LABOR COLONY, India — For Zareen, a 47-year-old housewife from this slum about 50 miles northwest of Bangalore in southern India, the word “microfinance” invokes terrible memories of the time when she had to sell her blood and everything she had to repay loans she took from a local microlending company.
“I went to the local clinic and sold my blood. I had no other option as the lenders’ agents said they would not leave my house if I did not repay them right away. I had sold every other valuable in my house, including utensils and dresses,” Zareen told International Business Times.
Another woman from the same neighborhood, Dilshad, had a similar experience and sold her blood for 1,000 rupees ($16.03).
“They (microlenders) have trapped us,” said Varalakshmi, a Labor Colony housewife. “Several people committed suicide by hanging themselves, while many others ended their lives on railway tracks.”
The crisis came only a few years after the concept – which essentially involves giving a poor person (nearly always a female) a small loan so that she could start a business and climb out of poverty – was being celebrated internationally as a powerful solution to an intractable problem. The United Nations Economic and Social Council proclaimed the year 2005 as the International Year of Microcredit. The following year, Muhammad Yunus and the Grameen Bank he founded in Bangladesh were awarded the Nobel Peace Prize for their pioneering work to provide small loans to the poor. Dozens of academic studies seemed to back up the value of this Third-World strategy: A premier analysis funded by the World Bank claimed that microcredit had reduced poverty in Bangladesh, and one of the researchers later estimated that 5 percent of Grameen Bank borrowers escaped poverty each year.
Since then, however, some harsh realities about microlending have come to light. Much of the research purporting to show a correlation between higher earning and higher borrowing has been widely discredited. Moreover, in-depth controlled studies depict communities that remain largely unchanged by this approach. In 2005 the nonprofit National Bureau of Economic Research began to examine quality-of-life indicators for 52 randomly selected poor neighborhoods in India in which a new microlending agency had set up shop and 52 similarly chosen indigent neighborhoods where microlending was not available. After three years, the availability of MFI did not affect bottom-line poverty data such as household spending, nor did it have any effect on developmental improvements often attributed to microfinance, such as health, education or women’s empowerment.
“There has been enough time and evidence now to explore the full impact of microcredit in depth, and, set against its vaunted reputation, my verdict is dour,” wrote David Roodman, a leading expert on microfinance, in the Washington Post. Though it has devastated individuals and families, Roodman wrote that in financial-improvement terms, “Microcredit rarely transforms lives.”
In the wake of the microlending crisis, and in part as a result of the resulting studies, new approaches to financial improvement for the poor are being explored. Some contain aspects of microlending but focus much more on financial inclusion, the current buzzword. This includes savings accounts and insurance policies – health and disaster – targeted at the very lowest economic strata. And it encompasses greater educational efforts to teach the poor how to manage finances – micro or otherwise – and to avoid the come-ons from malicious microlenders as well as customizing loans to an individual’s business or personal needs.
Among the microlending ideas that have lost credibility is the group model, which provides a lump sum for a cluster of people, usually a neighborhood, leaving it to the borrowers to decide how the loan will be distributed among the members. While the model avoids some moral hazards of the industry, its reliance on group pressure can be damaging for tight-knit communities like Labor Colony.
“It ruined our relations, as other group members who are also neighbors will come and sit at our home until we pay,” Zareen told IBTimes as she sat in her hut, which, despite its bright blue walls, is in dire need of repair, and slum children without shoes, or sometimes, pants, crowded in the tiny quarters to watch. “They used to scold and shout at us for not paying,” she recalled.
“Dealing with private moneylenders is better for us,” Zareen added. “If we don’t have money, we can escape these lenders by locking our door and sitting in a neighbor’s home, but with the group model that strategy won’t work.”
As the horror stories about microlending spread, activity in the sector slipped markedly. In 2011, the last year for which data is available, the total number of clients with outstanding loans fell for the first time from 205 million to 195 million, according to the Microcredit Summit Campaign, which tallies microloans worldwide. A large part of the decline can be attributed to strict regulations in Andhra Pradesh that took effect after the slew of suicides. These new rules limit the circumstances under which microlenders can sign up clients as well as their collection activities and have all but shut down microcredits in the state.
Too Much Credit
While India’s microlending crisis has received the most media attention, Bosnia, Morocco, Bolivia and Pakistan also experienced MFI bubbles that led to social instability and subsequent reform. In Bosnia, outstanding microloans more than tripled to $1 billion in 2008 from $275 million in 2005, but slumped to $830 million in 2009 on defaults and write-offs. And in Bolivia, after a relatively profitable period in the late 1990s, poor fruit vendors, cobblers and farmers, armed with dynamite, took the superintendent of banks hostage in 2001, demanding forgiveness or reduction of the debt they incurred through microlenders and consumer lenders. Although the hostage situation was resolved through negotiations, few actual loan concessions were granted.
Speaking of microlending globally, Maclyn Clouse, a professor who teaches a microfinance class at the University of Denver’s Reiman School of Finance, said that the effectiveness of the initial loans, which were generally made to people who legitimately needed the money to startup or expand businesses, led to a more lenient atmosphere and questionable loans. “The issue began when microfinance became more successful and more well-known, and other financial institutions discovered that this may be a profitable institution,” said Clouse.
With an oversupply of credit as lenders rushed to fill a perceived demand gap, microfinance agencies became less selective about their borrowers, freely giving loans to people who used the money for unproductive purchases, such as TVs, or to repay a debt with another microlender. These loans were made at usurious interest rates, higher than traditional moneylenders in the region.
“I took out four loans,” said Asmita, a woman from Zareen’s village. “I had to marry off my daughter and repair my house, so I had to raise funds for that. When I could not pay the loans back, the lenders asked me to mortgage the house to raise money. They used to come and sit at my home asking for dues.”