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Washington DC. July, 19 2011 - Events of 2009 in the Kolar district in Karnataka, a state in southern India, offer a valuable case study for the microfinance sector because they show the complex intersection between cultural and social factors and household financial decisions. Kolar, famous for its silk industry, is a small town which witnessed mass defaults after a local organization banned MFIs from operating in the area.
A study released by the Association of Karnataka Microfinance Institutions identified several factors that led to the crisis including aggressive growth of MFIs, multiple lending, coercive collection practices, not re-financing loans for customers with legitimate hardship, and non cooperation with the Anjuman Committee, a local Muslim organization that finally issued the “Kolar Fatwa, ” banning MFIs from operating in the area.
Within weeks of the ban, the 43 MFIs operating in the area lost about Rs 60 crores ($13.4 million).
Immediately following the repayment crisis, CGAP and EDA Rural Systems jointly conducted a study on clients in Kolar district. The study surveyed 900 clients in two mass default towns (Kolar and Ramanagaram), as well as two towns that did not experience defaults (Nanjangud and Davanagere). Both defaulters and non-defaulters were interviewed. Some of the main findings are as follows.
Despite large incidences of repayment stress, only 2% of the clients in the mass default towns reported that their economic lives had become worse after taking MFI loans. In contrast, almost 89% said that their household condition had improved because of increased income generation from business, and lower interest rates of MFI loans compared to other options, while 9% reported no change.
Over-indebtedness is difficult to define. This
study found that it is not clear at what threshold customers feel the burden of repayment. When asked how much debt they can bear comfortably, borrowers provided a wide range between Rs. 6,000 ($130) to Rs. 60,000 ($1300). Thirty-four percent of the respondents in default towns said that they either skipped meals, other important expenses or sold assets to repay the loans taken. However, only 22% of the respondent from those areas said that they regretted taking those loans or would have changed their amounts in hindsight.
The study also found that clients with low financial literacy are more likely to experience repayment distress. For example, large numbers of customers were unable to answer the following question correctly: “You want to buy baskets worth Rs. 47. If you pay the shopkeeper with a 100 Rupee note, how much change will you get?” After controlling for factors like debt, income, religion, and education, the researchers found that the group of clients who were less likely to repay also had a greater gap between their monthly income and the size of the loan. This client is likely to have a total loan amount of $6,300, while earning an income of $177 per month.
Forty-one percent of the MFI customers surveyed said that they use MFIs because they feel that MFIs provide lower interest rate than other available options.
India’s microfinance sector has relied on a joint liability group model which assumes that peer pressure can help mobilize repayments. The experience in Kolar has shown that a reverse peer pressure could, also, mobilize mass defaults. A study in progress by Gine, Krishnaswamy and Ponce finds, the higher the number of initial defaulters in a center, the higher the probability that the others will default in a joint liability group model.
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