Banking & Finance

Thinking small

Indian debacle sends warning to China

Fancy a loan?

Local events in India’s financial system would not usually shape the deliberations of Beijing policymakers. But when one of the subcontinent’s poorest states was forced to suspend micro-lending activities last week, China would have taken notice.

“What started off as an initiative for social and economic upliftment of the rural poor has now morphed into a highly competitive business with the sole aim of making profits,” Konijeti Rosaiah, the chief minister of Andhra Pradesh warned reporters, “People are getting caught in debt traps and they see no way out.”

What is causing the trouble? Micro-finance companies charging peasants huge interest rates (some as high as 70%) for loans.

It’s a crisis that is of more than passing interest in China, where the country’s leaders are looking for ways to reduce economic inequality and boost rural consumption. Micro-credit is meant to be an important part of those plans. An estimated 250 million (mostly rural) people still don’t have access to loans. So India’s extensive experiments in the product offering could offer some lessons.

So far, the type of loan sharking recently reported in India has been prevented by strict rules on capital requirements and an interest cap of 20%. The problem is that those rules have dissuaded many for-profit investors (village banks and micro-credit companies) from getting involved.

If profits are limited, then where’s the money to come from? NGOs can’t do much more of the lending as their capital is limited to donations (they can’t take in deposits from villagers).

But one Sichuan-based NGO thinks it has finally found a way to make micro-credit work.

It hasn’t been an easy road for Gao Xiangjun, founder of the Association for the Rural Development of Yilong (ARDY). “I failed once before,” she explained to Southern Metropolis Daily recently. “So I now better understand that micro-credit cannot be operated purely on sentiment.”

ARDY operates on the Grameen model: borrowers offer no collateral, but 3-5 other villagers (typically women) guarantee the debt. Loans are capped at around $1,000, and crucially interest is usually no higher than 10-12%.

But Gao was forced to suspend lending between 1999 and 2004, after discovering that loan officers had been making bad loans and reporting false information. She says she felt “kidnapped by the branches”. One of her main problems: local loan officers were paid a commission for the money they lent, regardless of whether it was repaid (sounds remarkably like the US sub-prime crisis).

A visit to micro-credit NGOs in Bangladesh and Mongolia helped Gao find a way to solve the problem. Loan officers are now compensated based on how their loans perform. Accounting is now kept independent from lending.

The revamp seems to have done the trick, as ARDY has been in the black since 2007 and has a repayment rate of 98%. “This means that we’ve achieved sustainability in serving the poor,” argues Gao.

She also thinks she’s found a way around the NGO’s chronic lack of capital. Since it can’t take deposits, it partners with local ‘Village Funds’, established by the government for poverty relief. The government matches the money the villagers contribute to the fund, and ARDY helps them establish a committee that operates like a local micro-credit bank.

It took Gao two years, but she finally managed to convince local officials to turn over ownership of the funds to the village committees. An important development, she says, as “local cadres might misappropriate the money when the public construction projects are short of cash.”

Gao’s ‘Village Fund’ idea might not generate fabulous profits, but she hopes it will at least become a transparent way to get affordable credit.

That could be an improvement on what’s happened in Andhra Pradesh. As Grameen Bank founder Muhammad Yunus puts it: “Micro-credit is not about exciting people to make money off the poor. That’s the wrong message completely.”


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