Microfinance, Indebtedness and Overindebtedness Isabelle Guérin, Institute of Research for Development, Provence University (France) French Institute of Pondicherry (India) Head of the Research programme RUME Associate Researcher to CERMI - Solvay Business School

Problem to be addressed: Microfinance is usually considered an efficient tool for reducing the vulnerability of poor people and helping them to protect against risk ahead of time. But little attention has been paid to the risks of microfinance for the clients, especially financial fragility and over- indebtedness.

Research objectives To analyze the effects of microfinance on indebtedness and over-indebtedness in a context (Tamil Nadu, rural south-India) where: Rural households are already highly indebted (before microfinance) Rural households are already highly indebted (before microfinance) There is an active policy of financial inclusion and uneven growth of microfinance supply There is an active policy of financial inclusion and uneven growth of microfinance supply annual growth of 40% in volume and 80% in clients Microcredits are mainly used for « non productive » purposes (between 60 and 80%) Microcredits are mainly used for « non productive » purposes (between 60 and 80%) mainly health, education, repayment of previous debt, ceremonies

Methodology A combination of quantitative and qualitative analysis in three Districts of South Rural India In-depth analysis of indebtedness practices In-depth analysis of indebtedness practices Around 1000 households – clients and non clients 30 villages - diversity of socioeconomic contexts Longitudinal analysis (400 clients): 2004 – 2006 Longitudinal analysis (400 clients): 2004 – 2006 Individual interviews with clients and household members, moneylenders; Individual interviews with clients and household members, moneylenders; Village and local financial markets monographs Village and local financial markets monographs

Specific attention is given to the quality and reliability of data: Debt as a taboo subject requires trust, confidence and time Debt as a taboo subject requires trust, confidence and time The huge diversity of terminologies requires good knowledge of local contexts The huge diversity of terminologies requires good knowledge of local contexts There are distinctive gender financial responsibilities within the household (requires interviews with men and women) There are distinctive gender financial responsibilities within the household (requires interviews with men and women) Qualitative analysis as a key component Data collection: Data collection: a good konwledge of local contexts is the only way to collect reliable data help to raise relevant research questions Analysis Analysis Non linear chain of impact Qualitative approach and rigor are not incompatible ! There are also criteria of scientific validity: Contextualization Contextualization Triangulation Triangulation

Main Sources of Income Most households are involved in agriculture But non farm occupations are a growing source of income Self-employment in the non farm sector is limited (10-20%)

Result 1: the burden of debt (before microfinance) Official Data (NSSO) Own Data % Households Indebted 20%80-90% Average Oustanding 4000 INR INR (approximately one year of household income) Huge diversity of borrowing sources : tandals (mobile moneylenders), terinjavanga (known persons), professional moneylenders, pawnbrokers, relatives and friends

Result 2 Increase of global indebtedness (+ 30%) Debt reorganisation (reduction of the share of private moneylenders, increase of the share of pawnbrokers and microfinance) Increased variety borrowing sources

Diversity of trajectories Type 1: « Careful Management » (20% of clients): Limited oustanding debt (<5000 INR) Limited oustanding debt (<5000 INR) Limited use of microfinance Limited use of microfinance Type 2: « Debt reduction » (30% of clients) Mainly due to life cycle evolution Mainly due to life cycle evolution Impact of microfinance: mainly substitution for informal finance Impact of microfinance: mainly substitution for informal finance But there are ceiling effects : But there are ceiling effects : the comparative advantages of microfinance (self-help- group) are limited in comparison to informal finance amount, flexibility, lack of discretion, excessive moral pressure

The clients’ perspective (1) Good quality of financial services means… Good quality of financial services means…

Type 3: « Rising Indebtedness » (50% of clients) Main factors: life cycle events (ceremonies, health, death) but also incitement to consumption Main factors: life cycle events (ceremonies, health, death) but also incitement to consumption Microfinance impact: Microfinance impact: leverage effect (better creditworthiness) juggling practices Risks of over-indebtedness since microfinance acts mainly on « revealed » creditworthiness but not on « core » creditworthiness Risks of over-indebtedness since microfinance acts mainly on « revealed » creditworthiness but not on « core » creditworthiness

Microcredit Rs Pledging Rs « Well-known person » Marriage Rs Reimbursement Microcredit 5000 Rs Rs « Well-known person » Monthly Instalment Income Reimbursement Rs Relatives « Well-known person » Rs Monthly Instalment Interest Pledging Capital Reimbursement

Implications and conclusions « Financial dualism » does not work as a theory : there is great overlap between formal and informal finance rather than opposition and substitution there is great overlap between formal and informal finance rather than opposition and substitution Risks of over-indebtedness reinforce the need for the improved protection of microfinance consumers checking income and pre-existing debt before providing microcredit checking income and pre-existing debt before providing microcredit The diversity of clients (not only in terms of poverty level but also in terms of propensity to go into debt and position in life cycle) calls for a diversity of services The diversity of clients (not only in terms of poverty level but also in terms of propensity to go into debt and position in life cycle) calls for a diversity of services