The role of microfinance and moneylenders in rural economy

The advent of microfinance, particularly in Bangladesh, is mainly attributed to the existence of an imperfect credit market in rural areas, swept by informal sources of credit like money-lenders. Moneylenders not only charge exorbitant rates of interest to the borrowers (say 30-40 per cent per month), they also forfeit the assets in case of loan default or delays. The condition of Upen in Rabindranath Tagore's Dui bigha jomi is a pointer to the perils of the poor faced with such informal sources of credit.
After decades of dominance of the moneylenders in rural credit market with devastating consequences, the public sector stepped into the market through establishing branches of the government-owned banks to provide credit in the rural areas. Such banks began to provide credit at a much lower rate than that in informal market but drawbacks were there. First, the poor segment in rural areas was deprived of cheaper credit due to lack of collateral. Thus it was the richer segment that reaped home the benefits of such credit. Second, those bank branches were located mostly in semi-urban areas at the cost of rural hinterlands. And finally, the loan size suited mostly the richer segments of the people, not the poorer ones.
It has long been observed that in a regime of unequal ownership of land and inequitable social structure, institutional credit is likely to reach the larger farmers fast. The inequitable structure denies access of the poorer segment to credit despite their dire need for adoption of input-intensive modern agricultural technologies. In consequence, differentiation of peasantry and polarisation of peasant households are likely to occur following increased supply of credit and diffusion of improved technologies.  
  To face the twin problems of both informal and government credit, NGOs (non-governmental organisations) appeared as a solution. At the moment, three sources of credit are in existence in rural Bangladesh: public banks, NGOs and informal sources (contributions of cooperatives or societies are minuscule). According to a census in 62 villages conducted by the BRAC in 2013, 55 per cent of rural households access 44 per cent of credit from NGOs/MFIs and 11 per cent from informal sources. Again, informal sources still account for roughly one-thirds of the total credit supply in rural areas.  However, it cannot be denied that the rural credit market has grown relatively more competitive over time.
While a number of studies are available on rural credit market, Debdulal Mallick of Deakin University (Australia) takes on the linkage between formal and informal credit markets. As far as Bangladesh is concerned, it should be construed as a rare attempt when the linkage remains largely unexplored in developing countries. Drawing on the data from 156 villages in three districts in northern Bangladesh - as the baseline survey for BRAC's  ultra poor programme and supported by Focus Group discussions - the author addresses one important aspect of the linkage by empirically investigating the impact of microfinance intervention on the moneylenders' interest rate in northern Bangladesh. Needless to mention perhaps, one of the important reasons for the expansion of microfinance industry is to substitute the informal market and help the poor people escape the clutches of the 'evil moneylenders'. Recent theoretical development points out that the response of the interest rates in the informal sector to the expansion of formal credit depends on the features of both sectors, such as market structure and repayment schedule.
The descriptive statistics emerging from the survey are interesting. In the surveyed villages, on an average, there are 3.9 MFIs (microfinance institutions) carrying out lending operations with a range of 1 to 9. The average number of big MFIs is 3.6 indicating competition for clients even among big MFIs. On an average, one-third of households borrow from MFIs. Further, in roughly one-third of sample villages, higher percentage of clients utilise loans for productive investment with agriculture attracting more investment. As opposed to this, moneylenders' loan went to productive investment in only one-tenth of the sample villages. More importantly, in around 27 per cent of villages, the poverty situation  improved and in 17 per cent, it remained the same during the last five years preceding the survey.
It has been found that moneylenders' interest rates increase with the percentage of households borrowing from MFIs in the village. The productive investment of a loan lowers the moneylenders' interest rates. However, greater coverage of MFI programmes triggers increase in moneylenders' interest rates in villages in which more loans are invested in productive economic activities and the reasons are not far to seek. "As loans are utilised for productive purposes, the likelihood of repayment increases so that moneylenders are able to charge lower interest rates. But, if the overall demand for funds goes up, as indicated by higher percentages of households borrowing from MFIs, and if MFI loans are inadequate or seasonal working capital is unavailable from MFIs or the repayment schedule is tight, borrowers will resort to moneylenders for additional funds to sustain their productive projects. Hence increased demand for funds will drive up moneylenders' interest rates. These results are robust to correction for endogeneity" (Debdulal).
Debdulal then drives us to policy implications.  Borrowers can make more productive investments if MFIs meet their demands for loans by allowing more flexibility in loan disbursement and repayment schedules. Second, borrower projects will be more profitable if MFIs expand their programme of loan-only to loan-plus. En passant, one needs to know that BRAC follows a loan-plus approach, where loans are accompanied by various forms of assistance for the borrowers such as skill development training, provision of higher quality inputs, and ethnical assistance. Finally, the active presence of moneylenders is not necessarily baneful but can be beneficial, if increasing competition between formal and informal lenders increases borrowers' access to funds at competitive prices (interest rates).
The writer is a Professor of Economics at Jahangirnagar University.
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