Lending Schemes for the Poor
Probal Roy Chowdhury
INDIAN MICROFINANCE: THE CHALLENGES OF RAPID GROWTH by Prabhu Ghate Sage Publications, 2008, 227 pp., 350
May 2008, volume 32, No 5

Prabhu Ghate provides a fascinating account of the Indian micro-finance scenario. For the non-initiated, the word micro-finance brings several very contradictory images to mind. One is that of Mohammad Yunus sharing the 2006 Noble Peace Prize with his creation, the Grameen Bank, the micro-finance organization in Bangladesh. Another is that of farmer suicides in Andhra Pradesh, purportedly arising out of the farmers’ inability to repay their loans. Given all these contradictory information, one may naturally ask as to what is so great about micro-finance. In particular, what is micro-finance all about anyway?  Micro-finance essentially refers to lending schemes for the poor where the loan amounts are usually rather small (hence the prefix micro). The Grameen model in particular has many other interesting features, e.g. group-loans, focus on women, etc.

The surprising thing though is not that the loan amounts are small, but rather that these loans are made at all and, as recent experiences, in particular that of the Grameen Bank in Bangladesh suggest, that such loans can have very high repayment rates. This is quite remarkable given that traditional economic theory tells us that in the absence of collaterals such loans are unlikely to be viable. Not surprisingly, micro-finance appeared to be a win-win situation for all concerned. In fact, 2005 was declared as the international year of micro-finance. Further, micro-finance schemes were given pride of place in meeting the Millennium Development Goals.

Like in many other developing countries, over the last decade or so the Indian micro-finance scenario has grown rapidly. In fact some would argue that this growth was much too rapid, being at the expense of quality. Moreover, as the sub-title of this book suggests, the author has some sympathy for this viewpoint. Even if one does not completely agree with this viewpoint, there is clearly a need for pausing and stocktaking–and for some clear-headed assessment of the emerging trends. This book is a laudable effort in this direction.

The dominant Indian micro-finance model is the self-help group (SHG) linkage approach being coordinated by NABARD, which covered about 14 million poor households in March 2006. As we later discuss, the SHG linkage model has largely followed a different pathway compared to the Grameen Bank model. The MFI model, which covered about 7.3 million households in 2006, on the other hand, largely mimics Grameen. Even allowing for some overlap between the two sets of borrowers, these are impressive numbers. The book provides some summary statistics pertaining to the performance of these two, and then goes on to compare and contrast these two approaches. It also talks of some interesting new developments in the field, in particular micro-insurance, transfer of income schemes, computerization of micro-finance operations, etc. Of topical interest is the discussion on the recent Andhra crisis, and the lessons to be learnt thereof. The book ends with some discussion on training and capacity building, and some ongoing research in the field.

For the policy maker it provides a useful ready reckoner, for the practitioners a useful checklist of things that could go wrong, and guidelines for further progress. What, however, does a professional economist take away from it? As one myself, I shall be unabashedly subjective and report on what I find interesting. Hopefully these observations will find resonance with other economists, as well as the general reader.

For me the most interesting aspect of this book lies in the comparison between the SHG linkage programme, and the more traditional Grameen-inspired MFI model. In common with Grameen, the SHG-linkage programme involves elements like joint liability and sequential lending. There are also dynamic elements in the sense that repeat loans may be contingent on repaying the existing loan. Under such institutional schemes, borrowers, it is argued, have an incentive to peer-monitor each other, ensuring timely repayment. Further, during group-formation, they have an incentive to select only relatively efficient borrowers. Such peer monitoring and group-selection are efficient because the villagers have a greater level of information about each other compared to bank officials, who are mostly outsiders. Thus many of the standard arguments as to how joint liability and sequential lending can bolster monitoring and improve self-selection of ‘better’borrowers into groups apply. There are several points of differences between the SHG-linkage model, and Grameen though. Typically under the SHG-linkage programme, some NGO organizes several villagers into a potential borrowing unit that is asked to save some amount for a given time. In case they manage to do so, the NGO links up this group with a bank, which makes a further loan to the group. Thus, in contrast to Grameen, under the SHG-linkage programme loan disbursement is contingent on savings performance. Further, unlike in Grameen, the NGO is primarily associated in the group-formation process, but not necessarily thereafter. The author also points out that the SHG linkage programme involves the loan going to the group as a whole, which is then allocated among the members. This is in contrast to the Grameen system, where the loan is in the name of individuals, even though there may be elements of joint liability. Moreover, under the SHG-linkage programme there is purportedly much greater scope for empowerment. This is because under the SHG-linkage programme, the participants themselves take many decisions that, under the Grameen system, are taken by the concerned NGOs.

As the author rightly points out, despite these differences, the SHG-linkage programme seems to be doing well according to most parameters, including repayment rates. This suggests that while there are valuable lessons to be learned from Grameen, one need not ape the Grameen model blindly. While the literature makes a beginning in analysing the SHG-linkage model (there is a very interesting chapter by Annie Duflo and colleagues on some ongoing research), it is yet to come to grips with issues of institutional structure and their incentive implications. This is perhaps where the professional economist can come in and fruitfully interact with the practitioners. Thus one important contribution of the book lies in asking interesting questions, ones that could and should generate further research. I have already discussed some of these. In conclusion let me just list a couple of others questions:

  1. How does the competition between MFIs and SHG-linkage programmes play out? In particular, how does it affect the incentive for repayment?
  1. How does diversifying into micro-insurance (in particular health-insurance) affect the incentives?
  1. For a political economist the suggestion that micro-finance providers and the government occupy the same policy space, thus creating a potential source for conflict, is of interest. All in all, the book is a must read for those interested in the issue of Indian micro-finance.

Probal Roy Chowdhury is Professor of Economics at the Indian Statistical Institute, Delhi Centre. His research interests span game theory, industrial organization and development economics. He was awarded the 2007 Journal of Development Economics Best Paper Award for his work on micro-finance. His current research interests include the self-help group (SHG) linkage micro-finance programme in India. 

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