4th Week Overcharging

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Microfinance under scrutiny

Overcharging

Microlending is under attack, unfairly

Nov 18th 2010

ANDHRA PRADESH (AP), on India’s eastern coast, has more people who have borrowed from microfinance institutions (MFIs) than any other state in India. It houses the headquarters of some of India’s fastest-growing for-profit MFIs. Of late, though, the state has seen a vicious political backlash against the microfinance industry that has made it virtually impossible for MFIs to operate. Sam Daley Harris, director of the Microcredit Summit Campaign, a non-profit group, reckons that microfinance in the state “is in the midst of a near-death experience.”

India is not the only country where microfinance is under scrutiny. On November 9th Bangladesh said it would cap the annual interest rate MFIs can charge at 27%. Critics in both countries accuse microlenders of pursuing growth without regard for their clients’ ability to absorb the credit they dole out. A survey of a representative sample of nearly 2,000 rural households in AP released on November 16th by the Centre for Microfinance (CMF), an Indian research institute, makes it possible to assess such claims. It suggests that fears of an epidemic of over-indebtedness due to excessive lending by MFIs are exaggerated.

The state may be India’s most developed microfinance market but it is hardly awash with microcredit. Whereas 82% of households have borrowed from informal sources, mainly village moneylenders and relatives or neighbours, only 11% have an MFI loan. On average, borrowers also owe over four times as much to informal lenders, which charge far higher rates, than they do to MFIs.

Nor have MFIs in the state faced rising defaults, as they should have if borrowers were really in over their heads. Some reckon that MFI clients are able to stay afloat only by borrowing from one microlender to repay another. But the CMF survey finds that a mere 3% of those who borrow from MFIs have more than one such loan; in contrast, 70% of people have at least two informal loans. People with several MFI loans also tend to take them out simultaneously, rather than staggering them, as they would if they intended to use one to pay instalments on another. Some probably take out several MFI loans for the good reason that they need a larger lump sum than any single small loan can provide.

Credit is not all that poor people need. There is also an enormous unmet demand for savings accounts. Reducing transaction costs enough to make it feasible to cater to very small savers is difficult. MFIs might be able to do this more cheaply than banks, because they have existing relationships with the kinds of people who would use such basic savings accounts. Yet MFIs are prohibited from taking deposits, or even from acting as local collection agents for commercial banks. Fewer restrictions on microlenders, not new ones, would be the best way of helping the poor.

Finance and Economics