The Gen Z revolution in Bangladesh that began July 1 unfolded dramatically and routed Prime Minister Shaikh Hasina from office August 5. Its parallel drama is a credit story with two wildcard factors, one universal, one unique to Bangladesh.
Songbook Of The Credit Canaries
Credit distress and protesting youth go together, like love and marriage or death and taxes. The typical adult response is to hear it as noise from the mouths of immature, ignorant, undisciplined babes, rather than perceive feedback about unemployment, inflation, homelessness, red tape, political alienation and corruption as early warning signals of a credit system going down.
Youth protest drove Bangladesh’s change of guard, and it was a factor in Sri Lanka’s Aragalaya (2022), Tunisia’s Dignity Revolution, and Arab Spring (2011)—countries where ordinary people found it difficult to make ends meet because the money to repay debts and buy inputs for their tiny businesses was so hard to come by.
This is credit capacity in its most elemental form.
Local Politics—Global Credit Truths
Observers have not always connected the dots between credit market woes and civil unrest in other places and times.
In the 1980s, China experienced periods of protracted liquidity and credit tightening that finally let up in the 1990s when policy shifted towards building the financial infrastructure to better circulate capital. Whereas English language coverage of unrest in the late 1980s focused on political turmoil, local newspapers in China, Hong Kong and Taiwan wrote extensively about a parallel credit contraction. As economist Chu-yuan Cheng wrote, “Economic decline was a direct cause of the 1989 unrest.”
And in the U.S., mid-1960s civil unrest coincided with credit market stresses in the period 1965 – 1970, which then-Fed Chairman, McChesney Martin, termed “the wildest inflation since the Civil War.“ Credit certainly was not the sole driver of unrest—there were social upheavals and an unpopular war in Southeast Asia—but whereas the politics were fully explored in public discourse, the underlying credit causes remain relatively unexamined. Given what happened next in U.S. monetary policy history, that history may be worth reexamining.
Pipelines Of Credit Woes
Grassroots economies are the real source of labor capital that domestic macro-economies depend on. An economic underclass in revolt can create a macro-problem for governments, jeopardizing their capacity to repay debts and purchase critical inputs. The problem can become self-fulfilling if credit rating agencies get involved.
Compared to even to large corporations, sovereigns have built-in credit privileges and a long rope. For one thing, they don’t go out of business just because their rating is serially downgraded or they default on debt obligations. But their capacity to govern and operate can become severely constrained. Their reputations with private investors are damaged. They may lose their people’s mandate to govern. Recent credit history in North Africa, the Middle East and South Asia is instructive:
Sri Lanka’s sovereign ratings by Moody’s and Standard & Poor were for many years stable at single-B. Not high, but stable. In the pandemic, the economy sharply contracted. In 2020, ratings slipped to Caa1/CCC+. Youth protests in 2022 catalyzed more widespread protests that paralyzed the economy. Sri Lanka’s ratings today are still at the bottom of the credit scale: Ca/SD (Selective Default).
Tunisia’s former head, Ben Ali, was a market reformist. Its sovereign rating was investment grade (Baa3/BBB) from 1995-2011. But below the economic surface lay a deep disconnect between high finance and the daily grassroots struggle. In the last days of 2010, a street vendor died setting himself on the fire to protest financial harassment by municipal authorities. His death ignited protests across North Africa in a movement known as Arab Spring. Before 2013, autocratic leaders of Tunisia, Zine El Abidine Ben Ali, Libya, Muammar Gaddafi, Egypt, Hosni Mubarak and Yemen, Ali Abdullah Saleh, forced out of office or killed.
Tunisia’s sovereign rating dipped below investment grade in 2013, to Ba2/BB. S&P immediately lowered it to B, then withdrew it. Moody’s dropped it eight notches, from Ba3 to currently Caa2—telegraphing Moody’s view that the default risk had at least doubled, from 33% to 65+%. Sovereign ratings of other countries followed similar trajectories: Egypt’s rating went from double-B to Caa1/B-. Oil-exporting Libya and Bahrain entered 2010 with IG ratings (A-/A-) but since Arab Spring, Bahrain has tread water at single-B while Libya and Yemen are unrated—and presumably unratable.
This Place And This Time Could Be Different. Maybe.
Bangladesh is at an inflection point. The conditions for establishing a more inclusive domestic credit paradigm have never been more favorable. In response to student demands, Muhammad Yunus was appointed Chief Adviser and interim head. He returned to Dhaka on August 8. That’s a new story element: Bangladesh’s decision to view its “canaries” as stakeholders with voices.
Also new: Yunus’s authentic expertise in grassroots economic development. No other head of state—not in the developing nor the developed worlds—can match his know-how or street cred as a grassroots finance innovator. He his journey to founding Grameen Bank began in the famine of 1975, when he made tiny loans to individuals. Methodically he built the building blocks for Grameen Bank, the world’s first private micro-lender, which he established in 1983 to offer unsecured working capital nano-loans to impoverished borrowers, especially women. He won the Nobel Peace prize in 2006 for his efforts to make finance peaceful.
To cap his lifetime achievement by linking the grassroots economy with the national supply chain of credit as the head of government is the stuff of legends. It could be also be a future model of finance for all to study, if it can be made sustainable.
But a power struggle put Yunus in office. When Shaikh Hasina came to rule in 2008, her enmity against Yunus came into full view. He was called “bloodsucker” of the poor and in 2011 forced out of Grameen. A 2013 law was passed to wrest Grameen from his involvement and bring it under close central bank supervision. Yunus had since been charged with over 150 violations of law—enough to occupy the 84-year-old for the rest of his life. Methodically, he had been working to have them dismissed. But the political uncertainty is expected to continue.
From the orthodox sovereign credit perspective, Bangladesh faces two opposite scenarios. One is known: a return to the standard playbook of downward spiraling NIG sovereigns. The other is outside the standard playbook of sovereign credit rating assessment. In the short-run, neither is going to lift its sovereign credit rating.
But if the financial system paradigm were tweaked to utilize domestic capital resources more efficiently by recognizing labor value objectively, the improvements to productivity and financial flexibility would be quantifiable. Even without a sovereign rating upgrade, the results would show through 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 reasons legitimate or sustainable. But, that story is for another time. Relevant here is that the credit risk of micro-loans is often exaggerated.
Before the GFC, my firm (dba R&R Consulting) was active in this field. Our clients were multilateral development banks, micro-finance rating agencies, and what today we call ESG investors. R&R carried out the first (and probably last) true static pool analysis of defaults and losses on micro-loan pools, funded by The Center for The Development of Social Finance and published in 2006. The analyst, Sylvain Raynes, had built Citibank’s credit scoring system in the 1980s and in the early 2000s credit-scored entire portfolios of emerging market bank loans.
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 pool default rates comparable to loans to middle class consumer risk—neither prime nor subprime, with losses around 5%.
That’s right. The world’s only empirical static pool loss analysis showed that micro-loan loss rates resembled U.S. 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 highlighted the necessity of access to credit as the oxygen of entrepreneurship. He also said, with characteristic humor, the stumbling block to credit justice is not that people are not creditworthy but that banks are not people-worthy.
But as Yunus moved through the Dhaka airport last week, he struck a sober note on the challenges ahead: “Discipline! Hard work! Get it done!”
The Power And Meaning Of Credit Discipline
A darker conclusion of our 2006 analysis was that the bad reputation of micro-loans is not wholly undeserved. Credit risk was much lower than expected, but non-credit risks were material: Weather. Illness. Above all, 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 be able to handle the special challenges of micro-credit analysis and underwriting by countering the data scarcity and intense granularity issues with machine learning and feedback to future underwriting. These methods could go a long way to scale and achieve the risk transparency to make micro-loan pricing commercially fair to both sides. But the political challenges remain. The embedded polarization between rich and poor is a way of life in many places. Changing that equation is threat to the status quo privileges of power.
