What Does Productive Loan Use Look Like?

In a January 2008 conference organized by CMF and the College of Agriculture Banking (CAB), Professors Esther Duflo and Abhijit Banerjee presented a baseline dataset, developed during an ongoing CMF study on Spandana’s micro-lending program, which provides insight into how households use loans (which this entry focuses on), and the make-up of tiny family-run enterprises. The dataset derives from a survey of about 2400 randomly selected households from 120 “small” slums located in or near Hyderabad city, and results are summarized here.

Before jumping into the numbers, it could be good to provide a little background on the loans received by households in slums around Hyderabad. 60% of surveyed households have at least one outstanding loan, and 46% of the households have more than one outstanding loan. The average loan size was Rs 20,000 (median was Rs. 10,000) and the average interest rate was about 80% a year. Loans received in these slums rarely came from commercial banks or MFIs, and instead mainly came from the following sources:

• Moneylenders (49%)
• Friends or neighbors (28%)
• Family members (13%)

Taking a Closer Look at How Borrowers Use Loans
When people were asked why they took out the loans, business creation or expansion were both not near the top of the list. People took out loans for other pressing needs, as the numbers below indicate:

• Health expenses (17%)
  
• Marriage (13%)
• Temporary difficulty (10%)
• Home construction (10%)
• Consumption (10%)
• Start a new business (7%)
• Business expansion (1.33%)

As Banerjee and Duflo point out in the last two slides (pages 12 and 13) of this presentation of the baseline data here, credit is acting partly as a substitute for insurance. Virtually none of the households have health insurance, and 40% needed to spend Rs 500 or more on health in the last year. Moreover, the average health expense was Rs 7,500 (median Rs 3,000), and about 60% of households with a sick member needed to borrow money to pay for related health expenses.

Additionally, many of the other top reasons for taking out loans, such as home construction or temporary difficulty, could be viewed as productive loan use. Which raises the question, what is productive consumption, and how much of a role should MFIs play in compelling loan recipients to use loans for business creation/expansion or other specific uses?

Overall, I think this data indicates low-income households often use loans for core needs such as health and home construction. When they do not use loans in a productive manner, they are often used for critical social events (e.g., marriage), which is unlikely to change anytime soon. Therefore, as MFIs develop credit products, this reality should be kept in mind; not everyone can start their own business. But, the majority of borrowers use loans in a productive manner because people do want a roof over their heads and ways to help sick loved ones. Creating specialised credit products (e.g., for business assets in urban areas, livestock in rural areas) or excessive monitoring of loan use may not be worth the trouble.

I would love to hear thoughts on this topic – should MFIs provide/create loans targeted for business creation or expansion (or other targeted purposes), or do general loans work more efficiently?