Micro-credit: Finance for the Age of Diminished Expectations

Mritiunjoy Mohanty

IIM Calcutta

IEIM, UQAM

Micro-credit and the nature of risk

• micro-credit makes two important contributions to development practice

• first,to demonstrate that credit-worthiness and collateral do not go hand in hand

• it is possible to de-link the two • use a collectivist ethos ethos and group solidarity (and

implicit joint-liability) to minimise default due endogenous risk arising from adverse selection and moral hazard and to maximise repayment rates

• Collateral however covers both exogenous risk and endogenous risk. Collective monitoring unable to cover exogenous risk

• A report in 2002 by CARD, a microfinance organisation in the Philippines, offers the following explanation for borrower attrition:

• “It is a tragic fact that over time, husbands will fall sick, sari-sari [variety] stores will be robbed, harvests will be poor and children will die.” [Economist, Survey of Micro Finance, 04.11.05]

The micro-credit model

• the model is fairly straightforward and simple• focus on jump-starting self-employment, providing the

capital for poor women to use their innate "survival skills" to pull themselves out of poverty

• lend to women in small groups (credit circles), say of five or seven

• make loans of small amounts to two out of five• draw up a weekly or bi-weekly repayment schedule• the three who have not received loans will be eligible

only when this first round of loans has been repaid• in case any member defaults the entire circle is denied

access to credit

Women, agency and micro-credit

• The focus on women has both lauded and cricitised• In 1998 in a paper in World Development, Anne Marie

Goetz and Rina Sen Gupta found that while women were getting the loans, a "significant portion" of those loans are directly invested by male relatives (although women bear the liability for repayment)

• only 37% of the cases had women retained full or significant control over the businesses that were in their names.

• 22% of those they surveyed didn't know how their husbands, sons, fathers or brothers had used the loan and had not even been involved in "their" enterprises.

• But Govind Kelkar, Dev Nathan and Rownok Jehan writing in the Economic and Political Weekly (2004)

• “There is an enhancement of women’s agency – women as income earners, asset owners, more mobile, dealing with outsiders, taking up trade, going to the market, and so on. All these changes enhance women’s agency in daily life, give them greater voice in deciding household affairs. At the same time there is also the agency involved in bringing about these changes and in articulating new norms or systems of culture, more in consonance with, though not mechanically reflecting, these changes in roles.”

• it has not led to a situation where women with access to micro-credit programmes feel empowered enough to take control of their lives. That would simply be untrue.

• in a world where institutional structures tend to perpetuate inequalities of caste, class and gender and as a result women are invariably left holding the short end of the stick, even this small step is not be dismissed or sniffed at.

Repayment and coercion

• The issue of coercion in maintaining repayment schedules is very significant

• In the 1990s Grameen faced a series of crises where weekly borrower meetings were boycotted, loan repayments were stopped etc.

• Particular low point when during the disastrous 1998 floods, Grameen staff tried to force people who were not in a position to repay old loans to take on new ones

• WSJ article by in November 2001 by Daniel Pearl and Michael Phillips accusing Grameen of creative accounting

• Reports of coercive repayments tactics leading to suicides buttressed by studies that find grameen staff overbearing and coercive or what a study calls “disempowerment of clientele”

• Grameen reforms to become more client oriented with focus on client dignity and flexible repayment schedules, but re-payment tensions have not eased.

• Repayment tensions in other microfinance programmes as well. In India in 2006 in the state of Andhra Pradesh, media reports linked to 60 suicide deaths to repayment issues in grameen type programmes. The same reports also documented techniques forcing credit circle members to stand in the sun until recalcitrant members paid up, verbal abuse etc

• Outside of media reports studies have established serious client dissatisfaction due to ‘zero-tolerance’ policies towards default

Why micro-credit

• despite the above, given that formal credit channels tend to be lumpy and overly conservative in their risk assessment procedures

• it is possible to argue that provision of micro-credit may be a useful complement to overall strategies employment generation and poverty alleviation

• helping improve the stability of consumption levels and income flows of poor households.

Not a strategy for poverty alleviation

• it is not a strategy for poverty alleviation and growth. • When it comes to sustained growth, income generation and poverty

alleviation, what is its main strength – small loans made available for relatively short periods of time with tight repayment cycles – becomes its main weakness.

• And micro-credit is simply far too small and far too narrow (in terms of the risks that it seeks to mitigate) to aid in any significant manner in that process.

• As Vijay Mahajan of BASIX, one of the pioneers of India’s micro-credit movement has noted, “microcredit pales into insignificance as a “solution” for poverty alleviation and promotion of livelihoods”

• and wants a strategy that targets what he calls “livelihood finance” that will aid this process of asset accumulation, in which provision of financial services broadly defined (including insurance) forms an integral part.

Micro-credit interest rates• it is not as if it is strategy that comes cheap either • the rates of interest (both in nominal and effective terms - in

Bangladesh in 2004 these were 15 and 30% respectively and India the nominal interest is around 24%) charged on micro-credit loans are very high.

• whereas there might a monopolistic element in these high rates of interest, there are also structural reasons why they tend to be high.

• nne of the reasons for high repayment rates is close supervision of loan portfolios and supervision being expensive, transactions costs of micro-credit lending are high, leading to structurally high interest rates.

• one large private Indian Bank, ICICI, that has forayed into micro-credit in a big way reports that the cost of servicing a $1.5 million micro-credit loan portfolio is 40% higher than making the same size loan to a corporate client

Money-lending and micro-credit• one of the reasons why money lending has continued to thrive

alongside successful micro-credit operations. • in situations where formal credit mechanisms are absent or lacking,

given the limits micro-credit programmes impose on individual loan amounts, sometimes their (micro-credit operations) very success increases the demand for loans from money lenders!

• money lending and micro-credit programmes have some attributes that are similar. For example, even though money lending is traditionally linked with collateralised lending, they also lend money to those who lack collateral and therefore operate in the same market space as micro-credit – lending to borrowers banks would consider high-risk.

• therefore it is reasonable to expect that successful micro-credit operations leading to a decline in the importance of money lending.

Why the hype?

• Then why the hype?• what makes microfinance such an appealing idea it relies

on the market and that it offers “hope to many poor people of improving their own situations through their own efforts,” says Stanley Fischer, former chief economist of the World Bank and now governor of the Bank of Israel.

• that marks it out from other anti-poverty policies, such as international aid and debt forgiveness, which are essentially top-down rather than bottom-up and have a decidedly mixed record.

• Self-employment rather than waged employment• Moves attention away from structural reasons for poverty

because access to credit solves everything

Global Poverty Ratios

05

1015202530354045

1981 1984 1987 1990 1993 1996 1999 2001

Global Poverty Ratio

Global excludingChina

Poverty Ratios: Sub Saharan Africa & India

0

10

20

30

40

50

60

1981 1984 1987 1990 1993 1996 1999 2001

Sub-Saharan Africa

India

Global $2 Poverty Ratios

0

10

20

30

40

50

60

70

80

1981 1984 1987 1990 1993 1996 1999 2001

Global $2 PovertyRatio

Global $2 excludingChina

Total Number of Poor

0

200

400

600

800

1000

1200

1400

1600

1981 1984 1987 1990 1993 1996 1999 2001

Total

Poor excluding China and India

430440450460470480490500510520530

1981 1984 1987 1990 1993 1996 1999 2001

Rest

Sub-Saharan Africa and the Rest

0

50

100

150

200

250

300

350

1981 1984 1987 1990 1993 1996 1999 2001

Sub-Saharan Africa

Rest

• NYT columnist wrote that better that Walmart provide jobs rather than Microfinace provide self-employment

• Grameen Pakistan wrote to say we need both.

• Krugman:

• “We live in an ‘age of diminished expectations’ an era in which our economy has not delivered very much but in which there is very little political demand that it do better.”

• Age of Diminished Expectations, 1994, pxi,

Exogenous risk and subsidies

• It is worth recalling that subsidising market interest rates and thereby socialisng exogenous risk is socially productive because it calls forth more investment.

• It has been practiced by many economies including USA in housing mortgage.

• Is a much better alternative micro-credit because of potentially better asset and employment pay-offs