Comment by shrikant | Hacker News Reader

Comment by shrikant | Hacker News Reader

[I was involved in a project for SKS Microfinance in a previous job, and I've gotten up-close and personal with their numbers for a few months, all pre-IPO]

A majority of the small-ticket loans are given out under the umbrella called IGLs (Income Generating Loans), which is basically capital for asset development and/or small-time business building. (e.g. the spice shop woman in the article) These are the loans given out at 24%.

One of the issues is that a lot of borrowers take out IGLs and, once they have the cash in hand, end up spending it non-income generating activities, like weddings, or funerals, or baby births, or girl-child-attaining-puberty ceremonies.

There is another class of loans called ELs (Emergency Loans) that are interest-free, and meant for 'unforeseen emergencies' - typically critical medical treatment and funerals.

So yeah, when you take a loan at 24%, but spend the money on a 0%-loan-activity, problems abound.

There is a fairly large amount of education and training that has to take place amongst the local populace in terms of fiscal responsibility, and significant cultural obstacles to overcome to teach it to them.

Thanks for the post shrikant. Most people don't seem to realize this, and it's in part because of all the attention MFI's are getting rightnow. There's very little data and numbers available, but are some - http://microfinance.cgap.org/2010/11/11/who’s-the-culprit-ac...

This table, taken from the above blog post, was of particular interest. It describes what percentage of the loans are used for what. In looking at these numbers it's important to take into account the types of people to whom loans are given to - that is to say, someone that can get a loan from an MFI may not be able to get a loan from a Bank etc etc.

Also note that certain line items like 'Buy Livestock' may be much higher for something like a Bank because the bank's loan terms may incentivize certain types of loan utilizations.

Any time you see data like this, keep in mind it's far from clean and quite imperfect (data collection methods are door to door and done on foot), so take it with a grain of salt. Also, the columns may not add up to 100 because some double c counting goes on (i.e. if a respondent used the loan for more than one thing it will be counted more than once under separate categories) But if this data is an indication of what actually goes on in microfinance, it's not quite being capitalized for it's intended purposes. This seems explainable in that at the end of the day a line of credit is a line of credit no matter what verbage you attach to it. We call it a microfinance loan, but the people that receive these loans probably don't know what microfinance loans are; that's to say they probably just call them loans.

 		Usage of Loan Money by Type of Lender

				Bank	MFI	SHG	Informal
 Start new business		2.0%	2.5%	1.9%	1.1%
 Buy agricultural inputs	57.5%	13.2%	19.3%	19.9%
 Purchase stock			3.0%	9.9%	4.2%	2.7%
 Buy livestock			2.7%	6.0%	5.6%	1.7%
 Purchase land			0.8%	0.9%	0.7%	0.6%
 Home improvement		9.7%	22.1%	13.0%	14.2%
 Repay old debt			14.6%	25.4%	20.4%	7.0%
 Health				11.4%	10.9%	18.6%	25.3%
 Education			4.1%	4.4%	5.7%	5.3%
 Marriage			4.3%	4.8%	2.2%	12.2%
 Funeral			0.1%	0.2%	0.5%	1.7%
 Other festival			0.6%	3.5%	3.6%	4.8%
 Unemployment			0.0%	0.0%	0.1%	0.8%
 Purchase jewellery		0.5%	0.6%	1.6%	0.4%
 Other consumption		26.5%	31.6%	49.9%	24.9%

[...] the people that receive these loans probably don't know what microfinance loans are; that's to say they probably just call them loans.

And this is the crux of the issue.

The table only denotes what the borrower took the loan for, and not for what actual use the money was put to. Basically it boils down to this: once the money is in their hands, unless the borrowers have had some information dissemination of a substantial sort, it can be used for any purpose.

It is typically the lending party's duty to take solid steps towards educating the borrower as to the actual purpose of the loans, and MFIs in India (IMHO) were initially doing a stellar job of this (ok, well, SKS at least - I sat in on some of their 'group training seminars'). I'm not close to the domain now for about a year though, so I couldn't comment for sure any more.

As an aside: (I don't think they'll take action against me for saying good things about them, so I'll go right ahead) SKS' impairment levels were so ridiculously low that I would end up manually re-calculating the figures to ensure Mondrian wasn't lying to me or our software wasn't badly broken.

As another aside: there is also an emerging trend of 'micro-insurance' products (livestock insurance, crop insurance, 'hut' insurance, etc.) being offered by MFIs as well as large insurance companies which I did a field study on, which reached conclusions similar to what I learned from the SKS project - the illiterate and poor initially cannot even conceive that someone would want to help them out without shafting them, but with substantial education to a few key influential and smart members of the community, the message can be gotten across.

The table only denotes what the borrower took the loan for, and not for what actual use the money was put to. Basically it boils down to this: once the money is in their hands, unless the borrowers have had some information dissemination of a substantial sort, it can be used for any purpose.

I don't think (and I could be totally wrong, I don't know the process of actually getting one of these loans) that the left column denotes what the borrower took the loan for. I think it's what the loan was actually used for. The data collectors, I believe, sampled some subgroup of people and asked what the loan was spent on.

If SKS microfinance is charging 24% they are a loanshark, period.Rates as high as that are usury and should not be lawful.

I'm of half-Indian and half-European descent and I am always ashamed of my Indian heritage. The Indian people as a collective simply do not know what it means to be humane and have never heard the word solidarity. I don't mean that Western countries are perfect, just that they are lightyears ahead of India.

Civilized countries have laws that protect the poor. Interest rate limits for people (not corporations) are generally and histroically limited to about 8-12%. The US exception caused the subprime crisis, but was compensated for the poor by generous bankruptcy laws.

Also, western countries have bankruptcy laws, social safety nets and a lot of private charity.

Even poort western countries such as Bolivia have a minimal level of solidarity so that no-one should feel that suicide is the only way out.

India, I am disappoint.

Of course any developing entrepreneurs will have higher interest rates - they are greater credit risks, and the costs of making the loan are similar for small loans an large loans. To properly compare, you have to compare the the 24% rate to the previous lenders, who, if I remember correctly charged rates from 100-300% and up.

That's all well and good provided that the loan is unsecured and generous (i.e. humane) bankruptcy laws are available.

In India, bankruptcy means a rural farmer will lose everything, including his land and his seed corn.

You can't have it both ways. Either the loan is secured and farmers pay low interest rates.

Or a high rate is allowed because the loans is an unsecured loan with high credit risk. But then the debter should be able to default without severe consequences, just a damage to his credit rating.

Neither is possible, because India doesn't know what humane capitalism is.

Edit: Sure 24% is better than 300%. So I should congratulate India for leaving the Feudal ages and entering the Robber-baron capitalist era of the 19th century.

Well OK: Congrats India! Now let's enter that 20th century, shall we?

You're posting many claims of this nature in this thread, but like my gran used to say 'when you're in a hole, stop digging'. Much of the West does not have what you call 'humane bankruptcy laws', most debts in most of Western Europe is non-dischargeable. The US is quite the outlier in this respect.

Furthermore, bankruptcy is not a counterbalance for high interest rates! It's a purely pragmatic tool, not a designed part of the system! It's very delicate to fiddle with what is fundamentally a relationship of trust between lenders and people taking loans through statute, and while improvements are possible everywhere, just saying 'India should have liberal bankruptcy laws' (i.e., discharging loans should be easy) is nonsense because the shocks this would cause in the financial system (at the micro level) would be severe and there's no telling if the long-term benefits (if any) will outweigh the sure short-term catastrophe.

I adore your use of a homey saying, it reminds me of Lord of the Rings.

There's no 'general and historical' interest rate limit of 8-12%. Credit card APRs in the United States range up to 30% or so, and payday loans can have APRs of well over 100%. In other countries, rates for products catering to the poor are similarly high - this is just the cost of doing business when extending small amounts of credit to poor prospects with high default rates.

The wisdom of that is what should be debated. Since businesses need to charge high interest rates to compensate for defaults, does mean the poor shouldn't have access to credit at all? Note that that's what effectively happening in Andhra Pradesh, where laws to 'protect the poor' have dropped the repayment rate of loans to under 20 percent, ensuring microcredit there will cease to exist.

Check your facts: http://www.lectlaw.com/files/ban02.htm

E.g. Alabama: ALABAMA, the legal rate of interest is 6%; the general usury limit is 8%. The judgment rate is 12%.

Like I said, it's not perfect, there are many exceptions. The US has devolved quite a bit from the humane society that built it up.

But generous bankruptcy laws still make it possible for Americans to escape high debt. In India, suicide seems to be the only solution for some.

Did you even read your own link? Here's the second (!) paragraph from it:

"But my car loan is higher than that"; "But I'm paying way more than that on my credit cards." That's right! Banks have separate rules. In fact, due to high inflation, in 1980, the federal government passed a special law which allowed national banks (the ones that have the word "national" or the term "N.A." in their name, and savings banks that are federally chartered) to ignore state usury limits and pegged the rate of interest at a certain number of points above the federal reserve discount rate. In addition, specially chartered organizations like small loan companies and installment plan sellers (like car financing companies) have their own rules.

That seems to support the claim that this is a recent departure from the "general and historical" caps on interest rates, though: most states have long had usury laws with interest-rate caps, and national banks were only exempted from them in 1980.

I agree with your bit about solidarity in India, but you might be a bit mis-informed about the interest rates.

The CoF (cost of funds) to SKS is in the vicinity of 12-14%, and the norm is to add 10% on top of that. More middle-of-the-curve MFIs usually charge 30%+.

Loan sharks in villages typically charge 100% and/or servitude, and are more often than not the cause of loan repayment related suicides.

I know my comments have a few upvotes attached to them already, and I don't really see any point in cribbing about karma points anyway.

However, it would be useful to me if the person who downvoted both my comments in this thread were to drop a line explaining why/how I was detracting from the conversation in any way...

There was a very interesting article in the Economist about this. The gist of it is that 24% is indeed steep, but bear in mind that:

a) These are very small sums of money, so the proportional overhead is much higher b) Microfinance loans represent about 30% of loans, the rest coming from local loansharks, who typically charge around 2-300% apr (and have more violent debt collection procedures). Any cap on rates will lower that percentage, and so make things worse.

Interest rate is basically the price of money. In a developing economy like India, growing at 8-10% the demand for money is greater as a result, it's price is also greater.

If you make a term/fixed deposit in India for a year it attracts an interest rate of 8-9%. Education, Car and Home Loans for credit-worthy individuals from established banks range from 12-18%. Personal Loans, not backed by a security range from 20-24%. So a micro-finance institution lending at 24% p.a to 'non-professionals' in rural areas with no known credit history is not bad at all considering the risk that they take up and the cost of funds that they incur(as pointed out by someone else)

Interest rate limits for people (not corporations) are generally and histroically limited to about 8-12%.

[citation needed]

The evolution of the relationship between social and legal norms re: what are acceptable interest rates is a very interesting topic, with much cultural diversity and a broad range of case studies from canonical usury regulations in medieval Europe to the prohibition of pay day loans in much of the West in the 20th century, but blanket statements about 'loans being restricted from to 8-12%' lack any basis in reality and economic fundamentals. Just one counter example, I know of many people who took out mortgages (i.e., asset-backed securities!) right here in Belgium (a perfectly normal 'Western' country) less than 30 years ago with interest rates of 15 to 18%, and that was perfectly normal at the time, given inflation rates.

In the U.S. at least, there was a period of 150ish years where that was the case. Most states passed usury laws pretty soon after the U.S. was formed, and by the mid 1800s almost all had pretty strict interest-rate caps. They were loosened a bit towards the end of the 19th century, though some were strengthened again in the early 20th.

In 1978, the Supreme Court ruled that states couldn't enforce their usury laws against nationally chartered out-of-state banks--- the usury laws of the bank's state, not the customer's state, were the only ones that applied. That effectively killed usury laws, because it meant that banks just all incorporated in the states with the weakest usury laws. Then Congress completely preempted state usury laws for nationally-chartered banks in 1980.

But from sometime in the early/mid 1800s to 1978, most states had interest-rate caps in the 8-14% range, and most are still on the books, just ineffectual.

Keep in mind transaction costs which usually can't come down very much.

A $100 transaction cost on a $10000 loan is comparatively insignificant to us.

A $100 transaction cost on a $1000 loan is pretty crappy.

If you give out 50US loans are expexted to do due diligence and are onyl allowed to take 8% (4US) how should that work if you also have to cover for defaulting loans and pay fo the capital you are providing.

Luckily this is not really a problem since you return on investment should be closer to 1000% than to 100% (obviously your returns will diminish pretty fast as soon as your investment gets bigger). Therefore even interests rates of 50%+ shouldn't be a problem as long as it invested in income generating activities.

If you are interested in that topic I wrote my master thesis about it: http://www.scribd.com/doc/92714/Microfinance (partly a bit dated but the basic premise regarding interest rates should be still valid).

Is it possible to combine the microfinance program with the assests , at least for some classes of assets ? maybe things that increase agricultural productivity , or decrease energy costs , i.e. things like drip irrigation tools or solar panels or efficient stoves ?

That way you have some partial collatera- so you might reduce the interest , and you can help people choose the best income generating assets , so you increase loan repayment chances.

Also you can share distribution costs between loans and assets.

Does this model make sense ?

I was so far unable to grasp the justification for the extremely high interest rates of micro loans. What is going on, and how can such high interest rates ever work?

They are risky investments in projects which supposedly have high rates of return.

also high rates of default

the loans are non-collateralized loans and short-term, and the borrowers are high risk. Think about a pay-day loan with no collateral.

I think SKS jumped the shark when they decided sometime in late 08/early 09 to directly sell gold & other consumer durables instead of providing cash lump sum.

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