Corruption threatens to disrupt microcredit business

Senior managers at Smile Microcredit Bank and its welfare business operator are known to be undergoing a criminal probe for alleged bribe-taking and embezzlement.

Analysts say the scandal resulted from institutional loopholes in the process of selecting welfare business operators to whom the bank entrusts lending resources, as well as the lending process for the operators.

This means the microcredit bank, which pledged to provide “smiles” to the working class, has instead caused frowns through major loopholes.

If prosecutors find circumstantial evidence that corruption in the bank was rampant, the Lee Myung-bak administration’s signature policy for helping the working class could suffer a setback.

Microcredit comprises four main parties: welfare business operators, regional foundations, a bank foundation and a corporate foundation. Prosecutors are focusing on the welfare business operator that borrows money from Smile and lends to the working class in need of funds.

A senior Smile manager is known to have lent 3.5 billion won (3.1 million U.S. dollars) to a welfare business agency in return for 100 million won (89,000 dollars) in January last year from the agency head, who also leads an organization under the political group New Right.

Smile allocates funds to welfare business operators chosen based on certain criteria and lets them use the funds as resources for lending. Under the rules, it is difficult for a welfare business operator to secure loans for lending from the microcredit bank.

Welfare business operators, including Social Solidarity Bank and Joyful Union that applied to enter the microcredit business, must have a redemption ratio of 90-95 percent for loans to the working class and deposit 2 percent of their financial assistance to Smile as potential loan loss reserves. Smile thus imposed strict conditions to minimize underperforming loans.

Park Sang-geum, the president of Social Solidarity Bank, said, “We recently applied for funds due to the easing of loan redemption requirements, but couldn`t receive funds due to a relatively low ratio of loan redemption.”

Management and oversight designed to check the ethical standards of the welfare business and ensure transparency in operation of funds were also completely lacking.

A financial regulatory source said “Due to lack of personnel, we cannot afford to oversee fund situations after funding sources are lent to welfare business operators.”

On the eligibility of welfare business operators, critics cite the selection as welfare business operators of pro-government groups that lack experience in credit loans in the 2009 parliamentary inspection of the government.

Corruption in lending by microcredit is not easily caught because lending is secretively made between operators and loan applicants. Even when the Board of Audit and Inspection audited Smile Microcredit Bank early last year, nothing was mentioned about corruption in loans.

The government watchdog merely gave advice on matters needing regulatory improvement, including difficulty in the selection of operators and lack of a cooperative system with a welfare business operator.

Another reason for the fiasco is that when the watchdog mentioned insufficient implementation of funds from dormant deposits despite the existence of such structural defects, Smile greatly sped up lending to the working class.

The number of monthly loans before July last year, or the early days of Smile’s operation, was around 200 cases but surged to up to 1,100 cases after the audit.

A source at a financial institution that donated dormant deposits said, “To increase records of loans to working-class people, the bank hurriedly selected welfare business operators and negligently conducted post-management of loans to a certain extent.”

Smile has won wide positive responses from the working class with 36,445 borrowers receiving a combined 227.2 billion won (201 million dollars) through late September this year. Experts say, however, that if the microcredit bank’s operations are halted due to a corruption scandal, many innocent people could suffer.

The Financial Services Commission said, “The prosecutorial investigation should not lead to the contraction of the microcredit business itself, which has taken off as a lending system for the working class.”

The commission and the Financial Supervisory Service will survey the overall situation of Smile’s operations, including the selection of welfare business operators and process of fund provision, from early next week.

tnf@donga.com legman@donga.com