The Indian Economy Blog

October 19, 2006

Microfinance, Hurricane Katrina And Rural India

Filed under: Miscellaneous — Amit Varma @ 3:43 pm

Mohammad Younus has an excellent piece in the Wall Street Journal on how microfinance can be used to rebuild the areas affected by Hurricane Katrina.

But can microfinance work in all conditions? I don’t know much about the local economies of New Orleans or Mississippi, but it’s not been a roaring success in India yet. Karthik/SK/Wimpy/SKimpy explains why it is “not exactly suited for the Indian context”:

The simple fact is that in rural India, the major demand for loans comes from agriculture, which involves large negative cash flows up front and (hopefully) large positive cash flows a few months down the line and the microfinance institutions here barely seem to understand this.

One of the fundamental principles of finance is that the cash flows of the source of funds should approximately match the cash flows of the application of funds. And therein lies the major failing of Indian microfinance. What Equated Weekly Installments implies is that if I give you a loan at the beginning of the crop cycle, I expect you to pay me a large part of it before the completion of the cycle! And the only way (in most cases) that you can make such payments is by going to the local moneylender, thus getting stuck in a debt death spiral.

The reason the model has worked so successfully in Bangladesh is because there the loans are not for agriculture. They are doled out to women so that they can start their own small businesses, which usually yield steady weekly cash flows – you might notice that the cash flows from the business are in tune with the cash flows from the loan.

A fine insight.

(SKimpy link via email from Aadisht.)

7 Comments »

  1. Cautionary words on the limitations of microfinance by Thomas Dichter is worth a read.

    Comment by The Rational Fool — October 19, 2006 @ 6:50 pm

  2. “One of the fundamental principles of finance is that the cash flows of the source of funds should approximately match the cash flows of the application of funds.”
    I consider credit cards in western economies to be: a)perfect microfinancial institutions, b)more than willing to ignore the principle quoted above because the more longer the repayment cycle, the more money they make. That’s why in the west, credit cards fuel business start-ups and expansion which require large cash infusions upfront and very slow repayment cycles. Why don’t credit card companies in India go after the rural agriculture clientele? The long payment cycle of agriculture would suit the credit card companies’ profit model just fine.

    Comment by Sarat — October 20, 2006 @ 3:58 am

  3. “One of the fundamental principles of Finance is that the cashflows of source of funds should approximately match the cashflows of the application of funds”
    In the case of large commercial borrowers,banks can appoint their staff or even external agencies to monitor the utilisation of funds.But we ca’nt expect illiterate or semi-illiterate farmers toknow the principles of financial management.So naturally they are tempted to spend the loan money on family functions,marriages of their daughters etc.When the next season comes,local money lender helps them out in repaying bank loan so that they can obtain freash loan.
    btw,Indian micro finance institutions do not copy grameen bank model.Effectiveness of self help groups,as a model of mfi,in the poverty alleviation schemes can be a subject of debate.But i will not call them as failures

    Comment by con man — October 20, 2006 @ 11:48 am

  4. This is an interesting take on the misfit of microfinance in India. I think what you are saying, however, is that microfinance does not work so well in the agricultural sector. This does not mean it is not a good fit in India. Also, because microfinance happens at the level of extremely small institutions (e.g., small banks, cooperatives, or NGOs), adpatation to local situations can occur much more rapidly than it can in the “one-size-fits-all” model that tends to be applied by large development banks.

    Given this, I think that microfinance institutions can learn to change their approaches with respect to India’s farmers. On the other hand, if the loans required by Indian farmers are larger than the average loan sizes microfinance institutions usually make, perhaps these institutions will simply decide that India’s agricultural sector is outside the realm of microfinance’s ability to make a difference.

    Comment by Stephen Zavestoski — October 23, 2006 @ 10:23 pm

  5. I am not sure the ‘fine insight’ is really an insight. I don’t think the authors know what they are talking about.

    The reason microcredit works in Bangladesh is because it is used for generating income substitution (usually by women) – buy that cow or chickens or cell phone. Microcredit is not about long-term loans and high initial investment – it’s about small borrowing, small investment, and tiny payments. Of course the agriculture loans are not sustainable because that’s not what microcredit is about. And it’s not like Bangladesh and India are thousand miles apart and culturally polar opposites. One can’t switch the definition and brand it a failure.

    Comment by Chandra — October 28, 2006 @ 11:56 am

  6. Micro-finance to provide loans for India’s farmers is the same system being applied nearly everywhere like those in Third World countries like the Philippines, though micro-finance in that country is being provided by both the national government—through agri-based agencies—and the private sector and cooperatives.
    But in essence loans—even micro-finance loans intended to enable borrowers to empower themselves by enabling them to buy the equipment or fiannce the business they need—are viewed as nothing more than dole outs by the recipients and this is one cycle government and its constituents must break.
    In other, more wealthy countries, some don’t have the luxury of waiting for processing on their loans since they want to secure it immediately to either address personal emergencies or to shore up businesses.
    Hence institutions like payday loan groups flourish to provide financial aid not only for financial emergencies but also to help prop up businesses. Thus securing payday or cash advance loans either online from sites like findmypaydayloan.com is one way of providing capital for that prospective venture.

    Comment by jordan elliott — December 18, 2006 @ 8:33 pm

  7. Well with all the publicity around micro loans now, we will certainly see where it works. My feeling is that it won’t work unless the individuals involved are driven to be reliable. If their is stron community, there is pressure not to ruin the system. But in a place where social ties are broken, it’s “ever man/woman for herself” and I don’t think it will work.

    Comment by eric — April 15, 2007 @ 1:20 pm

  8. When a Micro Credit loan is considered for sanction, the repayment installments are calculated based on the total household income and not necessarily from the income of the activity considered for financing. As such agriculture loans can also be given and repayments may be fixed based on the household income.

    Comment by Olee Bora — July 11, 2007 @ 4:50 pm

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