Thursday, September 10, 2009

Expanding Microfinance Market in India: Another Credit Bubble?

Economist: Froth at the bottom of the pyramid
Wall Street Journal: A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum
SKS: Letter to The Wall Street Journal

Microlenders started as non-profit, social agencies to aid the poor in financing their small businesses. As investors perceive microfinance as a profitable investment opportunity, however, microfinance has attracted billions of dollars worldwide over the past few years and now microlenders compete for profits. These for-profit microfinance institutions have been accused of charging the poor high interest rates (close to 100 % a year) and lending recklessly to those who are unable to repay loans.

A recent article in the Wall Street Journal on August 13th, warned of a credit bubble in the Indian microfinance market, the most dynamic microfinance market in the world. Reporting on a "repaying revolt" by over-indebted borrowers in a silk-making city in southern India, it pointed out that Indian microlending shared some similarities with U.S. subprime mortgage lending. For example, micro loans are made without any proof of income from borrowers and loan officers receive commissions for making larger loans. In addition, borrowers use loans for purposes other than expanding their small businesses or helping themselves out of poverty, i.e., using loans to "finance shopping sprees" or to pay off previous loans from other lenders.

Vikram Akula, founder of SKS, one of India's largest microfinance institutions, said in his response to the article that it was "unbalanced and misleading," and made a "sweeping generalization" based on anecdotal information from one neighborhood. According to Mr. Akula, microfinance institutions in India still have repayment rates of over 95%, and most microfinance institutions in India require borrowers to take "financial-literacy training," and to pass a test.

Jonathan Morduch, a co-author of "Portfolios of the Poor," agrees on the possibility of a bubble because lenders, with only limited information about borrowers, sometimes over-lend. He also emphasizes the urgent need for credit bureaus in the developing countries. However, these may be just localized bubbles, and there is currently no evidence of a global bubble. Moreover, given the fact that the microfinance industry has not yet served 90% of one billion poor people worldwide who want access to financial services, occasional local bubbles and competition would be good for the industry since they can bring more efficiencies, better pricing, and diverse products to customers, according to Alvaro Rodriguez Arregul, a former chairman of ACCION International.

Discussion Questions:
1. Do you agree with the WSJ's comparison between microlending and subprime mortgage lending and its warning of a credit bubble in the Indian microfinance market?
2. What kinds of regulatory reform would support microfinance institutions to minimize potential local credit problems and better serve the poor?
3. Microlenders first started as non-profit organizations. Do you think competition in the microfinance industry among for-profit microlenders would benefit the poor as Mr. Rodriguez said?

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