Microfinance or debt trap? What the poor don’t know

By Moin Qazi

The worst appears to be over for the micro-finance sector with most micro-finance institutions (MFIs) improving their financial health after having undergone severe stress during the year following demonetization. However, there were several other roadblocks that were a result of demonetization. The aggressive approach of loan recovery officers at a time when the poor clients were financially hard-pressed and were desperately fighting a battle on several fronts underlined a huge weakness of micro-finance. In the aftermath of demonetization, the sector had to write off more than Rs 5,000 crore.

Micro finance remains robust

However, micro finance continues to thrive despite being under fire from legions of critics. One plausible reason for the lingering faith in the power of micro finance is that it provides a convenient strategy for investors to demonstrate that they are active fighters against poverty and are trying to save the poor while making a substantial amount of money from them. It is built on a false belief that credit is the most vital need of the marginalized. One of those who has thoroughly studied the phenomenon, Thomas Dichter, says the idea that micro finance allows its recipients to graduate from poverty to entrepreneurship is inflated.

He sketches out the dynamics of micro-credit: “It emerges that the clients with the most experience started using their own resources, and though they have not progressed very far—they cannot because the market is just too limited, they have enough turnover to keep buying and selling, and probably would have it with or without the micro-credit. For them, the loans are often diverted to consumption since they can use the relatively large lump sum of the loan, a luxury they do not come by in their daily turnover.” He concludes that“Definitely, micro finance has not done what the majority of micro finance enthusiasts claim it can do—function as capital aimed at increasing the returns to a business activity.”

Behind the scenes of micro-finance

Micro-finance has come under increasing scrutiny in recent months. Stories of astronomical interest rates driving the poor deeper into poverty, compounded by tales of malicious moneylenders intimidating borrowers to the point of suicide, have recently come to light in the international press, exposing fundamental flaws in the design of institutional for-profit micro-finance. Not only are borrowers often innumerate, illiterate and unfamiliar with interest rate calculations, but they frequently have little or no awareness of local demand for goods and services. Consequently, they often fail to establish successful income-generating ventures and therefore cannot repay their loans.

Micro-finance, including micro-credit, is often considered to be an instrument that promotes empowerment. While it can stabilize livelihoods, broaden choices, provide start-up funds for productive investment, help poor people to smooth consumption flows and send children to school, it can also lead to indebtedness and increased exclusion unless programs are well designed.  

Micro finance for women

According to Naila Kabeer, Professor of Gender and Development at the London School of Economics, women who have some prior experience of entrepreneurship and are not engaged in it for purely subsistence reasons are likely to benefit greatly from micro finance activities, given the barriers they face in accessing formal financial institutions. However, for poorer women who are struggling to get their enterprises on a viable basis, financial services on their own are unlikely to be enough and may even end up plunging them into debt. These women would need financial services as part of a larger package of supportive measures which address their human capital deficits, their unpaid domestic responsibilities and perhaps also lack of self-confidence and fear of taking risks.

In the world of micro finance, women borrowers are viewed as autonomous individuals who make independent choices in the marketplace. This is not the reality. Rural women live in extended family structures. These women’s identities are relational, shaped by factors such as marital kinship, ethnic, and tribal allegiances.They negotiate complex kinship and social obligations.

It’s not surprising to learn, therefore, that in most cases men control the loans that women receive. The men may simply use the money for their own purposes; in addition to male control, other problems affect a woman’s ability to repay a loan. In case of a default, they suffer humiliation and public shame, which heightens tension both at home and in the community. Such humiliation of women in a public place gives males in the household and in the lineage a bad reputation. In extreme cases, peers may take the defaulter to the police station. For a man, if he is locked inside the police stations for several days, it would mean almost nothing to other people in the village. But if this happens to a woman, it will bring shame to her household, lineage and village. 

The biggest problem is that people who get these small loans usually start or expand a very simple business. The most common business for micro finance is simple retail—selling groceries, where there are often too many people, fierce competition, and where they don’t really earn enough money to get out of poverty.

The debt trap involved in it

We need to create more jobs, and micro finance does not help to do that yet. The debt trap is an under-reported problem. Quite a few people invest money, their business does not make money and goes under, and they are stuck with the debt. The interest rate on this debt, even with a micro finance loan, is quite high, so some are never able to repay it. Another reason why they get into a debt trap is that, in theory, you should take a microloan to invest in the business. However, in practice, a lot of people use microloans for a wedding, festivals, or to buy something. A lot of these people don’t know how to use debt.

Micro finance and rural housing

What the micro finance industry needs to do is to rejig the agenda. They should take a cue from affordable housing finance companies which are using micro finance principles to enable those from low-income households to realize their dream of a decent habitat.

The Swarna Pragati Housing model, which has now won international acclaim, is turning out to be a game-changer in rural housing. The great thing about it is that it uses micro finance to power this revolution. For a financial institution, assessing credit history in rural communities can be challenging as many households do not have a bank account or documentation to support their income. To overcome this, the model uses the candidate’s participation and repayment history within a self-help group as an extension of their credit history, leveraging the Grameen Bank model of micro finance. 

One of the biggest obstacles to credit is that many rural householders may not possess the proper documentation needed to substantiate ownership of land or property. The model is using another empowering grassroots institution in the Indian governance grid—the local panchayat, to establish ownership through public validation. It is, in a way, enabling gram panchayats to become more autonomous units in financial and social democracy. Perhaps Swarna Pragati is one of the justifications which should make the architects of Panchayati Raj feel proud.

For micro finance to achieve real transformation, it needs visionaries like Ramesh Kumar, who has made high-quality housing, affordable even in the smallest of the towns, to show what micro finance can do if its potential is creatively unleashed to address some of the toughest challenges—housing certainly being the topmost.

It may appear that the naysayers are ready to sound the bugle and shout out “the king is dead, long live the king”, but micro finance can redefine itself as a leaner, more modest business with a social conscience and a mission-oriented goal, and continue to be profitable. Although, only time will tell.

Featured Image Source: Visual Hunt