libya and Bahrain entered 2010 with GI ratings (A-/A-), but since the Arab Spring, Bahrain has moved to single-B, while Libya and Yemen are unrated – and likely unrated .

This place and this time could be different. May be.

Bangladesh is at an inflection point. The conditions for establishing a more inclusive domestic credit paradigm have never been more favorable. In response to the students’ demands, Muhammad Yunus was appointed Chief Counsel and Acting Chief. He returned to Dhaka on August 8. This is a new story element: Bangladesh’s decision to see its “canaries” as stakeholders with voices.

Also new: Yunus’ genuine expertise in grassroots economic development. No other head of state – in either the developing or the developed world – can match his know-how or street cred as a grassroots financial innovator. His journey to founding the Grameen Bank began in the famine of 1975 when he made small loans to individuals. Methodically, he built the building blocks of Grameen Bank, the world’s first private microlender, which he founded in 1983 to provide unsecured working capital nano-loans to poor borrowers, especially women. He won the Nobel Peace Prize in 2006 for his efforts to make finance peaceful.

To cap his lifetime achievements by linking the grassroots economy to the national credit supply chain as head of government is the stuff of legend. It could also be a future funding model for all to study if it can be sustainable.

But a power struggle put Yunus in office. When Shaikh Hasina came to power in 2008, her nemesis against Yunus was on display. He was called the “bloodsucker” of the poor and in 2011 was forced out of Grameen. A 2013 law was passed to extricate Grameen from its involvement and bring it under strict central bank supervision. Since then, Yunus has been charged with more than 150 offenses – enough to keep the 84-year-old busy for the rest of his life. Methodically, he worked to get them fired. But political uncertainty is expected to continue.

From the orthodox sovereign credit perspective, Bangladesh faces two opposing scenarios. One is known: a return to the standard NIG sovereigns downward spiral gameplay. The other is outside the standard sovereign credit rating assessment register. In the short term, neither will raise its sovereign credit rating.

But if the paradigm of the financial system were changed to use domestic capital resources more efficiently by objectively recognizing the value of labor, improvements in productivity and financial flexibility would be quantifiable. Even without a sovereign rating upgrade, the results would show in the numbers.

What you don’t know about microfinance

Microfinance grew rapidly in the run-up to the global financial crisis, not entirely for legitimate or sustainable reasons. But, that story is for another time. Relevant here is the fact that the credit risk of micro-loans is often exaggerated.

Before the GFC my firm (dba R&R Consulting) was active in this area. Our clients have been multilateral development banks, microfinance rating agencies and what we now call ESG investors. R&R conducted the first (and probably last) true static pool analysis of microloan defaults and losses, funded by the Center for Social Finance Development and published in 2006. The analyst, Sylvain Raynes, had constructed the score credit of Citibank. system in the 1980s and early 2000s branded entire portfolios of bank loans in emerging markets.

Static pool loss analysis is the modern building block for capital market loan pricing and risk reserving. Based on a limited sample set, we observed default rates comparable to middle-class consumer loans – neither prime nor subprime, with losses around 5%.

That is correct. The only empirical static analysis of defaults in the world showed that microloan loss rates resembled US mass market auto loan collateral.

These findings are reinforced in quotes from an interview of Yunus moderated by me in 2022. At the time, he emphasized the need for access to credit as the oxygen of entrepreneurship. He also said, with characteristic humor, the stumbling block for credit justice is not that people are not creditworthy, but that banks are not worthy of people.

But as Yunus moved through Dhaka airport last week, he wrote a sober note about the challenges ahead: “Discipline! Hard work! Finish!”

The power and significance of credit discipline

A darker takeaway from our 2006 review was that microloans’ bad reputation is not entirely undeserved. Credit risk was much lower than expected, but non-credit risks were significant: Weather. Disease. Above all, the political risk. Wherever local government did not support micro-lending, loss rates were very high. Even 100%.

Since the GFC, data science has advanced to address the particular challenges of microcredit analysis and underwriting, combating data scarcity and intense granularity issues with machine learning and feedback for future underwriting. These methods could go a long way to scaling up and achieving risk transparency to make microloan pricing commercially fair for both parties. But political challenges remain. The built-in polarization between rich and poor is a way of life in many places. Changing this equation is a threat to the status quo privileges of power.