Market for 33 percent interest loans: Financial inclusion and microfinance in India

ABSTRACT

Financial inclusion is the process of building viable institutions that provide financial services to those hitherto excluded. These may include savings, insurances, remittances, and credit. Microfinance became the most dominant method for achieving financial inclusion. However, different microfinance schools of thought recommend opposite ways for attaining financial integration. India is a particularly insightful case study due to the sheer number of people excluded from formal financial services, as well as the spectrum of actors and approaches. The aim of this article is threefold. The first aim is to define financial inclusion, depicting its status quo in India and comparing it to its South Asian and Brazil, Russia, India, China, and South Africa (BRICS) peers using recently released data from the Global Findex database. The second aim is to focus on microfinance as the dominant vehicle for achieving financial inclusion by scrutinizing its definitions, contrasting its two leading “schools of thought,” and analyzing the central role of its dominant group-based approach. The third aim of the article will examine why people opt to take micro-credit at 33 percent interest rates.

Acknowledgments

I am very grateful to Jivanta Schöttli and the anonymous reviewers for their very helpful comments; as well as to all microfinance clients, practitioners, and researchers who patiently answered my countless questions during my fieldwork in India.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 See Global Findex by the World Bank, https://globalfindex.worldbank.org (accessed May 16, 2018).

2 Data for all regions exclude high income countries. See Global Findex.

3 The Indian “Rangarajan” Committee on Financial Inclusion defines financial inclusion as “the process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low-income groups at an affordable cost,” Report of the Committee on Financial Inclusion (2008), 1, www.sidbi.in/files/Rangarajan-Commitee-report-on-Financial-Inclusion.pdf (accessed May 16, 2018).

4 An excellent overview of financial inclusion definitions is provided by N. K. Thingalaya, M. S. Moodithaya, and N. S. Shetty, Financial Inclusion and Beyond: Issues and Challenges (Gurgaon, India: Academic Foundation, 2011), 28.

5 H. Aynsley, “Financial Inclusion and Financial Capability: What’s in a Name?” 2010, http://www.toynbeehall.org.uk/data/files/Services/Financial_Inclusion/Financial_Inlcusion_and_Capability_-_Whats_In_A_Name.pdf (accessed May 16, 2018).

6 A good literature review on the relationship between financial exclusion and inclusion, financial literacy and policy initiatives is provided by A. Atkinson and F. Messy, “Promoting Financial Inclusion through Financial Education: OECD/INFE Evidence, Policies and Practice” (OECD Working Papers on Finance, Insurance and Private Pensions, No. 34, OECD Publishing, Paris, France, 2013).

7 P. Ghate, Indian Microfinance: The Challenges of Rapid Growth (New Delhi, India: Sage Publications India, 2007), 93.

8 The Seoul Development Consensus points to nine areas in which „action and reform” is required to achieve “inclusive and sustainable economic growth and resilience,” ranging from infrastructure, private investment, job creation to knowledge sharing. See Global Partnership for Financial Inclusion (GPFI), “Seoul Development Consensus for Shared Growth,” 2016, www.gpfi.org/about-gpfi (accessed May 16, 2018).

9 “Markets and payment systems” refers to remittances and innovative technologies. Remittances costs rose in 2014 as accounts at money transfer operators vanished, due to new regulations on Anti-Money Laundering and Combatting the Financing of Terrorism (Global Partnership for Financial Inclusion 2016).

10 The Global Findex by the World Bank includes data on 148 countries, covering 97 percent of the World´s adult. The evidence stems from around 150.000 interviews in 2011 and follow-up rounds in 2014 and 2017, https://globalfindex.worldbank.org (accessed May 16, 2018).

11 A. Demirgüç-Kunt, L. F. Klapper, D. Singer, S. Ansar, and J. Hess, The Global Findex Database 2017: Measuring Financial Inclusion and the Fintech Revolution (Washington, DC: World Bank, 2018), 2.

12 “In India the leakage of funds for pension payments dropped by 47 percent (2.8 percentage points) when the payments were made through biometric smart cards rather than being handed out in cash.” Demirgüç-Kunt et al., Global Findex Database 2017, 2.

13 For an assessment of PMJDY see Agarwal, A. et al., “Banking the Unbanked: What do 255 Million New Bank Accounts Reveal about Financial Access?” (Working Paper, 2017), http://w3.bm.ust.hk/fina/2017symposium/paper/Sumit_JDY%20draft%20%20%20v17_November_12_final.pdf (accessed May 16, 2018).

14 The Economic Times, Jan Dhan Yojna makes it to Guinness World Records, 11.5 cr Jan Dhan accounts opened, January 21, 2015, //economictimes.indiatimes.com/articleshow/45955376.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst (accessed May 16, 2018).

15 The Global Findex definition of financial institutions includes microfinance institutions, cooperatives and credit unions. A. Demirguc-Kunt, L. Klapper, D. Singer, P. Van Oudheusden, “The Global Findex Database 2014 Measuring Financial Inclusion around the World (Policy Research Working Paper 7255, World Bank, Washington, DC, 2015), 4.

16 S. S. Chowdhury, and S. A. Chowdhury, “Microfinance and Women Empowerment: A Panel Data Analysis Using Evidence from Rural Bangladesh,” International Journal of Economics and Finance 3, no. 5 (2011): 86.

17 The Consultative Group to Assist the Poor (CGAP) lamented about the gender gap in digital finance in Bangladesh in 2015, http://www.cgap.org/blog/digital-finance-bangladesh-where-are-all-women (accessed May 16, 2018).

18 A similar picture emerges when asking individuals about deposits in the last year: India (42 percent), Bangladesh (51 percent), Pakistan (56 percent), South Africa (both 66 percent), Brazil (68 percent), China (71 percent), an Russia (79 percent), in contrast to USA (95 percent).

19 World Bank, “The Global Findex Database 2017,” https://globalfindex.worldbank.org

20 Demirgüç-Kunt et al., Global Findex Database 2017, 11, 35, 36.

21 Demirgüç-Kunt et al., Global Findex Database 2017, 11, 35, 36.

22 The World Bank´s Legal Right Index rates the strength of countries´ justice system. The Legal Right Index has a spectrum from “weak” (0) to “strong” (12). India and the Russian Federation reach the highest valuation among the BRICS (both 8); followed by South Africa (5), China (4), and Brazil (2) and contrasting to Bangladesh (5), Pakistan (2), and the United States (11).

23 P. R. Chowdhury, “Microfinance: The SHG-Linkage Program,” in The Oxford Handbook of the Indian Economy, ed. C. Ghate (Oxford, UK: Oxford University Press, 2012), 149–66.

24 Quoted in The Economic Times (November 23, 2010) Microfinance in India is like subprime lending: Y V Reddy, https://economictimes.indiatimes.com/news/economy/indicators/microfinance-in-india-is-like-subprime-lending-y-v-reddy/articleshow/6972903.cms (accessed May 16, 2018).

25 L. Karim, Microfinance and its Discontents: Women in Debt in Bangladesh (Minneapolis, MN: University of Minnesota Press, 2011).

²⁶ Karim, Microfinance and its Discontents, xxxi.

26 N. Castree, R. Kitchen, and A. Rogers, A Dictionary of Human Geography (Oxford, UK: Oxford University Press, 2013).

27 NBFCs are the most popular legal form for Indian MFIs.

28 J. M. Last, A Dictionary of Public Health (Oxford, UK: Oxford University Press, 2007).

29 S. Mayhew, A Dictionary of Geography, 4th ed. (Oxford, UK: Oxford University Press, 2009).

30 Asian Development Bank (ADB) “Finance for the Poor: Microfinance Development Strategy,” 2000, 2, www.adb.org/sites/default/files/institutional-document/32094/financepolicy.pdf (accessed May 16, 2018).

31 See "Compartamos homepage," www.compartamos.com.mx

32 Microfinance´s impact on women´s empowerment is tough to measure. Numerous qualitative studies suggest that women are perceived differently in their households and communities due to their participation in microfinance groups. A common operationalization is to focus on household and community decision-making capacity and control over resources. The Women´s Empowerment in Agriculture Index (WEAI) operationalizes empowerment using the dimensions production, resources, income, leadership, and time allocation. See S. Alkire, R. Meinzen-Dick, A. Peterman, A. Quisumbing, G. Seymour, and A. Vaz, “The Women’s Empowerment in Agriculture Index,” World Development 52, no. (2013): 71–91; N. Kabeer, “Is Microfinance a ‘Magic Bullet’ for Women’s Empowerment? Analysis of Findings from South Asia,” Economic and Political Weekly 40, no. 44/45 (2005): 4709–18 concludes that the evidence is highly contingent on “context, commitment and capacity.” See Kabeer, “Is Microfinance a ‘Magic Bullet,’” 4709). For further discussions and literature, see B. Armendáriz, and J. Morduch, The Economics of Microfinance (Cambridge, MA: MIT Press, 2010).

33 M. Zeller, and R. L. Meyer, ed., “The Triangle of Microfinance: Financial Sustainability, Outreach, and Impact,” International Food Policy Research Institute 40 (2002): 3.

34 Zeller and Meyer, “The Triangle of Microfinance,” 3–4.

35 Zeller and Meyer, “The Triangle of Microfinance,” 7.

36 E. See Rhyne, and M. Otero, The New World of Microenterprise Finance: Building Healthy Financial Institutions for the Poor (Sterling, VA: Kumarian Press, 1994); M. Robinson, The Microfinance Revolution: Sustainable Finance for the Poor (Washington, DC: World Bank Publications, 2001).

37 G. Woller, C. Dunford, and W. Woodworth, “Where to Microfinance?” International Journal of Economic Development 1, no. 1 (1999): 29–64.

38 Woller et al., “Where to Microfinance?”

39 FINCA provides microfinance through a “village banking” approach. At least 35 women form a group and collect initial savings in weekly meetings. FINCA contributes training regarding its methodology, group dynamics and basics of entrepreneurship. The group members elect a Village Bank Board of Directors. FINCA trains Directors to manage credits, including application screening, approval, disbursement, supervision, recovery, and book-keeping. FINCA project promoters supervise the meetings, and commercial banks provide savings accounts. See E. W. Chirwa, “Management and Delivery of Financial Services for the Poor: FINCA´s Village Bank Approach in Malawi,” Savings and Development 23, no. 1 (1999): 5–28.

40 Woller et al., “Where to Microfinance?,” 3.

41 Woller et al., “Where to Microfinance?,” 3.

42 M. Zeller and R. L. Meyer (eds.), The Triangle of Microfinance: Financial Sustainability, Outreach, and Impact (Baltimore, MD: The Johns Hopkins University Press, 2003), 4; Joseph E. Stiglitz and Andrew Weiss, “Credit Rationing in Markets with Imperfect Information,” The American Economic Review 71, no. 3 (1981): 393–410.

43 B. E. Coleman, “The Impact of Group Lending in Northeast Thailand,” Journal of Development Economics 60, no. 1 (1999): 105–41.

44 J. E. Stiglitz, “Peer Monitoring and Credit Markets,” The World Bank Economic Review 4, no. 3 (1990): 351–66.

45 Stiglitz, “Peer Monitoring and Credit Markets,” 361, 362.

46 M. Ghatak, and T. W. Guinnane, “The Economics of Lending with Joint Liability: Theory and Practice,” Journal of Development Economics 60, no. 1 (1999): 195–228.

⁴⁷ Ghatak and Guinnane, “The Economics of Lending.”

47 T. Besley, and S. Coate, “Group Lending, Repayment Incentives and Social Collateral,” Journal of Development Economics 46, no. 1 (1995): 1–18.

48 Besley and Coate, “Group Lending,” 16.

49 Besley and Coate, “Group Lending,” 16.

50 Roodman, “Much Grameen Bank Investigation, Signifying What?” 2013, http://international.cgdev.org/blog/much-grameen-bank-investigation-signifying-what (accessed May 16, 2018) points to the disapproval of this management structure: it “appears that the Board was ineffectual and that Muhammad Yunus ran the bank with a free hand. The highly touted female borrowers who constitute the board’s majority could not be expected to understand the octopus-like complexity of the Grameen family of companies, assuming they were apprised of it. And they certainly could not be expected to perform appropriate oversight.” See Roodman, “Much Grameen Bank.”

51 The New York Times, Micro-loans to the World’s Poorest, by C. H. Farnsworth, February 21, 1988, www.nytimes.com/1988/02/21/business/micro-loans-to-the-world-s-poorest.html?src=pm&pagewanted=3&pagewanted=print (accessed May 16, 2018).

52 S. Rutherford, “Grameen II: The First Five Years 2001–2005: A ‘Grounded View’ of Grameen’s New Initiative,” (2006), 13, www.cgdev.org/doc/blog/Rutherford,%20Grameen%20II--The%20First%20Five%20Years,%202001-2005.pdf (accessed May 16, 2018).

53 Rutherford, “Grameen II,” 17.

54 The data from the CMIE (Centre for Monitoring Indian Economy) refer to the year before the most severe microfinance crisis to date in 2010 in Andhra Pradesh.

55 A. Banerjee, and E. Duflo, Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty (New York: Public Affairs, 2011), 160.

⁵⁷ Banerjee and Duflo, Poor Economics, 160.

56 An interest rate of 33 percent per year sounds absurdly high for many people from OECD countries. The average annual percentage rate (APR) for a credit card in the United States was 15 percent. See K. Dilworth (2-Jan-2013), Rates begin 2013 at 14.96 percent, www.creditcards.com/credit-card-news/interest-rate-report-010213-unchanged-2121.php (accessed May 16, 2018).

However, the 10 million low-income clients of payday loans in the USA were charged 25 percent for a two-week loan in 2009, amounting to a 650 percent APR. See S. P. Carter, “Payday Loan and Pawnshop Usage: The Impact of Allowing Payday Loan Rollovers,” 2012, https://my.vanderbilt.edu/susancarter/files/2011/07/Carter_Susan_JMP_website2.pdf (accessed May 16, 2018).

57 These most recent available data refer to the year 2010. See MFTransparency (2011) Pricing Data Report. Transparent Pricing Initiative in India, www.mftransparency.org/wp-content/uploads/2012/05/MFT-RPT-201-EN-India-Pricing-Data-Report-2011-01.pdf (accessed May 16, 2018).

58 D. M. Roodman, Due Diligence: An Impertinent Inquiry into Microfinance (Washington, DC: Center for Global Development, 2012) calculations of inflation-adjusted MFI interest rates without “hidden costs” (such as compulsory insurance and deposits) show the following median for 2009: South Asia (15 percent), Eastern Europe and Central Asia (23 percent), Sub-Saharan Africa (24 percent), Latin America and Caribbean (28 percent), East Asia and Pacific (29 percent), and Middle East and North Africa (32 percent). The 95th percentile ranges from 44 percent in South Asia and the Middle East and North Africa to 67 percent in Sub-Saharan Africa and 73 percent in Latin America and Caribbean. See Roodman, Due Diligence, 185.

⁶¹ Roodman, Due Diligence, 185.

59 See MF-Transparency (2011): 28. MF-Transparency recommends including all mandatory aspects of microfinance costs such as forced savings and insurance.

60 Eastern Europe and Central Asia and Sub-Saharan Africa follow, with a distance. The Middle East and North Africa have the highest microfinance interest rate; followed by East Asia and the Pacific as well as Latin America and the Caribbean. (Roodman, Due Diligence, 184–185).

61 South Asia (74.8 million) is followed by Latin America and the Caribbean (24.9 million), East Asia and the Pacific (19.9 million), Eastern Europe and Central Asia (3.7 million), Africa (6.3 million), and Middle East and North Africa (2.4 million). See MixMarket, www.mixmarket.org (accessed May 16, 2018).

62 R. Rosenberg, “CGAP Reflections on the Compartamos Initial Public Offering: A Case Study on Microfinance Interest Rates and Profits,” 2007: 5, www.cgap.org/sites/default/files/CGAP-Focus-Note-CGAP-Reflections-on-the-Compartamos-Initial-Public-Offering-A-Case-Study-on-Microfinance-Interest-Rates-and-Profits-Jun-2007.pdf (accessed May 16, 2018).

63 Businessweek (13-Dec-2007) Yunus Blasts Compartamos, www.businessweek.com/stories/2007-12-12/online-extra-yunus-blasts-compartamos (accessed May 16, 2018).

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Markus Pauli

Dr Markus Pauli is a Lecturer in the Political Science Department at the National University of Singapore. His current research focuses on financial inclusion, governance of global food value chains, global governance and sustainable development. Previously, he was a Lecturer in Political Science at Yale-NUS, Singapore, a Research Fellow at Singapore Management University, and Research Fellow and Lecturer in Political Science, South Asia Institute, Heidelberg University. He worked on microfinance in India within the Cluster of Excellence, ‘Asia and Europe in a Global Context.’ He studied at the Free University, Berlin and the London School of Economics (LSE), specializing in Political Economy, Development, and International Relations. He has co-authored work on India´s democracy, socio-economic development, citizenship, and human security as well as on financial inclusion and collaborative governance for the Sustainable Development Goals.