November 17, 2010

The Dark Side of Microcredit

Personally, I've always been suspicious of the ethics of for-profit microlending. Its defenders claim that if it were limited to non-profit philanthropy, there would be much less money available to aid the myriad poor villagers in the developing world where it is desperately needed. Capitalism begets capital.

That sounds like a decent utilitarian argument. Trouble is, from a more principle-based position, there is something unseemly about saddling the working poor with interest rates so high they would be considered usurious in the U.S. Indeed, several U.S. states have regulated payday lending rates to below half (24%-36%) of what is common in international microcredit (80%-100% or more). The Federal government makes it illegal to sell payday loans to military personnel at higher than 36% interest.

As with payday debtors, microloan-debtors pressured to repay profit-driven creditors can find themselves drowning in debt very fast. And that's exactly what is happening now in India. Here's an excerpt from this NYT report:
Responding to public anger over abuses in the microcredit industry — and growing reports of suicides among people unable to pay mounting debts — legislators in the state of Andhra Pradesh last month passed a stringent new law restricting how the companies can lend and collect money.

Even as the new legislation was being passed, local leaders urged people to renege on their loans, and repayments on nearly $2 billion in loans in the state have virtually ceased. Lenders say that less than 10 percent of borrowers have made payments in the past couple of weeks.

If the trend continues, the industry faces collapse in a state where more than a third of its borrowers live. Lenders are also having trouble making new loans in other states, because banks have slowed lending to them as fears about defaults have grown.

Government officials in the state say they had little choice but to act, and point to women like Durgamma Dappu, a widowed laborer from this impoverished village who took a loan from a private microfinance company because she wanted to build a house.

She had never had a bank account or earned a regular salary but was given a $200 loan anyway, which she struggled to repay. So she took another from a different company, then another, until she was nearly $2,000 in debt. In September she fled her village, leaving her family little choice but to forfeit her tiny plot of land, and her dreams.

“These institutions are using quite coercive methods to collect,” said V. Vasant Kumar, the state’s minister for rural development. “They aren’t looking at sustainability or ensuring the money is going to income-generating activities. They are just making money.”
One might go so far as to argue that for-profit microlending is immoral in any case, and should be banned the way commercializing organs already is in most countries. England goes so far as to ban the commercialization of blood. A good capitalist might again counter that as with microlending, such restrictions would diminish supply. Interestingly however, this doesn't seem to happen as there is rarely if ever any lasting shortage in British blood banks.

Ethicists including Peter Singer argue that's because when people are made to realize that the only way those who need the blood will get it is for others to give it freely, more people feel compelled to give and give more. We thereby preserve the possibility of altruism, the argument goes, strengthening human bonds by appealing to our better natures. If so, then perhaps this would also happen if governments banned for-profit microlending. But the genie is out of the bottle now so it may be too late to realistically consider it an option. Even so, the practice could be regulated with caps on interest as with recent increases in U.S. payday lending restrictions.

10 comments:

  1. Good take on the Indian on Microfinance lending problems.

    Sonia

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  2. Thanks Sonia. Interesting blog you have as well. Like your post today on the new ERC report on regulating white collar crime.

    We can see evidence of the fact that it becomes rational to be corrupt in many places. Goldman Sachs is a conspicuous example as I myself blogged just a few days ago.

    One thing that I support that was not mentioned is a return to principle-based accounting regulations like they have in Europe, namely, where a company can be sued for skirting the spirit of the law.

    Do you have thoughts on this as an accountant?

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  3. Julian,

    Thanks for the appreciation. Personally, I hold the view that principle based guidelines are better, because they bestow certain level of humanity, trust and decency to the person following it.

    However, from professional experience this doesn't work. Because only decent folks will respect the spirit of regulation. The person who is interensted in breaking the rules and regulations will consider it as a big loop hole and use it for personal gain.

    In the present economic environment, I would say that rule based systems should be prescribed, because too much adaption has already been done and exploited.

    Sonia

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  4. Is every bakery claiming to sell bagels actually selling bagels? What IS a bagel? How is that different from a bagel-shaped roll?

    The Times article never actually connects a superficial definition of microfinance (credit in small amounts for poor people) with the social business defined by Grameen and others, which is much, much more than a system of extracting interest from poor people for profit.

    Furthermore, nobody serious about social businesses in general or micro finance has seriously suggested that it's a panacea, a one-size-fits-all-solution for poverty. It is what it is, one tool in the box, and a useful tool indeed.

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  5. Ok. But I didn't mean principle-based guidelines but principle-based regulations. These are actually meant to close loopholes of rule-based systems since companies may more easily be sued when they exploit loopholes by only upholding the letter of the law.

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  6. Surely Stefano, but my point is that this particular tool does seem flawed.

    BTW, I'm not so sure about Grameen actually doing it for profit as I strongly suspect all the revenue is going right back into the system.

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  7. Julian,

    Agree with you that principled based rules will be more effective. Sorry to sound like a pessimist, but it again depends on the law and judiciary system in the country.

    As you have yourself noticed, in India the legal aystem is extremely corrupt and unavailable to a common man. I have also written a couple of articles on my blog regarding this issue.

    Here, if the level of ineffectivenss of law is so high, that rule or principle, both are quite useless.

    So I think the situation is extremely complex and till the dirty dealings go, there is nothing which ethical people can do.

    Sonia

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  8. You write:

    "Trouble is, from a more principle-based position, there is something unseemly about saddling the working poor with interest rates so high they would be considered usurious in the U.S. "

    Well, the current prevailing credit card rates in the US are DOUBLE what the US considered "usurious" BY LAW 35 years ago, IF NOT TRIPLE.

    And "payday lending rates" "regulated" to 24-36% is like saying, OK, we won't send Vito and Nunzio out to beat you to within an inch of your life, we'll only send Tony out to break both your thumbs.

    Last I looked, the fed discount rate was below 2%. Banks charging even 5% would garner a huge profit margin, credit cards included. Game not fixed? Let's ask Vito, Nunzio and Tony...

    GV

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  9. look, can we call a spade a spade for a change?

    It is by not believing people that we turn them into liars.

    The prevailing philosophy and cultural mood among bankers is to borrow for nothing and jack up rates spectacularly high. Every society in every location at all times has judged this practice bad for society. Micro or macro, doesn't matter.

    In the 70s, poor, poor banks came hat in hand to congress and state legislatures - Oh, dear! Oh, Dear! Interest rates are so high (up to 18%) that we can't make money on these 7% credit cards. Good point. So please oh please remove these Usury Laws so we can make money again. Legislators, after weeping themselves silly, did just that.

    Then interest rates plummeted. The highest the fed discount rate has gotten since the early 80s is less than 10%. So why haven't the Usury Laws been reinstated?

    In fact, why weren't they indexed to begin with? Say, 10, 25, 50, shoot - 100% above the discount window?

    That would mean - right now - the max you could be charged on a charge card would be... 4%!

    Now, it doesn't take "rocket science" to figure that out, either now or back in 1980...

    So why wasn't it done? And why isn't it done now, especially as the Fed bailed these miscreant out?

    Follow the money...

    (Oh, and, in the immortal words of Mel Brooks' Roman Senators in History of the World Part I:

    "Leader of Senate: All fellow members of the Roman senate hear me. Shall we continue to build palace after palace for the rich? Or shall we aspire to a more noble purpose and build decent housing for the poor? How does the senate vote?
    Entire Senate: FUCK THE POOR! )

    GV

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  10. Yes, thanks for pointing out the historical trend GV. Great quote too btw! I'd forgotten that scene.

    Good point about credit cards. And remember that this is the main concern of Liz Warren's new regulatory agency. We'll see what comes of that. My point was simply that even if payday rates are capped in many places, microfinance, which is supposed to be ethical given how it's marketed, may not be. But if they want to keep it somewhat ethical to attract investors who still seek money but desire a good conscience, then they need to make sure that the debtors are able to default without the Vito/Duzio scenario.

    It's interesting that Grameen doesn't seem to have this problem...

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