Debt spirals: Microfinance edition

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Bloggers at CGAP are wondering if microcredit squeezes out informal moneylenders, or if microfinance loans can actually lead to additional forms of borrowing.

Unfortunately, the latter is quite prevalent. Richard Rosenberg explains:

I remember a conversation with Saurabh Sinha years ago in which he said that he and Imran Matin were finding that members of Grameen and other MFIs (microfinance institutions) in several Bangladesh villages used moneylenders as often as non-members, or more often. That sounds counter-intuitive, until we remember that most microcredit requires a fixed weekly repayment schedule that probably doesn’t match up very well with the irregular income streams of many borrowers. It isn’t so surprising that they would occasionally go to a more expensive short-term loan from a moneylender in order to bridge a gap in repayment of a less expensive long-term loan. Businesses small and large do exactly the same thing all the time.

Borrowing from moneylenders to pay back microfinance loans can only be a problem if it becomes routine. Put simply, borrowing from a money lender at a high rate of interest to pay off a lower-interest microfinance loan cannot go on forever. When this relationship falls apart, it is usually the informal money lenders who receive repayment priority.

This frequently results in unexpected defaults on the books of MFIs:

The ability to “cross-finance” back and forth between the MFI and the moneylender, repeatedly borrowing from one to repay the other, can hide the problem, temporarily at least. If a lot of borrowers are doing this, the MFI’s repayment rate can look great for a while, but eventually the house of cards will fall.  When that happens, I’d guess it’s usually the moneylender rather than the MFI who gets paid. This kind of situation may have contributed to Grameen’s delinquency problems in the late 1990s.

This seems like a difficult challenge, one that Mohammad Yunus neglected to mention during his recent visit to IFC. It is aggravated by the fact that MFIs cannot check the credit history of most borrowers, as the infrastructure for checking credit is not in place.

Perhaps a new project to put in the pipeline?

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