Microfinance or on Why I'm in India So Far Away in The Heat for Such a Long Time

The reason I'm in India is, as I've mentioned before, to work in a micro health insurance project with the Center for Microfinance (CMF). Before starting my work on this project I'm attending a 10 day intensive course on microfinance in Chennai, where CMF is based. CMF is a non-profit organization focused on improving accessibility and quality of financial services for the poor through rigorous research, knowledge dissemination and evidence-based policy for Microfinance Institutions (MFIs).

For those of you unacquainted with microfinance, the basic setup is as follows: Credit markets by definition have information problems. The lender faces two types of information asymmetries: adverse selection, that is, not knowing the type of the borrower, if he will repay or not, and moral hazard, if once he gets the money he will not use it adequately to be able to repay.

Collateral solves these problems since the lender can tell the type from collateral and no matter what the borrower does he will at least get that. Poor households do not have collateral in the form of assets that can be valuable to a formal lender (a bank, for example), so credit markets are either non-existent or very costly. The high cost comes from the fact that the local moneylender has to invest in gathering information and monitoring his clients to know their type and their actions. Also the opportunity cost of those resources is high for the moneylender, so interest rates are very high.

Microfinance solves the collateral problem through joint liability. Borrowers form a group and are screened for a period of time, either by requiring them to save some amount before they get a loan or by lending them increasing amounts and seeing their repayment rate. Once the group members get loans they are all responsible for the payment of the total amount, so they bear the full risk of one member defaulting. The joint liability setup is further reinforced by the presence of social sanctions among group members. By making group members be women (and married women most of the time) the risk of migration/fleeing decreases, so the market can exist or theoretically be less costly than moneylenders.

Most microfinance schemes in India operate as self-help groups (SHG), that is, the group of women is pursuing some other development goal than just getting loans and are usually sponsored by an NGO. In this type of scheme the NGO only acts as an organizer and supporter of the group and as the link between the group and a formal bank. But in the past years there has been a tremendous increase in MFIs that use a JLG model, since it can be scaled up very quickly and is sustainable (moreover, highly profitable).

This past week we have been discussing many of these issues and listening to very good speakers on the subject. To round off things today we went on a field visit to SMILE to actually see an MFI in operation. Tomorrow we will visit a local NGO, Hand-in-Hand to see their work. I'm excited.

P.S. I dedicate this title to C.Schubert