Thursday, November 18, 2010

India's microfinance crisis

Microcredit institutions are popping up everywhere around the world, and have achieved some great results as well as some great press. Now a fascinating article in the New York Times by Lydia Polgreen and Vikas Bajaj illustrates some of the downsides of microcredit. "India microcredit faces collapse from defaults" reports that "almost all borrowers in one of India’s largest states [Andhra Pradesh] have stopped repaying their loans, egged on by politicians who accuse the industry of earning outsize profits on the backs of the poor."

Supporters of microcredit operations often don't realize that most microcredit loans carry interest rates that by Western standards seem quite high. One Indian bank representative notes in the NYT article that "his company had reduced its interest rate by six percentage points, to 24 percent, in the past several years as volume had brought down expenses." The article suggests that such a rate is actually quite low, compared to rates charged by microfinance companies in other countries.

(In fact, Kiva, the excellent microcredit organization that accepts micro-donations from donors everywhere and channels them through existing microfinance organizations in the developing world, has faced some complaints in the past because many donors, who see their contribution as a form of charity, are under the impression that loans are either interest-free or very low-interest.)

Comparatively high interest rates are probably unavoidable, in that microcredit loans almost inevitably involve more overhead per dollar lent than do large loans. It is also worth noting that India's inflation rate is fairly high (currently around 10%, but as high as 16% earlier this year), so the real interest rate is much lower. Nevertheless, the accumulating interest can cause trouble for borrowers, as the NYT article illustrates.

Given how successful microfinance has been, it is hardly surprising that less scrupulous financial institutions have entered the field. Nor is it surprising that some borrowers borrow irresponsibly, if given the chance to do so. The real danger, highlighted in the NYT article, is that the resulting problems will undermine the entire microfinance industry.

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