This post is in response to an article, “Loan Defaults Versus Over-indebtedness in Rural Tamil Nadu”, published on the CGAP blog on June 10th, 2013. The article asserts that microfinance institutions (‘MFIs’) in the state of Tamil Nadu (‘TN’) in India are facing repayment problems. The article further states that repayment problems are due to the increasing indebtedness of the rural households, which in turn is caused by the availability of various funding options to households and increasing expense due to changing lifestyles, and further mentions that there are willful defaults by the borrowers. The assertion of repayment problems in TN and the reasons and assumptions put forth by the author do not corroborate with our experience and data. The article also ignores the recent development in regulation and the implementation of Credit Information Bureaus (CIBs) processes in the microfinance sector in India. The original article can be accessed at: http://www.cgap.org/blog/loan-defaults-versus-over-indebtedness-rural-tamil-nadu
Microfinance is typically availed by section of society that is financially vulnerable and politically sensitive. Any opinion on the sector, particularly expressed through a public portal, should be supported by reliable data and in-depth research. We feel that a comprehensive response to the article is required to adequately address the questions raised by the author.
IFMR Capital is a registered non-banking finance company (‘NBFC’) based in Chennai, Tamil Nadu, India. IFMR Capital had microfinance exposure across 23 states and 296 districts in India. This includes the state of Tamil Nadu. It tracks the loan-by-loan data on repayment of pools structured, arranged and invested in by it. IFMR Capital has so far conducted monitoring and field surveillance visits to MFI operations in 192 districts, 440 branches and 1181 centers across India and has deep on-the-ground insights into microfinance operations and risks in the country.
Are microfinance repayments suffering in Tamil Nadu?
IFMR Capital’s monitoring team visits centres and branch operations regularly as detailed above. During the financial year 2012-13 a total of 15 monitoring visits were conducted in Tamil Nadu covering 7 Microfinance Institutions, 18 districts, 49 branches, and 99 centre/group meetings. All these visits showed high percentage of collections (close to 100%). The few instances where instalments were missed were usually due to the borrower being unwell or traveling. In such cases, the joint liability was intact and other members contributed for the absent member. This continued even through the four months of near drought situation during which parts of Tamil Nadu struggled with low and erratic rainfall. Even during these difficult conditions the repayment by microfinance clients was not under stress. As of March 31st , 2013 the average PAR 30 across our six partner MFIs in Tamil Nadu is less than 0.09% for the preceding two quarters.
Collection efficiency of IFMR Capital’s securitized microloan pools has consistently been high. As on March 31st 2013, the average collection efficiency on 33 live securitized transactions, with pools originated from Tamil Nadu, was 99.82%. 24 of these pools had collections efficiency of 100%. Further, there is a decreasing trend in the observed default in the securitized pools from Tamil Nadu and other states.
The above chart shows that as of March-2013, there is a decrease in the observed portfolio overdue since the end of FY2010-11 based on the 55 microcredit pools securitized by IFMR Capital between March-2010 to March-2012 across the four states of Tamil Nadu (TN), Karnataka (KT), Maharashtra (MH) and Uttar Pradesh (UP).
Are rural households over-indebted?
The article mentions that rural households are chronically indebted and ‘are caught in a spiral of debt’ which effects their ability to repay microfinance loans. The article further asserts that microloans are rigid and force households to borrow more. There is evidence to show that low income households often borrow and repay frequently to finance the timing mismatch between cash inflows and outflows. It has also been documented that low income households depend on multiple, often informal, sources of finance (Portfolios of the Poor). There is however no evidence to conclude that these households would borrow from these sources beyond their repayment capabilities. Further, under the new regulatory regime for microfinance, all MFIs are required to enrol with credit bureaus. They contribute credit information to these bureaus and use credit bureau information to check for indebtedness of the borrower. By regulation, an MFI cannot be the third lender to a client. This has resulted in both responsible lending by the MFI and disciplined credit behaviour by the client.
MFIs now follow a stringent code of conduct and customer protection procedures. The collection mechanisms of MFIs are now well regulated and are designed to protect the borrower. Further, regulation has ensured that the MFI product details and terms are well documented, standardized and transparent. Transparency, documentation and standardization should not be confused with rigidity. Some MFIs have expanded their product suite to offer emergency loans, festival loans, water loans, sanitary loans and education loans to existing customers who have a good repayment track record.
The author’s assumptions that rural households are increasingly indebted and that lifestyle changes and needs are driving expenses faster than the real income need to rigorously tested. There is no substantive evidence to assume or conclude that:
- Rural households have increasing demand for consumer durables regardless of affordability
- Households continue to spend more on rituals even if the expenses are higher than wages
- Urbanized lifestyle, which also includes use of electricity, gas stoves, mobile phones and better transport, necessarily means that expenses are increasing more than income.
- Households will borrow more to meet increasing expenses rather than looking for alternate source of income or reallocating expenses.
Is microfinance forcing households to borrow more?
The article mentions microcredit as one of the many reasons for over-indebtedness. It would be wrong to assume in the first place that the mere availability of microcredit, or any source of funding for that matter, could cause over-indebtedness. It would directly imply that borrowers do not understand financial management and are ready to ‘consume’ loans thoughtlessly because loans are readily available and further that microfinance lenders are oblivious to the real consequences of such indiscriminate lending.
Microcredit is an alternative source of finance to poor households. It is unclear why the author has concluded that households only use microcredit for additional consumption and do not use microcredit to substitute informal debt. Microcredit is cheaper, standardized and transparent whereas informal credit is often very costly, unreliable and riddled with coercive collection mechanisms. In our experience MFIs actively encourage clients to borrow for income generation activities including for micro-enterprises. This is further verified through loan utilization checks. Many MFIs also pursue the complementary objective of livelihood promotion among their borrower base.
Are multiple borrowing options tempting microloan borrowers to default?
The Reserve Bank of India has significantly strengthened the regulatory framework for microfinance lending and also brought in comprehensive measures for customer protection. The Joint Liability Group (‘JLG’) model has acted as a deterrent against willful defaults. as the underwriting is done by the group. With the advent of credit bureau usage, willful defaults have decreased. Borrowers are aware that their credit history is being recorded and preserved by the bureaus and is being used by other MFIs to assess their credit worthiness. The author’s assumption that borrowers have little incentive to repay MFIs is not substantiated by observed behavior and is weak particularly in the new operating environment for MFIs.
Informal finance and social inequality
The question about the potential risks due to informal finance sources raised by the author is based on the assumption that ‘perhaps informal financing is high in south India’. It is unreasonable to state without any supporting data that informal sources of funds are higher or lower in a certain part of India.
Another question that the article raises is the possible link between the social inequalities and mass defaults in microfinance. We have not observed any localized or mass defaults on our portfolio of exposure to MFI partners in or outside Tamil Nadu.
Our portfolio exposure, loan performance data and on-the-field monitoring findings do not lead us to believe that there is a problem of over-indebtedness in Tamil Nadu. Neither do we have reasons to believe that there is any loss of legitimacy or trust that may cause client non-repayment and localized or mass strategic defaults.