Wall Street Journal Also Raises Microcredit Bubble Fears

August 13, 2009

In an article that was published in tomorrow’s(!) Wall Street Journal, reporter Ketaki Gokhale emphatically asserts that “a credit crisis is brewing in ‘microfinance’”:

Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband’s vegetable cart. Then she borrowed more.

“I took from one bank to pay the previous one. And I did it again,” says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts — two for $209, another for $293, and then $356.

At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance “increased our desires for things we didn’t have,” Ms. Taj says. “We all have dreams.”

Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That’s equal to about a fourth of her annual income.

Interestingly, one inspiration for my own post on this subject was another dispatch from India.

From my desk in Washington (well, actually cottage back porch in Maine), I cannot judge the situation with the confidence of the WSJ reporter stationed in India, so I assert only that bubbles could exist, not that they do. I note that the article’s evidence boils down to a few stories and quotes and some exaggeration of the significance of people using microcredit for consumption rather than investment. It reminds me a bit of the WSJ article written by Michael Phillips and Daniel Pearl shortly before Pearl was kidnapped and murdered in Pakistan. Phillips and Pearl correctly reported that the Grameen Bank was having repayment problems and not really coming clean about them—but missed the story that Grameen was in the process of launching thoroughgoing reforms that would soon renew growth. Grameen did not have a meltdown. (Addendum: Ghokale is working for the WSJ in India on a Daniel Pearl Internship.)

So I can’t tell for sure if the herd mentality has taken over in Indian microcredit, or has merely infected commentators like me wondering if there is a bubble.

Still, the former is a possibility worth taking seriously.

Hat tip to @tactphil and @impactSP2walden, who tweeted it.

Update: Ujjivan, a microfinance institution covered in the story, has posted a dissenting response. (Hat tip to @DefeatPoverty and @MFPrimarySource.) Unitus president Ed Bland has too. And here’s SKS founder Vikram Akula, who persuasively demonstrates that the reporting was shoddy.

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1. Hugh Allen Says:
   August 15th, 2009 at 12:38 am

   David,

   I am reminded of a tale told to me by the ever-eloquent Paul Rippey, then of the Financial Sector Deepening Project in Uganda. He interviewed a microfinance client in Uganda who described the trajectory of his MFI membership more or less as follows: “First I borrowed $50 and that was OK. Then I was required to borrow $100, I managed to pay it back, although it wasn’t easy. Then I was expected to borrow $200, so I left the programme.” It’s not only the temptation to consume, when it’s made easy, but the deliberate inducements to do so (and in larger and larger amounts) that have driven micro-finance for so long. I am very uneasy about an industry whose definition of success is having poor people take on bigger and bigger debts, based on the odd assumption that they’ll invest the loan and make a handy profit. If that hasn’t been the history of credit to the poor in the developed world, why should it be the case in poor countries, where fewer opportuníties to invest exist and where the experience that would make it safe is usually in short supply? There’s also an excellent study done by Tango Consulting for CARE Bangladesh that indicated that when microfinance institutions started to penetrate the North West of Bangladesh, the demand for moneylender credit increased at almost exactly the same rate – and a larger proportion of total household income went to debt service payments. The speculation is that moneylenders were used in order to service MFI debt. The biggest problem faced by rural micro-finance programmes is to create portfolios sufficient to support the higher costs of reaching remote places while knowing that debt-capacity is limited and the preference is for savings, not loans.

2. David Roodman Says:
   August 15th, 2009 at 7:20 am

   Thanks for the lead, Hugh. Is this the report you mentioned? I will definitely read it.

3. Dave Richards Says:
   August 15th, 2009 at 12:42 pm

   Hugh,

   I think you are making the same anecdote-to-conclusion argument that the WSJ is making. We can ALWAYS find examples of any system/program that isn’t working for someone.

   I have personally interviewed many MFI borrowers and the various studies I’ve read over the years have never cited any material issue for borrowers being (or feeling) required to take larger loan sizes. While I’m sure you can find some borrowers who believe this, this is just not a representative or mainstream issue. Frankly, it’s a red herring IMHO.

   When we quote anecdotal information and then draw generalized conclusions we do a great disservice by distracting from the larger, more important issues which need attention in order for the most positive overall social impact.

   I agree that the challenge with rural microfinance in some parts of the world is how to become profitable based on the higher cost of doing business in lower density population situations. (This is not an issue in most of India and Bangladesh as rural populations are generally very dense.) I disagree that the ONLY solution is higher loan sizes (or higher fees/interest rates.) I believe the right solution is innovation to increase operating efficiency. At Unitus, we continue to see entrepreneurs who are applying technology, partnerships and other innovative approaches to lowering their operating cost in order to reach out to rural poor with financial products which are reasonably priced for which both the client and the MFI can make a profit (sustainable). I believe that this is the way forward.

   Dave.

4. Daniel Says:
   August 26th, 2009 at 7:35 am

   I remember reading a note by Abhijit V. Banerjee worrying about these some of these issues back in 2002 (from a theoretical point of view):
   The Uses of Economic Theory: Against a Purely Positive Interpretation of Theoretical Results (available at http://papers.ssrn.com/sol3/pa....._id=315942 )

   His main concern at the time was that economists might be able to have a more positive impact on the lives on the poor if they spent more time working on normative issues (such as how to keep/make microfinance sustainable). Positive issues (such as whether a particular program worked well and, if so, why) were important but not everything.

5. V.Rengarajan Says:
   August 11th, 2010 at 10:32 pm

   Besides the issues at institutional levels, there are some factors at client level also influence the micro credit bubble.
   To my view with the given freedom to access micro credit from multi sources, there are two human factors at poor client household level (demand side) which influence more the nature of impact of micro credit at household level, irrespective of the loan size and market situation, are 1) ‘capability’ of the poor client for productive use of micro credit for income generation and 2) behavior of the poor- that is ‘propensity to consume’ fuelled by media resulting over consumption or conspicuous consumption leading to debt trap at micro level and pseudo development at macro level. . The latter plays more tempting role in increasing the desire of the human being as illustrated in RAMNAGARAM CASE in the above posting