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Tackling the Credit business in Iraq and Afghanistan

By Prof. Brett King

20 November, 2008

One of the obvious challenges in (re)building the banking and economic systems in Iraq and Afghanistan is the provision of loans, lines of credit and general opportunities for funding grass root activity for small businesses and consumers. Essential to the success of stimulating economic activity will be the commitment of banks, supported by the IMF and others, to small and medium size businesses that are the cornerstone of commerce in these socio-centric communities.

While big business like Oil has the potential to bring in the big bucks in the Middle-East, the reality is that this generally has little impact on the man on the street, except for flow-on commerce. Even then, it is debatable that any significant revenues will actually get back to the community as wages or social improvement, simply due to the fact that the governments challenges in building core infrastructure will remain for many years, absorbing any ‘spare’ cash left over after the multinationals have taken their share.

Let’s propose for a moment that the banks in these resurgent Middle-Eastern population centers are committed to encouraging SME growth, and microfinance initiatives for community and family businesses. Indeed, let us suggest that such is essential for any growth in the corporate banking sector over the next few years, and for local economies themselves. The issue then arises as to how banks can control credit risk in environments that will remain unstable for some time to come..

AAFM was approached recently to conduct banking training in Iraq and Afghanistan in respect to credit risk and loan approvals. We realized, however, that the conventional loan approvals process was simply not a realistic fit (reference: Larr, Peter ; Riebe, Strischek, Dev ; Cross, Rob et Al - Journal of Lending & Credit Risk Management). The issues in relation to traditional loan approvals and credit assessment methods are significant, including:

i)    No proof of income
ii)    No taxation statements, annual reports or other formal documentation
iii)    No proof of address
iv)    No or inadequate identification documents
v)    No credit agencies
vi)    No credit history
vii)    Little in the way of security
viii)    Basically the worst nightmare for a credit officer trying to get an approval past a Citibank or HSBC compliance checklist.

Ok, so how do we mitigate credit risk? Do we just accept huge NPL losses downstream, or is there a middle-ground? Actually the better question probably is, in terms of developing the market, are the risks associated with these loans, sufficient to warrant such touch compliance and credit risk rules that we traditionally see in the west, or do banks need to adjust their thinking for these markets?

Risk is, of course, relative. Beyond credit risk, the other elements of risk in these emerging markets appear far more critical and less manageable than straightforward credit issues. But what about case studies in such markets, are there any precedents…

Some Microfinance initiatives have actually proven the opposite. Subsistence and staple crop farmers in parts of southern India entered into microfinance deals with Bank of India and other state and national collectives. This experience showed that there was less than 2% default rates on these microfinance loans.

Professor Muhammad Yunus Nobel Lauriat and Founder of Grameen Bank drew great praise for leading the charge in microfinance opportunities in Bangladesh. The majority of those taking up these microfinance opportunities were actually women and families. The experience in Bangladesh, just as in India, showed that NPLs and Defaults were in the minority, and positively these microfinance loans went straight into the community where they could do significant good.

Granted isolated case studies from Indian farmers and Bangladeshi mothers, might not be enough to convince your average banker of the acceptable risks in lending to the great under-banked poorer communities in the sub-continent or in post-war Iraq and Afghanistan. So, how can banks mitigate the risks in micro-credit that we appear to face?

The answer actually may appear as a solution based on Shariah compliance. The principal of lending in Shariah, is centred around ownership of an asset and essentially passing ownership of that asset back to the lender over time, a concept that could be linked to what we used to call a lay-away or lay-buy scheme in the old retail days before credit cards were so easy to come by.

Banks need to learn to assess the value of the asset that is being purchased or invested in, and how this could be leveraged by the lender for greater income or profit opportunities. By learning to assess the purpose of the loan in a simple, straight-forward manner, lenders will be able to sufficiently diversify their loan portfolios and reduce some of the risks.

In the end, lending will come down to, how you are going to use the funds, not KYC or tough compliance requirements that are untenable and mean little in the post-war societies of Iraq and Afghanistan. In this way, bankers will need to become more socially and more commercially aware, than remaining ignorant of how the cash is eventually used by the lender. In fact, this might even be a model that could bring some relief to the compliance workload in the west, and result in better, deeper customer relationships, where bankers actually try to understand the client business, rather than categorize your credit profile based on demographics that have little emotion to them.

About the Authors

Brett King is the Foundation Director of the American Academy of Financial Management Ltd FZL a global professional organization dedicated to improving the skills and careers of financial and management professionals everywhere. Now known as the International Academy of Business and Financial Management (IABFM) the organisation is the most successful professional organisation of its kind in the world