Microfinancing consumers

Microfinancing consumers

Microfinance institutions (MFIs) have been partially filling the gap left by bigger banks, and providing financial services to the unbanked population. They have been providing microcredit to borrowers for income generating and consumption, based on group guarantee—making one’s neighbour a co-signatory on the loans builds up the peer pressure that can ensure repayment. However, based on the observations and analysis of the portfolio of MFIs, it has been found by rating agencies that the majority of the microcredit provided to group members are strictly for income-generating activities, but not broader consumer finance.

In fact, even if borrowers of a group show good credit history for four or five loan cycles, MFIs end up providing loans directly to individuals without group guarantee. But this is still only for income-generating activities.

Rating agencies expect that as the income levels of borrowers improve, they would also require consumer credit. Now, the question arises whether MFIs should enter into consumer financing and how it would help borrowers. What are the risks involved in providing consumer finance by MFIs?

Microfinance borrowers, apart from accessing credit from MFIs for income-generating purposes, would also be tapping other sources of credit to purchase consumer appliances. Purchase of such consumer appliances or electronics or machinery may directly or indirectly affect their existing sources of income-generating activity as its use may yield higher income for the borrower. For example, if a general store owner purchased a refrigerator, it would lead to better storing of perishable items, thereby bringing additional income from the sale of these items.

Thus, provision of consumer credit from MFIs would help borrowers in increasing income and improve their economic status. But MFIs should provide consumer finance to only those borrowers whose activity is directly linked to the purpose for which the borrower is seeking consumer credit. For instance:

• Purchase of refrigerator for a borrower engaged in tailoring might not be useful; however, for a general store owner, it would be useful for storing cold drinks and other perishable items—thus increasing business.

• Purchase of two-wheeler (such as a motorcycle) for a borrower engaged in selling milk or dairy products would be useful, whereas for a person involved in sheep rearing, it may not lead to any increase in income.

• A borrower who acts as an intermediary in selling agricultural products such as rice and wheat would benefit from the purchase of a mobile phone.

However, MFIs also need to exercise caution since consumer financing may not necessarily be backed by group guarantee—leading to higher risks. Such financing would also increase indebtness of the borrower and put pressure on their debt repayment capacity in case products purchased under consumer credit do not lead to a substantial increase in income.

Thus, it’s only those MFIs with many years of experience in microfinance and with an established client base (and, hence, credit history) who should explore this option. Apart from this, screening of clients by the loan officer would also be an important step. MFIs also need to have excellent systems to track the performance of their borrowers on a constant basis to reduce the probability of default.

Soumendra K. Dash is an economist based in Mumbai. Comment at otherviews@livemint.com