Moneylending: Friend or Foe of Microfinance?

An ongoing study conducted by Innovations for Poverty Action (IPA) and the Center for Microfinance (CMF) seeks to gain a better understanding of moneylending in India. This study occurred as part of IPA’s project to illuminate the business practices of informal lenders and the relationship of these lenders to their institutional counterparts across five different countries: India, Ghana, the Phillipines, Mexico and Columbia. The study in India was conducted in the Fall of 2009, and, through 48 moneylender interviews and 44 borrower interviews, reveals the prevalence of high-interest informal loans. While informal lenders are notorious for these high-interest rates, little attention is paid to the important role that these lenders play in the financial lives of many of their borrowers. The duality that exists between usury and relief renders the moneylender a complex agent in the world of low-income financial services and hinders any clear-cut solutions to the problems they pose.

Can Moneylending be Regulated?

A crux in the debate over the treatment of moneylenders hinges on the question of whether moneylenders can be harnessed into regulatory control. From the moneylender perspective, the risks involved with registration include income tax liability and interest rate regulation. Despite these risks, there are also benefits associated with registration, including: ability to accept collateral, legal recourse for defaulted borrowers and decreased leverage for officials requesting bribes. Borrowers also stand to benefit from registration: registered moneylenders would be legally required to charge lower rates. While it is likely that registration has a downward effect on interest rates, registered moneylenders might employ similar tactics to registered pawnbrokers in charging interest beyond the monthly rate allowed by law.

Beyond Registration: Moneylenders as agents of MFIs?

Beyond regulation/registration, which would exert this downward effect on rates and introduce a large taxable income, there are discussions of directly incorporating moneylenders into the business practices of formal institutions, including MFIs. (For example, Sharma & Chamala in Economic & Political Weekly, 2003). After speaking with moneylenders and borrowers alike, I feel that considering such linkages yields compelling and thought-provoking solutions to the usurious, and sometimes abusive, threats posed by the moneylender. Moreover, these linkages might benefit borrowers by ensuring continuous access to credit as sources of institutional credit grow to fill the vacuum currently filled by informal lenders. Until microfinance organizations and other loan-giving institutions are able to reach adequate scale, it is important to enable moneylenders to maintain their business operations as they represent a significant source of credit for many underserved populations.

What are the advantages of incorporating moneylenders into MFIs?

Incorporating moneylenders as agents of microfinance institutions would present a low cost opportunity for microfinance institutions to achieve scale. The overlap between moneylender and MFI clients presents a jumping off point for the merits of such linkages: moneylenders possess valuable community contacts among the demographic that MFIs target, including the lower-income populations that MFIs struggle to reach. The feasibility of this linked moneylender model is supported by the dual lending structure favored by several SHG leaders interviewed in this study, who provided both SHG-funded and privately-funded (moneylender) loans depending on the availability of SHG capital and the needs of their borrowers/SHG members. Under this model, borrowers were not driven away from MFIs in the face of urgent capital needs, as many other borrowers reported they were, but instead, encouraged to stay within the low-interest realm of their SHGs in the case of emergency. Moreover, the comfort of most borrowers interviewed taking moneylender and MFI loans simultaneously corroborates the feasibility of such linkages.

Beyond increasing the reach and reliability of microfinance loans, the moneylender-as-microfinance-agent model might also enable MFIs to diversify the loan products offered without compromising their regular cash flows. While valuable to the business model and profitability of MFIs, the rigid repayment schedule was commonly cited as a shortcoming of microfinance loans among borrowers. In contrast, these same borrowers cited the flexible repayment schedule allowed by informal lenders as one of the advantages of moneylenders. Through moneylender-MFI linkages, moneylenders could potentially perform a bundling function and collect payments from borrowers on a different schedule than the rigid schedule required by microfinance organizations and submit these payments to MFIs according to the original repayment schedule, thus allowing MFIs to manage regular cash flows.

What Obstacles exist?

From the MFI perspective, these linkages become especially promising in areas where there is less microfinance penetration, such as Ahmedabad. However, it is in these low penetration areas that moneylenders might be most resistant to these linkages. An appealing commission structure would be instrumental to incentivize moneylenders to participate as agents. Although the downward pressure on interest rates would be a deterrent, moneylenders might place a premium on the higher rate of (timely) return enjoyed by MFIs. Based on moneylender interviews and direct observation of moneylender practices, it is evident that delinquent payments are a constant cause of concern and drain of resources. Collection of these delinquent payments consumes a significant amount of time for almost all lenders and the missed payments present a significant opportunity cost to lenders who are limited by capital constraints.

Considering these linkages, the question becomes how to incorporate moneylenders into MFI structures and not how to eradicate moneylending practices. While obviously many questions remain, such as whether linked moneylenders would be allowed to provide independent loans, one thing is for certain, more expansive notions on how to deal with moneylenders would be beneficial to MFIs and borrowers alike. Linkages between moneylenders and MFIs present one possible solution to ameliorate the financial services available to low-income borrowers, yet sociological questions determine the potential for implementation. Is the social stigma of moneylenders too formidable? Would informal lenders ever trust MFIs enough to enter into business partnerships?