Bubble in Indian Microfinance

See here.

The article implies that profit-seeking in the microfinance industry is the problem:

Some observers blame a fundamental shift in the microfinance business for feeding the problem. Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.

“We’ve seen a major mission drift in microfinance, from being a social agency first,” says Arnab Mukherji, a researcher at the Indian Institute of Management in Bangalore, to being “primarily a lending agency that wants to maximize its profit.”

However, this analysis is over-simplistic.  Presumably, the non-profit microlenders were relatively conservative in deciding whom to lend to.  As a result, they probably missed opportunities to lend to borrowers who could have repaid on time and who could have made good use of the money.  Therefore, a world in which only non-profit microlenders operates is a world with missed opportunities, that is, economic loss.

The profit-seeking firms were willing to take on more risk, and this involves making mistakes.  As a group, perhaps they made too many bad loans.  However, such a process is necessary to determine the optimal volume and make-up of a loan portfolio.  You can’t determine the optimal level if you are always undershooting, just like you can’t determine the optimal level of exertion when you are exercising if you never push yourself.  As microfinance is relatively new as a profitable activity, firms are still engaged in knowledge discovery; they are bound to make mistakes.  Going forward, those with the best mix of risk will be rewarded, as long as the government does not interfere with the market.

Meanwhile, borrowers over time will learn the risks entailed in borrowing.  If they are actually made to suffer for their poor decisions (and in many cases, outright lying; see below), then as a group, they will stop blaming other people (a.k.a. the lenders) and will start seeing their personal finances as their own responsibilities to manage.

All of this, of course, assumes that the lenders are not engaging in fraud, which I am sure is not always the case.  However, it is the government’s job to prosecute such fraud.  The Indian government has bureaucracies that only hurt its citizens.  It should redirect its efforts; perhaps, protecting its citizens against fraud would be a good start.

For those who doubt that at times, culture can retard the pace of economic development:

Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.

For another example:

But Ms. Sharma, a 29-year-old mother of three, acknowledges she lied. “You have to mention a business to get a loan,” she says. “There was no other way to get the money.” She used it to pay overdue bills and to buy food for her family. Ms. Sharma earns $8 a week, on average, in a factory where she extracts silk thread from cocoons.

…

Ms. Sharma, the heavy debtor, … would like to see the microlenders kicked out of the community entirely. “Not just for now, but forever,” she says.