The role of for-profit micro-credit firms in financial inclusion is the
subject of controversy. These firms extend credit to households that
have traditionally been denied credit by mainstream banking. Access to
credit for such households is supposed to alleviate liquidity
constraints and improve welfare.
However, there are concerns about whether such credit actually improves
the lives of borrowers. Poor people might make bad decisions about
credit; they may get trapped in indebtedness. For-profit firms might
charge usurious interest rates.
These concerns became particularly prominent when micro-finance firms
listed on stock exchanges with very high valuations (e.g. Mexico’s Banco
Compartamos in 2007 and India’s SKS Microfinance in 2010). Many people
were unhappy when billions were being made out of the task of serving
poor people.
Mohammed Yunus, considered the founder of micro-finance, has spoken out
against for-profit micro-finance firms. New regulations are being
created in developed countries like the US and the UK to better protect
the rights of customers of the ‘payday lending schemes’ that are
primarily used by the poor. Some governments have engaged in
interventions such as interest rate caps or outright bans. These
regulations are driven by the desire for consumer protection and
improving consumer welfare.
Stringent controls
In December 2010, Andhra Pradesh passed a law that effectively forced
the closure of the micro-finance industry by imposing stringent controls
on how payments could be collected and how new loans could be
originated.
The reason for this harsh intervention was consumer protection: several
borrowers were allegedly driven to suicide because they were harassed by
agents of micro-finance firms for loan repayments.
As a consequence of the ban, disbursements dropped to a mere 1.7 per
cent of loans disbursed prior to the ban. More than Rs7000 crore
micro-borrower loans were effectively in default, with recovery rates at
10 per cent.
At the same time that micro-finance came to a standstill in the State,
the assets of MFIs elsewhere in the country rose by 25 per cent. The AP
government tried to increase the disbursal of loans through self-help
groups. However, there was still a shortfall in credit to households,
which one estimate placed at about Rs 30 billion(‘Microfinance: the
state of the sector report’, 2010, 2011, and ‘The MicroScape, 2012’).
This was an intervention on a large scale: in 2010, AP had a population
of 84 million, out of which an estimated 27 million were in households
that borrowed from the micro-finance industry. Did this intervention
have the desired effect of improving household welfare? Going beyond the
impact upon the 27 million persons in borrower households, what was the
impact upon the population at large?
In a recent paper titled The real cost of credit constraints: Evidence from micro-finance,
Renuka Sane and I ask three questions: Was average household
consumption affected when micro-finance was banned? Which households
were more affected by the ban? Did the volatility of average consumption
change, indicating a higher inability of households to smooth
consumption?
Studying the data
We use data from the CMIE ‘Consumer Pyramids’ dataset to answer these
questions. CMIE releases average household characteristics collected
from a survey of a panel of 1,50,000 households from 200 geographical
regions across India.
This data is observed in each quarter from 2008 onwards. We use this to
calculate the average household consumption in 14 regions of AP each
quarter. We measure the impact of the ban as the difference in the
average consumption of AP households in the four quarters before and
after the ban. If there are changes visible in AP, these could have been
because of the ban or because of other macro-economic developments in
India.
Before we can attribute the observed change to the ban in AP, we need to
adjust for changes that might have taken place even if there was no
ban. For this we ask: What would average household consumption in AP
have been if there was no ban? For this, we identify regions outside of
AP with similar economic characteristics (such as number of households,
average income, education) but which did not implement a ban on
micro-finance. We compare the average household consumption between the
AP households (where the ban was in effect) and these ‘control’
households outside AP (where there was no ban) during the same periods.
The difference between the two can be attributed to the ban.
Decline in consumption
We find that consumption expenditure of households in AP decreased by
19.5 per cent as a consequence of the ban on micro-finance, compared
with those outside AP. This decline varied across components of
consumption: AP households spent 16 per cent less on food and 34 per
cent less on education as a consequence of the ban. Consumption across
all income groups was negatively impacted.
The impact was, however, bigger for households with liquidity
constraints, such as those in rural regions with access to fewer sources
of credit. There is also some evidence of higher volatility in the
expenditure on food in AP households after the ban, relative to
households in the control regions. This suggests greater difficulties by
households to smooth consumption as a consequence of the ban.
Our results thus suggest a fairly large negative impact of the ban on
micro-finance. While the ban was initiated by policymakers in AP under
the claim that this would help poor people, it has hurt everyone. This
analysis has two implications. The first is that even though consumer
protection is a noble goal, banning an industry is often not the right
way to improve things. Sophisticated thinking on consumer protection is
required. The second key idea is that government interventions should be
much more rooted in research and evidence. We will blunder from one
policy intervention to another, making mistakes along the way, unless
interventions are carefully analysed using the data.
(The author is Assistant Professor, IGIDR, Mumbai)
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