Traditional moneylending – informal, flexible, trust based and changing fast

As Microfinance Grows in India, So Do Its Rivals is the title of a recent WSJ article by Ketaki Gokhale which begins so,

The practice of making tiny loans to poor people, or microfinance, was supposed to help drive traditional village moneylenders from rural India.

Instead, traditional moneylenders, who typically charge high interest rates, are thriving, even in areas most heavily targeted by microfinance, [..]
Even as the government and nonprofit organizations came together to create the Indian microfinance market in the 1990s, traditional moneylenders’ share of total rural Indian household debt grew to 29.6% from 17.5%, according to a government survey.
[…]
One potential reason for their growth: Some microfinance borrowers say they need village moneylenders to help them pay their debts on time. Some academic researchers believe the moneylenders are keeping afloat many microfinance groups.

Peer pressure to pay back microfinance loans is intense, because microlenders almost always require borrowers to join small, tightknit groups. If one member defaults, none can get another loan. Microloans have a stellar repayment rate — close to 100% — and some analysts believe a hidden reason is the stopgap provided by moneylenders.

Drive out the village bania, a caricatured movie villain whose like has not graced the silver screen for quite some time. Before we continue to look at the anecdotes in the WSJ article, it behooves us to take a fair and balanced view of the village moneylender in India

There are 34,000 money lenders – and they have lent money to more than 2,00,00,000 farmers. They account for nearly 30% of the rural credit flows – and more credit than all the nationalized banks put together.

They charge between 18% to 36% p.a. interest generally. Lesser than what most ‘educated’ credit card users pay – and what ‘modern’ banks charge their English speaking customers.

So much about ‘usury’ by money lenders.

even while the WSJ’s own Indian arm loses all rights to call itself an objective observer of society.

The article seems to imply that traditional moneylenders charge far more interest than MFIs quoting the CGAP on this “fact”,

But the rates are still lower than those offered by the traditional
Indian moneylending industry, a chaotic jumble of pawn brokers, gold merchants and other private moneylenders — some licensed, most not. For centuries they have monopolized rural Indian credit markets but have been accused of fleecing people who don’t have access to formal banking by charging exorbitant rates and seizing all their belongings as collateral. They typically charge between 24% and 120% annually, according to CGAP.

I’m sure that no one had access to “formal banking” during those very centuries an extensive, sophisticated yet simple system of indigenous banking that extended credit and enabled trade to flourish across India.

I found it fascinating that this article set out to show why the informal economy had to be wiped out by the formal MFI one, in order to better serve the poor, only to support the exact opposite argument anecdotally. Perhaps its MFIs which need to be driven out of rural India’s villages?

One lender, who wished to remain anonymous because his business is unregistered, gives borrowers short-term, collateral-free loans “as quickly as an ATM gives money,” he boasts. Interest sometimes has to be paid on a daily basis and works out to an annual rate of 48%.

The poor use his loans as a stopgap when they can’t make their weekly microfinance repayments because their income was less than expected, he says.
[…]
The difference, however, is that the moneylenders give loans faster, without asking the women to form groups and serve as each other’s guarantors, as microfinance lenders do in order to ensure a higher repayment rate. They also charge significantly more than the four microlenders serving the neighborhood.

“Group pressure makes us go to moneylenders” to cover their microfinance loans, says Baleshwari, who goes by only one name, as does her sister. “We get small loans for 15 days to fill the gaps when we can’t pay. If you lag behind, the rest of the group members can’t get new loans.”

This dynamic is why some analysts believe the village moneylenders are actually floating the microfinance lenders.

The inherent conflict between the schedule of payments and the irregular income stream of income is the crux of this research. Rural MFI consultant and CGAP consultant  Brett Matthews had pointed out over many emails that MFIs prefer not deal with seasonality yet it was an overwhelming aspect of rural life,

But here in Mahabubnagar, few women have started their own businesses. Some of those in business have to rely on moneylenders. Microloan repayments begin the week after the loan is disbursed and continue with weekly payments. Most businesses don’t produce instant profits, and many are seasonal, so moneylenders can help when funds are tight.

This challenge was observed in The Philippines during fieldwork and discussed here  – specifically pointing out that MFIs expect repayment to start the week following the loan, an additional burden if the business for which the loan was secured needed some lead time to get going. One wishes the author had shared her source for this insight as it would have been interesting to follow up and explore other findings in this subject area in greater depth, if available.

Where microlenders, relative newcomers to rural India, rely on peer pressure for repayment, private moneylenders have historically been conservative in their practices: extending loans based on an intimate knowledge of people’s finances, and building their client bases over many years,

 

Trust.

The most critical element of doing business within rural communities everywhere as well observed among the urban BoP. What are the odds that your neighbourhood moneylender would be open to negotiation on smaller payments made as and when cash was in hand since he knew how and where you made your money?

But since microfinance took off in Mahabubnagar, he has seen moneylenders start to “adopt the methods of microfinance” — small loans, large volumes and regular repayments — “to scale up their business.”

In summary, it seems that traditional ways and means which offer speed, flexibility and trust are definitely in danger from their rivals, the
microfinance organizations but not that of being pushed out. Instead we
find they too are taking on the practices of high volume micro loans to
scale and compete with these newcomers.

One Comment

  • I can’t back up with specific field evidence as none of my informants used MFI’s nor high-interest money lenders – not to say they don’t exist Dharavi.
    Rather informants tended to borrow from family and friends, short term on no interest or from salaried friends and family, longer term on interest (equal to interest on savings or upwards to 8%) on flexible terms. Both support your discussion of trust and accounting for fluctuations in earnings. Still others used informal, community based micro-finance arrangements like bishi and chitty schemes which involve both credit and savings.
    Further thoughts on MFI’s that arose while in the field: if loans are provided for people who don’t necessarily exhibit entrepreneurial traits, then rather than facilitating successful enterprise they could easily create financial strain for those who are ill equipped to assess risk – which is surely the heart of entrepreneurial activity. 

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