Microcredit Accounting Control Fraud Deepens Bosnia’s Nightmare

By William K. Black

I write to recommend reading David Roodman’s recent column in the Washington Post (“Microcredit doesn’t end poverty, despite all the hype”).

Microcredit has been the fair-haired child in economic development despite very weak evidence that it was successful in reducing (much less “end[ing]”) poverty.  It has been praised by liberals, conservatives, and feminists – an odd but strong coalition.  Roodman explains that providing credit to poor people does not necessarily increase growth and reduce poverty.  Roodman notes that providing large amounts of microcredit can produce bubbles.  He notes that Bosnia is one of the nations that have experienced this problem, but does not note the critical article on the Bosnian microfinance crisis and he fails to mention the five-letter “f” word – fraud.  Doing so would greatly strengthen his argument and demonstrate that badly designed microcredit can spur control fraud, bubbles, financial crises, recessions, and increased poverty.  Roodman was writing a brief, general article about microfinance.  A longer article about Bosnia’s microcredit nightmare is a good complement to his piece and I urge reading both articles in full.

The new evidence on Bosnian microcredit was presented at the annual meeting of economists this January in Chicago.  The authors are Milford Bateman, Dean Sinković and Marinko Škare and the title of their superb article is “Bosnia’s Microfinance Meltdown.” 

Bateman, Sinkovic, and Skare document Roodman’s worst fears.  Their first paragraph demonstrates that they share Roodman’s concerns about the microcredit “hype” but go even deeper in their analytical inquiry to show why microcredit became so perverse in Bosnia.

“In this paper we challenge the uplifting narrative governing microfinance outcomes in post-war Bosnia and Herzegovina (hereafter Bosnia), and by extension in other developing and transition countries. For more than thirty years, the concept of microfinance has been lauded for its supposedly amazing power to use self-help and tiny ‘business’ projects to eradicate poverty and promote ‘bottom-up’ economic and social development (De Soto, 1989; Yunus, 1989; Robinson, 2001). The initial post-war promise in Bosnia was for poverty alleviation to be quickly secured through large numbers of sustainable jobs in microenterprises, additional income generated in the community, empowered women, an accelerated accumulation of social capital and, eventually, growing numbers of conversions of informal microenterprises into more productive formal SMEs (World Bank, 1997). However, in none of these important areas do we find that the microfinance model has generated the outcomes claimed for it: on the contrary, we document a number of seriously deleterious trajectories associated with the microfinance model that have combined, in our view, to help propel the Bosnian economy into its current deep economic crisis. In sum, we argue that the microfinance model as it has emerged in Bosnia is essentially a modified subprime-style lending program that, like the original sub-prime lending disaster in the USA (Dymski, 2009), has increasingly prioritised the private enrichment goals of senior managers quite irrespective of the enormous damage being done to the fabric of the Bosnian economy and society. Overall, we find the Bosnian case to be another example of what William Black (2005) terms ‘control fraud’ – the legalised looting and ultimate destruction of a financial institution by its senior managers.”

The authors then explained three key points that Roodman does not note but likely agrees with.  Microcredit today is radically different than the original model, which involved governmental subsidies.  The neoliberal embrace of microcredit led to the dismissal of the original model and the embrace of neoliberal governance, particularly executive compensation systems that are exceptionally criminogenic.  Microfinance was embraced as a means of converting former Soviet bloc nations to entrepreneurial capitalism, and Bosnia was held out as the exemplar.

“To make doubly sure the microfinance model accorded with important neoliberal ‘full cost recovery’ principles, the large international donor and government subsidy component that underpinned most MFIs, especially the Grameen Bank, also had to be eradicated. MFIs were thereafter instructed to work towards ensuring their own financial self-sustainability through market based interest rates and the adoption of Wall Street-style private sector incentive structures and methodologies (Otero and Rhyne, 1994). The resulting ‘new wave’ commercialized microfinance model that emerged effectively became the only acceptable definition of microfinance (Robinson, 2001), and soon after the international development community’s highest-profile anti-poverty intervention.


Very early on the microfinance model was given special prominence in post-conflict countries and regions. Perhaps nowhere has the microfinance model been more exalted as a post-conflict reconstruction and development policy as in Bosnia….”

Bateman, Sinkovic, and Skare show that the proponents of microfinance declared that Bosnian microfinance produced exemplary results.

“A number of impact evaluations undertaken of the most important microfinance programme in Bosnia, notably of the World Bank-supported Local Initiatives Project (Dunn, 2005), claimed to find significant positive impacts. High-profile individuals soon began to claim major success, including the then President of Women’s World Banking, Nancy Barry, who strongly advised that, ‘Any war-torn country should look to Bosnia as a role model’….”

The reality was the opposite.  Bosnian microfinance was becoming a disaster.  The authors explain that a large portion of microfinance went to support consumption, not the creation or expansion of small businesses.  They also make a point that has been almost wholly ignored in development – the implications for poverty of the failure rate for small businesses financed by Bosnian microcredit.  Nearly 50% of the new businesses created failed within the year.  The authors point out that such a high failure rate must produce a severe loss of wealth to the entrepreneurs’ families.  The authors conclude that “many of the poor clients who have failed in their attempts to establish a microenterprise have been quietly plunged into deeper, and often irretrievable, poverty.”  Worse, the authors note that one of the most important reasons for the exceptionally high failure rate of new businesses is that private sector demand is inadequate to support the existing businesses.  When microfinance funds the creation of new businesses it tends to increase the failure rate of existing businesses.

Fraudulent CEOs of microcredit firms (MFIs) typically chose to create perverse financial incentives by their loan officers that guaranteed catastrophe.

“Even though ‘saturation’ was manifestly evident by mid-2005/6 (Bateman, 2006), even more rapid growth of MFIs was proclaimed as important in order to satisfy supposedly ‘unmet demand’ for microloans. Predictably, multiple borrowing soon became one of the most serious client problems in Bosnia: a major survey of MFI clients found that 58% of clients were holding more than one active credit contract, with more than 32% of clients holding three or more active credit contracts (Maurer and Pytkowska, 2011: 3).

Moreover, even though a functioning public credit bureau has existed in Bosnia since 2003, as well as a private credit bureau, very few MFIs were interested to pay for any potential client data from these institutions. When the overarching goal is to find as many clients as possible, and given that bonus payments were a large part of a loan officer’s monthly salary and these bonuses largely depended on bringing in new clients, there is little incentive to exercise such caution.

By 2008, the end was in sight, and there was a double digit increase in the number of non-performing microloans. By 2009 around 28% all MFI clients were described as ‘seriously indebted or over-indebted’, which further breaks down to 17% being in a situation where the monthly repayment now exceeds the total household disposable income, with the other 11% operating just under that threshold (ibid: 4). It is also the very poorest that are in serious debt, with the incomes of those over-indebted found to be more than half that of those not overindebted (ibid: 4).”

At this point we know that the pattern of lending makes no sense for an honest lender.  As the glut of loans increases the fraudulent CEO of the microfinance lenders raced to increase lending.  The CEOs put their loan officers on compensation systems that create perverse incentive to make vast numbers of bad loans.  Bosnia had a system of credit checks, but the CEOs controlling the fraudulent microfinance lenders did not want to document that they knew the loans they were making were bad loans.

Each of these perverse steps was consistent with the recipe for optimizing accounting control fraud.  The four ingredients are:

  1. Grow extremely rapidly by
  2. Making bad loans at a premium yield while
  3. Employing extreme leverage, and
  4. Providing only grossly inadequate reserves against the inevitable losses

George Akerlof and Paul Romer, in their famous 1993 article about accounting control fraud (“Looting: the Economic Underworld of Bankruptcy for Profit”) emphasized the proverbial bottom line by showing that this fraud scheme was a “sure thing.”  It was guaranteed to make the CEO wealthy and it did so quickly.  Bateman, Sinkovic, and Skare found that Bosnian microcredit exemplified this “sure thing.”

“The often stunning Wall Street-style salaries, bonuses, share options and other rewards that senior managers of MFIs deem they deserve have become one of the most grotesque features of the ‘socially-oriented’ microfinance industry, notably in India and Mexico. The rapidly growing number of ‘microfinance millionaires’ (Bateman, 2010) has resulted in a loss of respect for the microfinance model among the rich and poor alike. Similar anti-social dynamics have emerged in Bosnia. First, Bosnia’s statistical services have been reporting for some time that the senior managers working in the country’s microfinance industry are now routinely among the highest paid individuals in the country. Adverse media comment is rising fast, forcing most MFIs into undertaking more PR events and lobbying in order to maintain their popular and, more importantly, political support. But citizen and government disenchantment with the microfinance industry continues to rise. Mujković (2010: 6) reported that MFIs in Bosnia were increasingly seen to be “exploiters who are charging exorbitant interest rates on loans to poor populations”. Much of the remaining trust in the microfinance sector was then lost in 2011, moreover, when the Bosnian statistical service announced in one of its regular bulletins that the highest paid individual in Bosnia was the Director of an MFI (Mikrofin), an individual who in July 2010 received a taxable monthly income (salary plus bonus payment) of 220,249 KM (around $US150,000). In a country where the average monthly salary is around $US600, even long-time microfinance supporters were deeply embarrassed at this latest Wall Street-style turn of events. After long claiming that microfinance was all about ‘assisting Bosnia’s poor to escape their poverty’, and after very significant grant funding from the international development community actually

provided the initial capitalisation for virtually every MFI (Agencija za Bankarstvo Federacija BiH, 2011: 25), many ordinary Bosnian people now feel that they have effectively been abused by the microfinance industry, not assisted to better their lives.”

Bateman, Sinkovic, and Skare recognized that what they were finding was accounting control fraud.  Their explanation turned me into an adjective.

III. Bosnia is a clear case of Blackian ‘control fraud’Finally, we found in the model of ‘control fraud’ developed by William Black to explain the rise and fall of the US Savings and Loans Institutions (S&Ls) in the 1980s, a very useful explanatory framework with regard to the emerging structure, conduct and performance of Bosnia’s microfinance sector. First, Black’s model correctly predicted that senior managers in Bosnia’s MFIs would insist on an unsustainable growth strategy, but would nevertheless be able to convince all external parties (e.g., auditors, regulators, the media, the international development community) that it was a sound strategy.  Second, Black’s model correctly predicted the methods variously used by senior managers to privately enrich themselves, such as their attachment to inordinately high salaries, regular bonuses, awarding of share options, use of interest free loans, and so on. Third, Black’s model correctly predicted that senior managers would eventually begin to convert the MFI’s assets (original grant funding plus retained profits) into their own private assets, such as when senior managers take a private stake in one of the MFI’s new investment projects, often using favourable loans obtained from their own MFI to do it. Fourth, Black’s model correctly predicted that senior managers would exhibit a visceral hatred towards, and attempt to frustrate, all Bosnian government regulators and any others who might try to properly regulate or monitor the microfinance industry. Fifth, Black’s model correctly predicted that senior managers would seek the psychological rewards associated with being the most profitable MFI, as well as adulation from elite opinion makers, including regular appearances as invited ‘experts’ at high-profile international donor events.”

I add only one clarification.  Fraudulent CEOs convert firm assets to their personal benefit primarily through the perverse compensation systems that the authors rightly criticize.  The recipe produces the “sure thing” – high levels of fictional income – that produces extreme CEO compensation.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @WilliamKBlack

19 responses to “Microcredit Accounting Control Fraud Deepens Bosnia’s Nightmare

  1. Excellent article. I read Batemen’s book, “Why Microcredit Doesn’t Work”, for a paper I wrote on the subject a few years ago. I made an interesting discovery in the course of the research that this article reminded me of. Next to the more contemporary books on microcredit in my library – most of which document its failure – there is a collection of older, more optimistic volumes proclaiming its promise and virtue. Among this older group, there is a subset of books advocating microcredit as a panacea for the U.S. With bizarre titles like ‘a million little bootstraps’ or something along those lines, the books seem like eerie relics, in light of the financial crises. I couldn’t help but wonder if the logic of microcredit had something to do with the new financial engineering. That is, the bundling of loans in an attempt dilute default risk has a strange assonance with Yunus’ innovation, without the direct social pressure and open ‘shaming’ tactics of course. Jim Carrey’s terrible movie, “Yes Man”, makes this point in a strange way.

  2. This font body text choice is hard in the eyes, almost impossible to read in anything except ideal conditions. Why would anyone choose Helvetica Neue LIGHT for anything but a design site, or as a display type? This is not a font for reading.

  3. Pingback: Daily Round Up « Sarajevo Seyahatname

  4. This is not related to the article.

    I’m just testing to see if paragraph/line separation works in this new comments section.

  5. This is a direct result of the neo-liberal stranglehold on economic policies globally. The best way to provide real aid and development to the poor is by way of progressive taxation and government action to raise living standards across the board. When governments don’t do that, there are always thousands of usurers lining up to provide “aid” to the poor in the form of liars loans, like the ones described in this article. Of course, that is what “aid” and “help” in general has to come to mean now. It means “loan”, and usually a non-collateralized high interest loan.

    The loans being provided by MFI institutions are kind of like the Third World equivalent of credits cards and pay day loans in the U.S.

    Dean Baker once wrote an article rebutting the notion that the upside to banks handing out credit cards like candy on Halloween was that they helped people start there own small businesses. This is ridiculous, given that about 4 out of 5 small businesses fail within five years. So giving everybody with a hare-brained scheme to start a business with high interest credit cards has had a negative impact on the U.S. economy. Not only do you have a failed business, but a former owner who is stuck with dealing with a pile of high interest debt.

    So it shouldn’t be surprising that handing out non-collateralized mirco loans to everybody with a hare-brained scheme to start a business, or just get by, in Bosnia and other poor countries, most of them poorer than Bosnia, hasn’t worked out well. Well, they have worked out well for the executives running the MFI banks, of course. So nothing new being reported here.

  6. The dynamics of this fraud can easily happen with many development projects whether it is a micro loan or anything else. We have to stop and look at the root causes and then offer appropriate strategies that overcome the prevalence of control by elites and the “rules of the game” that exists almost every place where opportunities and perceived resources are very scarce.

    The “rules of the game” are usually a result of what the anthropologist, George Foster wrote about and generated considerable attention. He identified the root cause of a prevailing cultural dynamic as the “perceived limited good”. It’s a zero-sum game in a subsistence society where loosing anything is life threatening and if someone else gains it causes a direct loss to everyone else. To make a complex story short, that perception requires that everyone’s first moral responsibility is to protect the nuclear family. Other moral standards have not yet arrived on this scene.

    That perception controls the political and economic cultures all the way to the top.
    Since those in power perceive that their highest moral responsibility is to take care of their nuclear family, state institutions are merely an instrument to fulfill that responsibility. That’s an important source of top-down corruption—or at least, what we call corruption.

    One antidote to this culture is to make every effort to teach that economic expansion can offer more wealth and opportunity for everyone than if they play by the “rules of the game” as dictated by the perceived limited goods.

    Another antidote can be to revert to traditions of tribal rule of law where decisions and initiative are done by consensus with everyone gaining an equal share.

    In any case, whenever a change agent can help develop the assets held by the peasant class, the peasants will then gain more power to negotiate a mutually beneficial arrangement with the elites.

    It’s tough.

    Bob Spencer

  7. Who would have thought saddling the poor with even more debt wouldn’t end well in the long run…

  8. Actually for students (and even the general public) who are exposed to a lot of micro and very little macro it’s very easy to fall into the trap of ignoring aggregate demand as a relevant factor to consider. It seems so stupid now, but back when I was initially exposed to the idea of micro-loans I thought they were a great market initiative…

    • PatientObserver

      I think that this is a reasonable reflection of the inadequacies of modern economics education.

  9. peter van dijk

    Refusing to distinguish “Micro-enterprise Credit” from a tool that supports building an inclusive financial sector is like “throwing away the baby with the bathwater”. Socio-political Micro-Credit should be included under a nation’s social welfare policy and its performance and expenditure controlled as under national budget control. Micro-Finance has for centuries performed an extraordinary role in countries that successfully built inclusive societies upon inclusive broad, sustained economies (with high minimum working conditions and pacts between labor and wealth, and based on transparent budget control). Refusing to make the distinction and refusing to use terms correctly and consistently is expressing a wish for continuing unstable, violent plutocratic states. More than ever wealthy socio-democratic nations need to help partners build inclusive truly democratic states and “smart subsidies” to both financial sector development and building efficient social welfare states can be a good strategy.

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  11. Bill, thank you very much for recommending my Washington Post piece. Coming from you, that means a lot.

    However, I have a fundamental question about this post. You assert that control fraud occurred in Bosnia. Fraud, as I understand it, is by definition illegal. Yet, contrary to your phrase, “new evidence on Bosnian microcredit” there is essentially no evidence of fraud in either this post or the paper cited. In the paper cited, we learn that the head of one of the microcreditors earned a 6-figure salary, which I agree is obscene—but is also disclosed in financial statements and does not constitute fraud. We also learn that the lenders kept making loans until the bubble popped. But that is axiomatic. We are asked to infer that the lenders knew that their last loans before the popping would go bad. Might be: but there’s no evidence of that, and it hardly goes without saying.

    I think your notion of control fraud is powerful and important. It may well even apply to Bosnian microfinance. But I’d say don’t cheapen your currency by endorsing the facile application of your weighty label. Let us not cry “murder” just because someone died.


  12. milford bateman

    I think the facile, if not idiotic, statement here is by David. In your posting you first praise Bill Black’s control fraud concept as ‘powerful and important’ but seem absolutely sure that our application of it to Bosnia is an utter damnation. Yet you just admitted an hour ago on your own microfinance book blog to not having read his book, and it was immediately clear that you didn’t actually know what the concept of ‘control fraud’ is! Oops. Seems you are so determined to attack anyone critical of microfinance, especially me, that you don’t even need to have an understanding of the ideas being applied before you egregiously attack those who apply them.


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