The heads of the various MFIs went to the commissioner’s superiors and got the order rescinded quickly, but the damage was done. People repay because other people repay, so once people stop, it is hard to get them to restart. One year later, 70 percent of the outstanding loans had yet to be repaid. Since then, Spandana loan officers have gone back to each of the affected villages and offered their customers new loans if they would only pay back the old ones (with no extra interest). These offers do work in some villages, and they have now managed to recover half of the outstanding loans, but the pressure to act as others do is evident.17 In some villages, everyone repays. In others, everyone refuses, even those who were only a couple of payments away from getting a new loan. Even among those who had just one more repayment to make to get a fresh loan (so that a payment of about 150 rupees would get them an extra 8,000 rupees, which they could either repay or even pocket, by defaulting again), one-fourth of loans with only one payment remaining have not been repaid. These defaulters tend to be members of groups in which no one else was repaying.
The Krishna repayment crisis was repeated, though without obvious political interference, in Karnataka and in Orissa respectively in 2008 and 2009, provoking the bankruptcy of KAS, another large microfinance institution. Everyone stopped repaying after KAS lost access to liquidity and could not disburse new loans. The crisis of fall 2010 in Andhra Pradesh was almost a repeat, on a grander scale, of the 2006 crisis. Once again, farmer suicides were used as an argument for politicians to attack the MFIs, and once again, repayments entirely stopped once the government stepped in. It brought some of the biggest microfinance institutions (SKS, Spandana, and Share) to the brink of bankruptcy. Such episodes suggest that MFIs might be right to focus on managing beliefs, and therefore it might make sense for them to insist on prioritizing repayment discipline over everything else. Opening the door to defaults, even as a way to encourage necessary risk taking, may lead to an unraveling of the social contract that allows them to keep repayment rates high and interest rates relatively low.
The necessary focus on repayment discipline implies that microfinance is not the natural or best way to finance entrepreneurs who want to go beyond micro-enterprises. For each successful entrepreneur in the Silicon Valley or elsewhere, many have had to fail. The microfinance model, as we saw, is simply not well designed to put large sums of money in the hands of people who might fail. This is not an accident, nor is this due to some shortcoming in the microcredit vision. It is the necessary by-product of the rules that have allowed microcredit to lend to a large number of poor people at low interest rates.
Moreover, microcredit may not even be an effective way to discover entrepreneurs who will then go on to set up large businesses. Microfinance gives its clients every incentive to play it safe, so it is not well suited to discover who has an appetite for risk taking. Of course, there are always counterexamples—every microfinance agency boasts on its Web site about corner shops turning into retail chains, but the instances are few and far between. The average loan that Spandana gives out increases only from 7,000 rupees ($320 USD PPP) in the first cycle to 10,000 rupees ($460 USD PPP) after three years, and there are almost no loans greater than 15,000 rupees ($686 USD PPP). After more than thirty years of operation, Grameen Bank’s loans remain, for the most part, very small.
HOW CAN LARGER FIRMS BE FINANCED?
But maybe it does not matter that microcredit is not designed to lend to larger borrowers. As we saw, credit constraints are likely to be much tighter for very poor borrowers than for somewhat richer ones. Perhaps there is a natural graduation process—start by borrowing from an MFI, grow your business, and then move on to a bank.
Unfortunately, it does not seem that more established businesses find it that much easier to get credit. In particular, they run the risk of being too large for the traditional moneylenders and microfinance agencies, but too small for the banks. In summer 2010, Miao Lei was a prosperous businessman in the city of Hangzhou, China. An engineer by training, he had gone into the business of setting up computer systems at various local firms. The problem was that he had to buy the hardware and software first and only after he set up the system would he get paid. No one would give him a loan. Once, he got a chance to bid on a particularly lucrative contract but it was clear that it would take more cash than he had on hand. However, the temptation was strong and he went ahead and bid. He remembers the days after his firm won the contract, running everywhere to try to raise the money, but nothing seemed to work. Defaulting on the contract would be the end of his career. In desperation, he decided to try to pull off an even bigger gamble. There was another contract up for bid, from a state-owned company, and he knew that if he won the contract he would get an advance, which he could use to finance the first contract. Then, perhaps, he could use the money from the first to pay for the second. He decided to put in a very aggressive bid—he was happy to lose some money to win it. He still remembers the evening when he was waiting to hear if his bid had been accepted. He sent the staff home early and spent hours pacing the empty office. In the end, his bid won, and somehow it all worked out. Money flowed in, and bankers with loans followed (once his revenues crossed 20 million yuan, bankers started coming to his door). By the time we met him, he was running four separate businesses.
Miao Lei, with a good degree and a reasonable business model, had to gamble to survive. Narayan Murthy and Nandan Nilekani, despite their degrees from the ultra-prestigious Indian Institute of Technology, could not get a loan to start the firm Infosys because the banker objected that the bank could see no inventory to lend against. Infosys today is one of the largest software firms in the world. It is hard not to assume that there are a lot more people like these three, but who just couldn’t make it because they didn’t get the right financing at the right time.
Even those businesses that do manage to get started, survive, and grow to a certain size don’t seem able to escape from being constrained in their access to capital. The town of Tirupur, South India, is India’s T-shirt capital (70 percent of India’s knitted garments are produced there). The firms operating in the region have a worldwide reputation: Buyers the world over go there to place large orders for their collections. Naturally, the town has attracted talented textile entrepreneurs from all over India. It also has many local entrepreneurs, the scions of wealthy farming families (from the Gounder caste). The outsiders are, not surprisingly, the experts in this line of business. The firms they run are much more efficient than those started by Gounders. For any level of capital, they produce and export more. What is more surprising, though, is that the average firm owned by a Gounder starts out with about three times more capital than those started by outsiders.18 Instead of lending money to the outsiders who were the experts in this line of business, wealthy Gounders started their own firms, despite the fact that they had no experience at all. Why did they do that? Or for that matter, why didn’t banks jump in and help the outsiders set up larger businesses? The answer is that even largish firms like these (the average firm owned by an outsider had a capital stock of 2.9 million rupees, or $347,000 USD PPP) are subject to the problems we described earlier. The Gounders started their own firms because they trusted their own community, and they were not sure the outsiders would repay them.
Recognizing this problem, developing countries have tried to use regulations to get banks to lend to these somewhat larger enterprises. India has a “priority sector” regulation, which constrains banks to lending 40 percent of their portfolios to the priority sector, consisting of agriculture, microfinance, and small and medium enterprises, which can include quite large firms (the largest eligible firms are larger than 95 percent of Indians’ firms). And firms were clearly able to invest some of these funds productively. When the priority sector was expanded in 1998 to include somewhat larger firms, the firms that were newly eligible invested the extra loans they got by virtue of being in the priority sector and made a lot of money. A 10 percent increase in loans l
ed to an increase in profits of 9 percent, after repaying the loan.19 This is a fantastic rate of return. However, the fashion nowadays is very much to eliminate this kind of mandatory lending, in part because banks complain that lending to these firms is expensive and too risky.
There exist some people who are trying to identify promising new businesses and fund them. Miao Lei, the businessman from China, does precisely that, perhaps because of his own experience. He buys equity in promising young businesses. But we are far from seeing the equivalent of the microfinance revolution for small and medium firms; nobody has yet figured out how to do it profitably on a large scale. Changes in the business environment, such as improvements in the functioning of courts, may well make a difference. In India, the introduction of faster court action led to much faster loan recovery, larger loans, and lower interest rates. However, this is not a magic bullet, either. When the debt recovery tribunals were introduced, lending to the largest firms increased, but lending to the smaller firms actually went down.20 This appears to be because the bank officer found it relatively more profitable to lend to the largest firms now that the bank could be sure it could collect on the asset the firm had pledged.
Ultimately, this problem stems from the structure of banks. Because they are, by nature, large organizations, it is hard for them to provide incentives to their employees to screen the firms, monitor projects, and make worthwhile investments. For example, if they decide to punish loan officers for default (which, to a point, they must), loan officers start looking for the absolutely safest projects, which are unlikely to be small, unknown firms. A future Miao Lei or Narayan Murthy may well go unfinanced.
The microfinance movement has demonstrated that, despite the difficulties, it is possible to lend to the poor. Although one may debate the extent to which MFI loans transform the lives of the poor, the simple fact that MFI lending has reached its current scale is a remarkable achievement. There are very few other programs targeted at the poor that have managed to reach so many people. However, the structure of the program, which is the source of its success in lending to the poor, is such that we cannot count on it to be a stepping-stone for larger businesses to be created and financed. Finding ways to finance medium-scale enterprises is the next big challenge for finance in developing countries.
8
Saving Brick by Brick
Driving from the city center toward the less affluent suburbs in almost any developing country, one is struck by the number of unfinished houses. There are houses with four walls but no roof, houses with a roof but no windows, would-be houses that might have an unfinished wall or two, houses with beams sticking out of their roofs, walls that someone started painting but never finished. Yet there are no cement mixers or masons in sight. Most of these houses have not been worked on for months. In some of the newer neighborhoods of Tangiers, Morocco, this is so endemic that the finished and freshly painted houses are the ones that stand out.
If you ask owners why they keep an unfinished house, they generally have a simple answer: This is how they save. The story is familiar. When Abhijit’s grandfather earned some extra cash, he would add a room to the house. This is how, one room at a time, more or less, the house where his family still lives was built. Poorer people cannot afford a whole room. Abhijit’s family used to have a driver who would occasionally ask for a day’s leave. He would buy a sack of cement, a sack of sand, and a stack of bricks and would take a day off to lay some brick. His house was built over many years, 100 bricks at a time.
At first sight, unfinished houses don’t seem to be the most attractive savings instrument. One cannot live in a roofless house; a half-built house can collapse in the rains; and if money is needed for an emergency before the house is finished and it has to be sold incomplete, the partial construction may be worth less than what it originally cost to buy the bricks. For all these reasons, it would seem more practical to save cash (say, in a bank) until enough money has accumulated, and then build at least an entire room, complete with a roof, in one go.
If the poor still save brick by brick, it must be because they have no better way to save. Is it because banks have not found a way to collect the savings of the poor, and there is a “microsaving revolution” waiting to happen? Or is there something we haven’t yet thought of that makes an unfinished house an attractive investment? And should we be impressed by the extraordinary patience of people, often living on less than 99 cents a day, who will deprive themselves of some of the little pleasures of life for years in order to complete their houses? Or surprised by the fact that, if building the house brick by brick is the only way to get to own a house, they don’t try to save more to build it faster?
WHY THE POOR DON’T SAVE MORE
Given that the poor have little access to credit to finance their ventures, and limited insurance to cope with risks, shouldn’t they try to save as much as they can? Saving would give them a buffer against a bad year in the field or an illness. It could also hold the key to starting a business.
At this point, one common reaction is, “How could the poor save—they have no money?” But this is only superficially sensible: The poor should save because, like everybody else, they have a present and a future. They have little money today, but unless they expect to stumble on a pile of cash during the night, they presumably also expect to have little money tomorrow. Indeed, they should have more reason to save than the rich, if there is at least some possibility that, in the future, a little bit of buffer could shield them from a disaster. Such a financial cushion would, for example, allow the poor families in India’s Udaipur District to avoid cutting meals when money runs out, which they claim makes them extremely unhappy. Likewise in Kenya, when a market vendor falls ill with malaria, the family ends up spending a part of the business working capital to pay for medicine, but that makes it hard for the recovering patient to go back to work because now he has little or nothing to sell. Couldn’t they avoid all that if they had some money set aside to pay for the drugs?
The Victorians thought that was just how the poor were—much too impatient and unable to think far enough ahead. Consequently, they believed that the only way to keep the poor from sinking into a life of sloth was to threaten them with extreme misery if they ever strayed from the straight and narrow. So they had the nightmarish poorhouse (where the indigent were housed) and the debtors’ prisons that Charles Dickens wrote about. That view of the poor as essentially different people, whose innate inclination toward shortsighted behavior is what keeps them poor, has persisted over the years in slightly different forms. We see a version of the same view today among the critics of microfinance institutions who accuse the MFIs of preying on the profligacy of the poor. In a very different vein, Gary Becker, the Nobel Prize winner and father of the modern economics of the family, argued in a 1997 paper that the possession of wealth encourages people to invest in becoming more patient: By implication, therefore, poverty makes people (permanently) more impatient.1
One of the great virtues of the recent movement, among microcredit enthusiasts and others, to recognize the nascent capitalist inside every poor man and woman is that it moves us away from this view of the poor as either carefree or totally incompetent. In Chapter 6 on risk and insurance, we saw that the poor are in fact constantly worrying about the future (particularly about looming disasters) and take all sorts of ingenious or costly preventive measures to limit the risks they are subject to. Poor people show the same kind of ingenuity when managing their finances. They rarely have an account in a formal savings institution. In our eighteen-country data set, in the median country (Indonesia), 7 percent of the rural poor and 8 percent of the urban poor have formal savings accounts. In Brazil, Panama, and Peru, that number is less than 1 percent. But they save, nevertheless. Stuart Rutherford, the founder of SafeSave, a microfinance institution in Bangladesh that focuses on helping the poor to save, tells about how they do this in two wonderful books, The Poor and Their Money and Portfolios of the Poor.2 As background
for that book, 250 poor families in Bangladesh, India, and South Africa described every single one of their financial transactions to survey researchers who visited them every two weeks for an entire year. One of their main findings is that the poor find many ingenious ways to save. They form savings “clubs” with other savers, in which each member is supposed to make sure that the others achieve their savings goals. Self-help groups (SHGs), popular in parts of India and found in many other countries as well, are savings clubs that also give loans to their members out of the accumulated savings of the group. In Africa, the most popular instruments are rotating savings and credit associations (ROSCAs)—more commonly known as “merry-go-rounds” in English-speaking Africa and as tontines in Francophone countries. ROSCA members meet at regular intervals, and all deposit the same amount of money into a common pot at every meeting. Each time, on a rotating basis, one member gets the whole pot. Other savings arrangements include paying deposit collectors to take their deposits and put them in a bank, depositing savings with local moneylenders, leaving them with “money guards” (acquaintances who take care of small sums of money for a little fee, or for free), and, as we saw, slowly building a house. Similar institutions also exist in the United States, mostly within recent immigrant communities.
Jennifer Auma, a market vendor in the small town of Bumala in western Kenya, embodies this sophistication. Auma sells maize, sorghum, and beans. During our entire conversation, she expertly sorted beans, the red ones to one side, the white ones to the other. When we met her, she belonged to no fewer than six ROSCAs, which differed in size and frequency of meeting. In one of them, she contributed 1,000 Kenyan shillings, or KES ($17.50 USD PPP), per month, in another one 580 KES twice a month (500 for the pot, 50 to pay for the sugar for the tea, which is an essential part of the ceremony, and 30 for the welfare fund). In another, the contribution was 500 KES per month, plus 200 as extra savings. Then there was a weekly ROSCA (150 KES per week), one that met three times a week (50 KES), and one that was daily (20 KES). Each ROSCA had a specific, separate purpose, she explained. The small ones were for her rent (this was before she built a house), the bigger ones for long-term projects (such as house improvements) or for school fees. Auma saw many advantages to ROSCAs over traditional savings accounts: They don’t have fees, she could make small deposits, and on average she got access to the pot much faster than it would take her if she saved the same amount every week. Moreover, the ROSCA group was also a good place to ask for advice.
Poor Economics Page 21