Microfinance in India

MICROFINANCE: NEW APPROACH REAPS REWARDS IN WEST BENGAL

A new approach to microfinance that is able to charge lower interest rates and, by selecting more reliable borrowers, lend over a longer period is proving popular and cost-effective in West Bengal, India. That is the main finding of a trial run by economists Pushkar Maitra, Sandip Mitra, Dilip Mookherjee, Alberto Motta and Sujata Visaria, to be presented at the Royal Economic Society’s 2013 annual conference.

The new approach to microfinance ensures that the loan cycles match agricultural cycles and that repayment is only due at the end of four months and at a lower rate of interest. Loans are provided after the harvest to allow farmers to store crops to sell when prices rise later.

As with most microfinance initiatives, there is no collateral required and only households with less than 1.5 acres of cultivatable land are eligible to borrow. Crucially, borrowers are liable only for their own loans: this prevents the ‘free-riding’ that has stained the group liability loans provided by traditional microfinance.

The key problems of how to select reliable borrowers and how to ensure timely loan repayments are overcome by appointing local community members to recommend borrowers in exchange for a commission tied to loan repayments – something the researchers call ‘agent intermediated lending’.

To test this new approach, the researchers piloted a scheme where local traders were appointed to oversee the lending in 24 randomly selected villages from two districts of the potato-growing belt of West Bengal. The results were then compared with another 24 randomly selected villages that continued to receive traditional microfinance loans.

More than a year into the programme, the take-up rate of new loans was higher than traditional microfinance loans. Repayment rates of the new loans were above 99%, compared with repayment rates of 83% for traditional loans – something the analysis puts down to the selection of safer borrowers.

The study also finds that the new scheme was more cost-effective, with administrative costs at about 10-20% of the costs of the traditional scheme. But the old scheme was more successful at targeting borrowers without any land.

More…

There is a widespread belief that microfinance is the panacea for the problem of low credit availability for the poor. But despite the rapid growth in outreach of microfinance institutions (MFIs), recent experience has highlighted a number of problems with the traditional microfinance approach.

Rigid, high frequency repayment schedules and a low tolerance for risk-taking restrict borrowers’ project choice and prevent significant effects on asset ownership and consumption. This may, in turn, limit loan take-up and anti-poverty impacts.

Group liability and strict repayment rules can also lead to contagious defaults, undermining the viability of MFIs, as witnessed in the recent microfinance crisis in India. As a result, researchers, policy-makers and MFIs themselves are searching for alternative forms of microfinance, which would generate greater benefit for borrowers and financial stability for MFIs.

These considerations motivated these researchers to design a new approach to microfinance. To facilitate financing of agricultural activities, loan cycles match agricultural cycles and repayment is only due at the end of four months. Loans are provided after the harvest to allow farmers to store crops if they so choose in order to sell when prices rise later.

There is no monitoring by MFI loan officials, and no requirement that borrowers attend group meetings or achieve any savings targets. As with most microfinance, there is no collateral requirement, and only households that own less than 1.5 acres of cultivable land are eligible to borrow. Borrowers are liable only for their own loans: this prevents the free-riding and contagious defaults that are possible with group liability loans.

The key problems of how to select reliable borrowers and how to ensure timely loan repayment are overcome by appointing local community members as agents to the MFI. The researchers call this the Agent Intermediated Lending or AIL approach.

This study evaluates one version of this approach where local traders and lenders are appointed as agents – the trader-agent-intermediated lending (TRAIL) scheme. In 24 randomly selected villages from two districts of the potato-growing belt of West Bengal, the MFI appointed TRAIL agents and incentivised them via commissions that were tied to loan repayments; their role was limited to recommending borrowers to whom loans were advanced directly at an annual interest rate of 18%, which is below the interest rates charged by most MFIs.

The TRAIL agent was required to recommend 30 households who would benefit from a loan, from which 10 were randomly chosen to receive loans. The TRAIL scheme was evaluated vis-à-vis the traditional group-based lending (GBL) approach. In another 24 villages, the MFI invited individuals to form five-member groups. Of the groups that met eligibility requirements, two groups were randomly chosen to receive joint liability loans that were otherwise structured similar to the TRAIL loans.

More than a year into the programme, the take-up rate of TRAIL loans was higher than GBL loans. Repayment rates of TRAIL loans were above 99%, significantly above GBL repayment rates of 83%. The analysis in the paper shows that the superior performance of the TRAIL scheme can be explained by its selection of safer borrowers.

Moreover, there is no evidence of any collusion between agents and borrowers. The TRAIL scheme was also more cost-effective, with administrative costs at about 10-20% of the costs of the GBL scheme.

But the GBL scheme was more successful at targeting landless borrowers. TRAIL borrowers were more likely to own intermediate landholdings (approximately 0.45 acres).

These results suggest that the AIL approach could provide a useful alternative to traditional microcredit. The TRAIL scheme was more cost-effective, had higher repayment rates, and provided imposed lower costs on borrowers through reduced monitoring, liability and MFI controls. But the GBL scheme was better at targeting the poorest households.

These findings suggest that MFIs could consider a multi-pronged approach where GBL and AIL schemes are offered at the same time. The poorest households would self-select into GBL contracts, while creditworthy small and marginal landowners would be more likely to be recommended for AIL loans.


ENDS


Contact:

Pushkar Maitra: Pushkar.Maitra@monash.edu

Interview with Pushkar Maitra:
http://www.bristol.ac.uk/cmpo/media/pushkar-maitra.MP3

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095
romesh@vaitilingam.com
@econromesh

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