Moneylenders and microfinance

The RBI has finally hit on a novel solution so that India can proudly say that its rural farmers are no longer indebted to usurious, unscrupulous moneylenders: call the moneylenders something else – “accredited loan providers” to be exact. That is the conclusion reached by the RBI’s Technical Group to Review Legislation on Money Lending in their report released three months ago. The report recommends that most restrictions on the practice of moneylending be removed and that moneylenders, or “accredited loan providers” in RBI’s lexicon, be given increased access to bank loans. The RBI hopes that by legitimizing the role of the moneylender it can both increase access to finance (since moneylenders themselves will be given more loans from banks and thus have more money to pass on to their borrowers) and reduce the most egregious cases of interest rate gouging and abusive practices by moneylenders.

Joking aside, the proposal is an interesting and creative one. Yet what worries me is that it involves huge reputational risk, for both the RBI itself and banks which would be induced to lend to moneylenders, and the gains, in terms of financial inclusion, are uncertain at best. One can only imagine the beating the RBI would take in the press if the proposal were to be adopted as law and a farmer lent to by an “accredited loan provider” committed suicide. (Indeed, the RBI is already taking a beating just for floating the idea.)

Similarly, it’s not clear if legitimizing moneylenders and inducing banks to lend to them would really translate into more or cheaper credit to those who depend on moneylenders for loans. Nobel laureate Joseph Stiglitz has shown that due to the monopolist nature of the money-lending market, subsidies to moneylenders may only result in an increase in profit to the moneylender. (no free online version: K. Hoff and J.E. Stiglitz (1997) "Moneylenders and Bankers: Price-increasing Subsidies in a Monopolistically Competitive Market", Journal of Development Economics, Volume 52, Number 2, pp. 429-462(34).) Furthermore, it's not certain that Indian moneylenders are strapped for cash in the first place or that banks, even with the prodding of the RBI, would be willing to lend to moneylenders at all. (Banks, after all, are not too big on lending to businesses with few tangible assets and whose profits they are unable to monitor.)

Is it just me or is the RBI staking way too much on a gamble with a very low potential payoff?