Today, microfinance — an approach to financial inclusion based on providing small loans and other financial services to poor people, primarily women — is a global multi-billion dollar industry with operations on all continents .Microfinance had once generated considerable enthusiasm, not just in the development community but also at political levels. It was considered a marvelous innovation and was expected to open a vista of solutions for several problems facing the low income pyramid
Although microfinance has won enthusiastic backing, it has also had its critics, who argue that it’s a strategy that manages poverty rather than transforming it. The opponents most usually paint it as the trade of old-fashioned money-lenders, preying on the inability of people to resist the temptation of a new loan.
Is microcredit transformative or ruinous? Very rarely borrowers start businesses. Most buy durables for their homes. The problem for many in rural areas is that they are ill-serviced by mainstream banks, and even when big banks are present, many find the application process too challenging. But while microfinance schemes were meant to offer hope to the poor, they have frequently been the source of exploitation.
Images of microfinance lifting people out of poverty now compete with ones of the poor driven by debt to suicide. Where does the truth lie? Research studies find no substantial evidence that small loans lift people out of poverty. The practical question is not whether microfinance should continue, but how it can play to its strengths without damaging its social conscience.
In fact, it turns out that microfinance usually ends up making poverty worse. The reasons for this are fairly simple. Most microfinance loans are not even used to set up businesses but instead are used by borrowers to fund household consumption in such cases the logic is simple – to help people buy the basic necessities they need to survive, or to pay for unavoidable expenses such as getting their children married off.. As a result, borrowers don’t generate any new income that they can use to repay their loans so they end up taking out new loans to repay the old ones, wrapping themselves in layers of debt. Even when micro-loans are used to fund new businesses, poor entrepreneurs often face a lack of consumer demand since most of their potential customers are also from poor households, struggling to make ends meet.
Because of circumstances beyond their control (sickness, drought ,flood, , theft and so on), lack of skills and business acumen or taking bad decisions, a proportion of poor borrowers encounter great difficulties in repaying loans. While microfinanciers suggest that such problems are overcome through ‘social support’ in some painless way this is often not the case
The poor need to be made aware of the flip side of microfinance .Microfinance – including microcredit – is often considered to be an instrument that promotes empowerment. Whilst it can stabilize livelihoods, broaden choices, provide start-up funds for productive investment, help poor people to smooth consumption flows, it can also lead to indebtedness unless programmes are well designed. We must not forget the caution: “Microcredit is microdebt.”
Most microloans in India are loans given to groups of women in villages and are built on the principle of joint liability. Joint liability (also known as group liability) means that lending group members are mutually responsible for each other’s loan repayments. If someone misses his or her payment, another person in the group must make good on it so that all members in the group can receive their next loan. Thus microfinance has a strong social mechanism for protecting the loans. The collective guarantee of loans is enforced through mutual support, peer pressure, and ultimately social ostracism if borrowers default.
Most poor borrowers don’t have much in the way of physical collateral, so joint liability—specifically the withholding of further loans until all repayments have been made—incentivizes group members to hold one another accountable for missing payments.
Joint liability inspires perverse incentives. If future loans will not be forthcoming until all repayments have been made, this can lead tension and stress within the group.
With group and possibly the village’s access to credit jeopardized by a single defaulter, it’s not hard to imagine the severe pressure groups can inflict on their members. The social humiliation can be intense, and the loss of face can sometimes affect a person for years.
By making trust the collateral, microfinance has introduced a ingenious innovation but it subverts the logic of lending when it absorbs the losses of extra due diligence by collecting a very large return on investment from borrowers .A good due diligence is desirable as healthy financial canon but high pricing defeats the principles of affordability.
Debt can both unlock you and lock you. Debt is one thing that has both the greatest promise and, perhaps, also the gravest perils. Debt or credit, the cash that we borrow from lending institutions, exists for a reason .Before you apply for it, you should ask yourself if you have a valid reason for it or you are taking it just because people are lining up the way pollsters queue up for freebies.
Before you take that loan you need to ask yourself is, “Do I need it?” The second question you should ask yourself is whether it is part of your financial plan .If it is ,are you sure you are going to get a return higher than what you will be paying for it .This financial return should also cover your own effort that will go into generating that return.
A central problem is this: most of us see women borrowers as autonomous individuals who make independent choices in the marketplace. But this is not always the reality. It is erroneous to believe that access to credit will necessarily make life honeyed and sweet. Even when they possess marketable, loan-worthy skills, women often find themselves beholden to their husband and male relatives. Women who cannot repay a loan are subjected to public shaming by the entire community of borrowers, who are pressured hard by microfinance institutions to recover or repay the defaulted sum themselves, lest they risk losing access to future loans. A defaulting woman therefore faces the ire of other borrowers who see her as breaking faith with them, and, instead of developing social solidarity, the loans heighten social tension.
Where groups are mature and equipped with handling basic credit management skills this normally doesn’t happen. Otherwise credit can be an unruly horse and ruin a family leading to intergenerational poverty. Getting trapped in an inescapable debt has serious social implications for women, and most microfinance loans go to women.
The hard truism is that microfinance has been saddled with misplaced expectations, and we have lost a sense of its more modest, even though critical, potential. It is actually a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It has all to do with how we are using it and how we are defining the outcomes. .Let us understand how positive the effects of microfinance can be, for both financial inclusion and livelihood promotion, if handled correctly. Let us not, in our over haste, throw the baby out with the bath water.
(The writer is the author of the bestselling book, Village Diary of a Heretic Banker.)