The continuing saga of the microfinance bubble

A recent article by Daniel Rozas pondered the existence of a microfinance bubble in South India. Rozas crunched the numbers and concluded that, in some areas, microfinance borrowing has overreached capacity. Rozas’s doesn’t have data on household finances, so he’s extrapolated from regional aggregates. The story is worrying, but he doesn’t nail it. 

The immediate risk of a bubble, of course, is that borrowers may be falling into a debt spiral, borrowing from one MFI to repay another. So far this does not seem to be the case. A IFMR-Centre for Microfinance study on multiple borrowing finds that multiple borrowers have an equal or lower arrears rate than their single borrowing peers. Rozas points out that the multiple borrowers in the study consisted primarily of highly motivated entrepreneurs seeking to raise more capital than what was offered by any one MFI.  However, similar to the way microentrepreneurs need to raise more capital than what is offered by any one MFI, borrowers often also need more cash for consumption needs than they can get from a single MFI. Just as you and I may have a car loan, a mortgage, a school loan and a credit card, microfinance borrowers may have one loan to pay for their children’s school fees, another to cover the cost of a relative’s funeral, and yet another to pay for food during the lean season—all of which are repaid from household cashflow.

The less immediate but greater risk of a bubble discussed by Rozas is that as clients carry higher debt loads, they have less room to absorb economic shocks. But having more loans doesn’t necessarily translate into a higher debt level. Rather than focusing just on number of loans, we should also look at loan size, maturity and repayment schedules. Many microfinance borrowers need cash infusions that are shorter-term and have more flexible repayment schedules than traditional MFI loan products. For poor households, cobbling together a portfolio of different loans can help bridge gaps and ensure that they have the cash on hand when they need it.

It’s also worth pointing out that in countries like India, where the regulatory environment makes it difficult for MFIs to collect savings, microfinance clients sometimes use loans as a substitute for saving. In the book Portfolios of the Poor, we saw that one way people patched together usefully larger sums was to take interest-bearing loans instead of using savings.  One woman justified her decision to take out a $15 loan (at 15% monthly interest) despite having $55 in a liquid savings account by explaining: “At this interest rate I know I’ll pay back the loan money very quickly.  If I withdrew my savings it would take me a long time to rebuild the balance.” Given the constrained set of choices that microfinance clients often face, this strategy is not altogether irrational.

Microfinance has a ways to go to fulfill the financial needs of the poor. They face significant challenges in consumption smoothing, risk management, and pulling together usefully large sums. These challenges require poor households to patch together a range of tools and mechanisms from a variety of sources. Often this includes multiple loans.

I’m not saying we should completely write off the possibility of a microfinance bubble. The truth is that MFIs do sometimes over-lend, due to limited information about whether households have adequate cash flow to service a loan, or pressure from competitors. But the flip side of this is that using multiple financial devices (loans, savings, insurance, etc.) is largely how the poor manage their financial lives—not necessarily an indication of a bubble.