As Microfinance Grows in India, So Do Its Rivals

Monday, December 21, 2009

By Ketaki Gokhale

Mahabubnagar, India

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, which was begun as a way to help combat poverty by granting the poor access to capital to start businesses. Muhammad Yunus, the Bangladeshi founder of microfinance, won a Nobel Peace Prize.

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. Another recent survey by the Reserve Bank of India found that between 1995 and 2006, the number of registered traditional moneylenders increased 56% to 19,627 from 12,601. Though much harder to quantify, unlicensed lenders are believed to have made similar gains, the survey says.

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.

Microfinancing has boomed in recent years. Though founded as nonprofits, the Indian microfinance industry has been turbocharged by private-equity firms, nearly doubling in the year ended March 31, delivering $2.5 billion in loans. Many microfinance lenders have recently registered as for-profit finance firms with the Reserve Bank of India, the Indian central bank, giving them wider access to funds but limiting them to “reasonable” interest rates. Those rates are still high — between 20% and 40% annually, according to the Consultative Group to Assist the Poor, or CGAP, hosted at the World Bank.

Source: Wall Street Journal (link opens in a new window)