Microcredit Success in India: How They Maintain Sustainable Growth

An analysis of the supply of micro credit loans in India and the effects of those loans on households.

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Introduction

In a country like India, where one in two people do not have a bank account and only 15 percent have access to formal credit lines, microcredit loans can provide people who would otherwise struggle under the harsh financial climate the opportunity to grow as entrepreneurs and gain some form of financial security. Although the microcredit industry in India hit some roadblocks with the Andhra Pradesh crisis in 2010 and the demonetization of the 500 and 1,000 bank notes in 2016, it is still growing strong at a 45 percent compound annual growth rate in the past five years alone. With the growth of an industry also comes an increase in the number of suppliers as well as an increase of the supply of goods; in this case that would be the microfinance institutions and micro-loans respectively. In fact, new institutions, like Inditrade Microfinance, are entering the market all over the country. The chairman of the new company, Sudip Bandyopadhyay, claims that “there are significant opportunities in the semi urban areas of the industrialized states for a focused micro finance player” and other institutions likely have the same thought. The Indian people are being given more and more opportunities to start or grow their businesses with the increase in the supply of loans and in fact, most these clients are women who are striving to support a better livelihood.

Supply of Loans

Although the theory of microcredit can be traced back to the 18th century, the first modern microcredit institution was not introduced until the late 20th century. In practice, an institution gives a loan to a group of aspiring entrepreneurs to start their new businesses. If the clients are successful, they can pay back their loan in full, and if not, the group defaults and they ruin any chance of receiving a loan in the future. Along with the client’s debt comes the social implications; joint lending almost requires that the individuals keep each other accountable for their portion of repayment.

With the introduction of microcredit also comes the theory of uncertainty. How likely is it that the client will pay pack their loan in full? Is the client’s undertaking a risky one or a safe one? If one of the clients in a group is successful, will they assist the others in paying back the loan? In addition to the initial cost of the loan, the institution will also charge interest to at least cover the opportunity cost of funds. Although, in an ideal world, where the credit market is competitive, the lender will not charge an interest rate above his or her opportunity cost of funds. So, with such a large population in India and the fact that it is not a developed country, one would question why lenders would even enter the market. It is a risk that many would not want to participate in; however, in India, institutions shouldn’t worry about repayment. From the 45 million clients, there is a 99.5% repayment rate, so it is no wonder why so many new microfinance institutions are entering the market. The reason for such high repayment rates will be analyzed in a later section, but when there is an increase in the number of lenders in the market for microcredit, the supply of loans will also increase. This and the high repayment rate are two causes of such high growth rates in the Indian microfinance industry.

The article also attributes growth to “adaptability to change” and “resilience in the face of challenges”. One such example of this is the demonetization in 2016. This basically meant that the government declared the 500 and 1,000 bank notes illegal tender. After this new policy took effect the borrowers’ businesses took a hit. Their cash flows started slowing down for weeks after the demonetization and on top of that, the lenders required their clients to repay loans using the new bank notes. Although there was a brief period of confusion for the participants of microcredit, they showed their resiliency and it took about 12 weeks for things to return to normal.

Impact of Loans on Indian Households

Microcredit in India has been particularly successful: new institutions are still entering the market and are being repaid at almost perfect rates. Such success could be caused by many different factors, but one of the main ones described in this article is the social accountability. The author explains that “the business thrives on a very high level of customer connect before, during and after the credit approval with all clients being met face to face in a weekly, fortnightly or a monthly meeting for about 30-45 minutes in a group setting.” By meeting with the rest of the group on a regular basis, the individuals feel more accountable since they would be letting their group members down if they fail in their endeavor. This is especially true in under developed or developing countries in that if their project fails and the other members must repay their portion of the loan for them (if possible), they realize their chance of getting another loan in the future is almost impossible.

Another possible reason for the success is the geographical location of the loans. For example, Inditrade is a company that began its operations in Solapur, India which is “known for handloom and powerloom weaving industry providing employment to a large number of workers.” With a high competition in that area for powerloom industries, the opportunity for new businesses is something a lot of people want to participate in. Therefore, there is a high demand for loans. This type of example is very common in India, which is why microcredit works. The author of this article has big plans for microcredit in India; although it has been successful in the past few years, he believes that there is some necessary “fine tuning” to make the system much more effective and to ensure its longevity. One of the biggest problems is the unpredictability and vulnerability of the customer base. Like the demonetization in 2016, there are many unexpected factors that can affect future repayment of loans. The future of microcredit looks bright and if the right to financial inclusion becomes a priority for the governments of developing countries, “it can become possible to reach the last Indian in need of financial services”.

References

Nambiar, Manoj. “Indian Microfinance industry will continue to demonstrate sustainable growth.” The Economic Times. Economic Times, 22 Apr. 2017. Web. 02 May 2017.  http://economictimes.indiatimes.com/small-biz/money/indian-microfinance-industry-will-continue-to-demonstrate-sustainable-growth/articleshow/58311757.cms

Ray, Atmadip. “Inditrade Capital begins microfinance business.” The Economic Times. Economic Times, 17 Apr. 2017. Web. 02 May 2017. http://economictimes.indiatimes.com/industry/banking/finance/inditrade-capital-begins-microfinance-business/articleshow/58220696.cms

 

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