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.

“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.