Micro Finance Institutions(MFI) - A boon for the poor?
Saturday, September 18, 2021
OKAY. FINE. I know you have been refreshing your mailbox since morning. Be honest, were you under the impression that I have forgotten to write today’s edition? Hahaahahah, I got you!!!
In my defence, I had finished writing the edition last night, but seems like I forgot to hit SEND!:(
In the last edition of The Passion Pad, we saw how banks are unwilling to touch the poor and the advantage of this void is taken by moneylenders and traders who charge outrageously high interest rates. This lead to the emergence of a new institution known as MFI. Your brain must be boiling with a lot of questions. Why are banks unwilling to touch the poor? What does Micro Finance Institutions offer that moneylender and traders do not?
Banks usually ask for some collateral before lending money. If the borrower defaults on the loan, the lender may seize the collateral in order to get the money back. But this does not justify the high rates of interest that poor pay or why banks only lend to the rich. There is some more information that a lender wants to know about the borrower. Some are things that the lender wants to find out before lending the money, whether the borrower is trustworthy or perfidy. They might also want to keep an eye on the borrower , just to make sure that the money is being used as promised. This verification costs time and time is money. This infact leads to a term which economists call as the multiplier effect. The more the loaned amount is, more likely borrower would try not to repay it. Hence the lender needs to be more vigilant if the loaned amount is big, thus driving up the interest rates. Therefore, a poor is more likely to borrow from someone he/she already know - a neighbour, relative or a friend. If we look from the perspective of the bank, how would they recover a loan if the borrower refuses to pay back? A branch of Citi Bank got into serious trouble when it was revealed that the bank branch is using ‘Gundas’ to recover the default amount. Another statistics reveal that more than 40% of the defaulter cases are still pending in courts. Moreover governments love to write off loans during the election season making the matter worse. Even if the government doesn’t waive off the loan, banks do not want to be associated with ‘farmer suicides’. All this leads to bank lending only to the rich and explains their unwillingness to touch the poor.
How does Micro Finance Institutions help?
Like moneylenders, MFIs keep a close check on their customers, but they do so in part by involving other borrowers who happen to know the customer. MFI typically lends money to a group of people who are liable for each other’s loans and hence have a reason to try to make sure that others repay. There is a subtle difference between the way moneylenders and MFIs operate. Someone who borrows from a moneylender has the choice whether to repay the entire amount as a whole or pay back in instalments depending on the agreement between the lender and the borrower. MFI client on the other hand has to repay a fixed amount every week. After the first week of borrowing, a group is expected to repay a fixed amount every week. This also makes it easier for the loan officer to collect repayment. Since the officer is only interested in the total amount he has to collect from the group, doesn’t matter if everyone from the group is contributing or not, he can easily collect money from 100-200 people in a day. Whereas moneylenders have to wait around not knowing when the money is coming back. All of this leads to a decrease in the administrative costs of recollecting the money, thus decreasing the interest amount that poor have to repay.
Inspite of all this, why do poor still borrow at exorbitant interest rates?
Unlike moneylenders who allow the borrowers to repay however they want, MFI clients typically have to repay a fixed amount every week. This form of repayment can be difficult for the poor as they don’t generate enough revenue in a week to start paying back.
Politics can be another factor. In 2010, Andhra Pradesh government had blamed SKS(A Micro Finance Institution) for the suicide of 57 farmers, because of the way loan officers pressurised farmers to repay. Government then passed a law, requiring the presence of an elected official - a clear signal not to repay. Mr. Vikram Akula, who was the CEO of SKS tried assuring the government that that 57 farmers who committed suicide were not in default. But it was of a little help to the loan officers and the institution.
Hence because of the political play, MFIs have been tottering. A large share of poor still rely on moneylenders and traders to borrow money. Do read Poor Economics by Abhijit V. Banerjee for a detailed insight into this topic!
See you next Saturday, until then have a great weekend :)
Cheers!
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Here are the last three posts if you were too occupied to read them:
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