Loan Defaults Versus Over-indebtedness in Rural Tamil Nadu

In India, compared with Andhra Pradesh, the neighboring state of Tamil Nadu is not facing a severe crisis. But repayment problems appear increasingly problematic, based on field work I did in January 2013 including interviews with managers of MFIs, NGOs, bankers and credit officers, visits to 10 villages and group discussions with clients.

Does this mean that clients are over-indebted? Not necessarily. Repayment defaults include both liquidity defaults and strategic defaults. Each of these has very different implications.

Salt worker sifts through salt. Salt worker sifts through salt.
 Photo Credit: Subrata Biswas

“Liquidity defaults” occur when clients don’t pay because they are unable to repay.

Many clients are chronically indebted and some of them are caught in a spiral of debt. Microcredit represents only a small part (on average microcredit represents around 10-20% of their outstanding debt)[1]. The bulk of the debt comes from other sources, often informal: pawnbrokers, local moneylenders (local elite, landowners, etc.), relatives and friends, and private financial companies. However, repayment of loans to micro-lenders may be more problematic than loans from other sources. Microcredit is often rigid, obliging clients to borrow from other sources which might be more expensive (but not systematically), and which are extremely flexible and negotiable .

Though precise quantification is difficult, we can reasonably assume that rural households are increasingly indebted, including among the poor. Real incomes are increasing (on average), but lifestyles tend to urbanize and needs are probably growing faster than wages (consumer durables, rising costs of social and religious rituals). Therefore, it would be wrong to consider that microcredit is solely responsible for households’ over-indebtedness (defined here as a process of pauperisation through debt). But it would also be wrong to assume that microcredit can substitute for informal finance and help people escape from vicious circles of informal debt. For the most part borrowers use it as an additional source of liquidity and for purposes which do not generate direct income (food, education, health, ceremonies, repaying past debt, housing, etc).

"Strategic defaults" occur in cases where clients are able to pay but unwilling to do so. There are two main reasons for this behavior.

In many cases, microcredit providers (whatever their status) rely on local male or female “leaders” for risk management. Lenders selected them initially for their charisma, knowledge of local communities and ability to mobilize people. They had the added value of being highly inserted into local networks of patronage (which remain the most common form of wealth redistribution in rural south-India).  The reliance on these key individuals to manage microcredit risk proved a very effective model for rapid growth -- but it also turns out to be extremely fragile (not to mention troubling from the perspective of reinforcing inequalities). We have seen that when a leader declares that clients are not obliged to repay, or when he or she loses credibility, then the whole system can collapse[2].

Credit supply for the poor and the unbanked is highly dynamic. Consumer credit in particular is mushrooming (through credit companies, but also private individual agents) and offer very convenient services (at the door step, without any obligation in terms of saving, group meeting, training). Compared with microcredit, the financial price might be higher but the opportunity costs are much lower. Since they have many alternatives, clients have little incentive to repay their microcredit loan.

The experience in Tamil Nadu raises three main questions:

Informal finance: This source of funds is perhaps particularly high in south India but is widespread in many regions. As we seek to measure market saturation and risks of credit crises, can we find ways to include informal finance in our analyses?

Social “integration” of microfinance: To what extent can microfinance utilize existing local practices and social networks in an appropriate manner to build trust and encourage responsible lending and borrowing, without reinforcing inequality? In our research and debates, we have not paid enough attention to the extent to which loss of legitimacy and trust might be key drivers of client non-repayment and localized or mass strategic defaults.

In conclusion, it is necessary to look more closely at the interaction between microcredit providers and their clients, not in abstract and theoretical ways, but taking into account the embeddedness of MFIs in social, political and cultural contexts that shape microfinance interventions.

------ The author is a research fellow focusing on microfinance at the Sorbonne University, Paris.

[1] This estimation is based on various household surveys done between 2006 and 2010.

[2] For more on the role of these leaders, see     Guérin I. (2011) Les effets insoupçonnés de la microfinance, Travail, genre et sociétés, 25 : 61-79. And Guérin et al. (2013)  Women’s empowerment: power to act or power over other women? Lessons from Indian microfinance, Oxford Development Studies, forthcoming




11 June 2013 Submitted by ivan (not verified)

The question posed is interesting, but I am not sure I understood the response . What seems interesting today is to look at the institutional side of the MFI world and in additional to looking at regulation, (and perhaps at other social factors as seems implied), looking at a new governance model allowing MFIs to grow, not be banks, still have controls and consumer protection - but help solidiy the social capital that they bring.

17 June 2013 Submitted by Mesay Matusala (not verified)

In both types of defaults, MFIs have been working to secure their loan in "collatralizing" them with guarantors, security forced deposits and asset collateral. In many MFIs I know, even the poorest borrower now is required to at least bring a guarantor or in many occasions asset collateral. This obviously seems a mission drift from what MFIs in the first place are meant to be. These MFIs once came to the brink of failure because of huge defaults. The MFIs once were NGOs and forced to be independent by regulatory bodies. But their clients and the community at large continued to think that they are free granting NGOs rather than interest bearing lenders. So chances are high that people come to these MFIs with hidden intentions of making strategic defaults.

On the other hand though, there are also MFIs I know that go year round without much of both types of defaults, especially the strategic defaults. This usually is because, for these communities, that MFI is the only source of finance since as well now because the informal financial sector no longer is affordable and engaging in that business will result in serious repercussions from the prevailing regulations. These clients even go to the extent of "protecting" the MFI. They expose other strategic defaulters and at the end of the days, a great culture of repaying loans on-time is created.

I believe there is no one best way and best practice in securing loans. MFIs need to capitalize on what works best given their opportunities around that give them a competitive advantage.

02 July 2013 Submitted by Vaibhav Anand (not verified)

On-the-field surveillance findings and portfolio performance data do not support the assertion that there are repayment problems and over-indebtedness in Tamil Nadu. In our opinion, the article does not take into account the recent developments in regulation and the implementation of credit bureaus in the microfinance sector in India. The detailed response to the article can be accessed at IFMR Blog page:…

12 May 2015 Submitted by Md. Abdul Hye Mridha (not verified)

Micro finance is a financial services for the non-bankable poor people. Now a days, people wants to do some things for their betterment in the society. Society is changing in terms of living, food, cloth, lifestyle etc. They are trying to adjust with the situation. Some time they may default and some of them are success in Bangladesh. If it is bad, non of them take credit from the MFIs. The indebtedness is increasing and their assets also increasing like, savings, housing assets etc. In this situation, the loanee may required some technical support or market linkage for their products. In Banking sector, What is happening, their are huge default with big amount and some time failed to meet up the loan amount.

So, where is credit there is default, but measuring in proper ways what is the situation and how to handle it in proper way..

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