What Does Productive Loan Use Look Like (part 2)

This entry is intended to expand on Michael Chasnow’s entry “What Does Productive Loan Use Look Like,” which you can find by scrolling down or clicking on the link.

Michael uses data from a household survey conducted in the slums of Hyderabad to demonstrate that borrowers in that context generally do not take out loans with the intention to use the money for starting a new business or business expansion. In the study Michael cites only a very small percentage of loans come from MFI or other formal finance providers. I thought it might be interesting to look at loan usage in another setting with greater access to formal finance penetration. Don Johnston Jr. and Jonathan Morduch’s paper “The Unbanked: Evidence from Indonesia” which examines survey data collected by Bank Rakya Indonesia (BRI) does just this.

For a little quick background, BRI is a massive state bank focused on microfinance that has penetrated into virtually all of Indonesia. The Bank has over 30 million savers and over 3 million borrowers. Highly profitable and publicly traded, it is one of microfinance’s greatest commercial success stories. BRI distributes loans of similar size and length to what is currently offered by most Indian JLG based MFIs, but there is no group liability mechanism.

In 2002, BRI administered a survey to 1,432 respondents across 6 provinces of Indonesia to “map the financial landscape and gauge potential markets.”* Respondents were randomly chosen from the nation census and both current BRI customers and non-customers were interviewed. Loan usage data was collected and BRI found the following:

- For respondents who were below the poverty line (BPL), 49% of all loans were used for business; the other 50% was used for household and “other” purposes. For respondents whose households lived above the poverty line the number rises to 56%.

- When given a loan from BRI or another formal bank (not including MFIs), around 60% of BPL households used their loan for business purposes. The percentage drops to 33% when considering only loans from informal sources and MFIs (in this case 55% of loans are used for household purposes). Notably, the number rises to around 47% for non-BPL households.

If you read Michael’s post on the Hyderabad data you may have noticed that the percentage of loans used for business is much higher in the BRI survey. There are a variety of possible reasons for this, including the fact that the Indonesia survey was targeted at a cross section of the population including those with access to credit, while the Hyderabad survey was conducted in slums with very little credit access. The numbers become much closer when looking at only informal and MFI loans to BPL families, and if MFI loans were removed from BRI survey perhaps the numbers would converge even more.

It seems to me clearly established that although important, loans for financing business expansion or start ups are not the only kinds of loans that poor consumers are demanding and when they do receive MF loans, that those are not the only purposes for which they are using them. We also know that the far majority of microfinance loans are given specifically with the stipulation that they be used for “productive”/business purposes. The question then becomes whether this is a problem?

In Amy Mowl’s 2006 interview with Malcolm Harper, former chairman of the Indian MFI BASIX, for the CMF’s newsletter, they had the following exchange:

Mowl: Even in the South when client incomes may be relatively higher, many of us have seen "productive" loans being used for consumption. Is there value in MFIs holding clients to the discipline of borrowing only for productive purposes?

Harper: I think its nonsense. And it does matter because it induces falsehood at an early stage of the relationship, which can easily lead to falsehood in more important things. If the client is forced to lie and say she's going to use it for a productive purpose and she's not, then that's the beginning of a slippery track to saying she's going to repay and she won't. It's nonsense. Luckily it's not nonsense that makes much of a difference as clients ignore it.Moreover, it's overambitious in the sense that it assumes that it gives the impression that if someone is a client of an MFI she's automatically got a livelihood, which of course she hasn't. It also exaggerates the importance of loans as opposed to other services, because if you need to start a little business you need something to invest and therefore you need a loan before you need anything else which is rubbish. So it both exaggerates what microfinance can do and distorts the emphasis of the products that are offered. And at the same time it understates what it can do in that microfinance can provide a full range of services—insurance, all these things—that goes far beyond running your own business. So it's very damaging in every respect.And it's part of a broader illusion and rhetoric that I still see coming out of some high-level meetings where they're still talking about micro-entrepreneurs... about microfinance being about creating this world of millions of self-employed women, which is totally unrealistic in terms of any long term goal. I've never seen what we would call a rich, developed economy which consists of millions of women sitting around selling bananas.There is anther aspect of this consumption and production division which continues to infuriate me, in which education and health are regarded as "consumption", somehow as a bad thing to spend money on. So it's sad to see the same silly rhetoric still being pumped around.

In contrast, I recently had a discussion with the director of a small MFI in Eastern India, who will remain unnamed, about the insistence on using loans for livelihood activities. In so many words, he told me that he knew people were going to use their loans for non-business activities but that he still thought forcing them to pledge to use the funds for business was constructive. He believes that for a portion of clients the pledge helps them stick to their original intention and maintain their discipline towards using the loan in a way that might make them better of in the long run, rather than spending the money on a short term need. His attitude was basically, “it can’t hurt, and it might do a little good.” Harper’s attitude is “it can’t help, and it might do a little harm.” I honestly find both viewpoints compelling.

At CMF, several of our research projects look into loan usage and the way that loan products can be created so as to stimulate productivity. Most apropos is a project in Kolkata which CMF is currently with the Village Welfare Society (VWS). The goal of this project is to see whether a moratorium on repayment for several months, instead of the status quo in which repayment begins the week after loan disbursement, will increase the use of loans for larger investments. The idea being that MFIs might be better off spending their time creating products that are actually catered to investment than collecting hollow pledges. So for lack of a better term, stay tuned…

* The main finding that Johnston and Morduch present in their paper is that there were a surprisingly large number of respondents that BRI deemed creditworthy who choose not to borrow. (the survey was administered by loan officers who assessed the creditworthiness of all respondents)