Informal Credit Transactions of Micro-Credit Borrowers in Rural Bangladesh

Abstract

summary Through a detailed study of informal credit transactions in a village in northern Bangladesh, the research empirically establishes that increased access to credit from micro‐finance institutions (MFIs) in Bangladesh has been unable to substitute for the higher‐cost informal credit sources. The reason for this is that MFI lending technology is insensitive to variations in household conditions. Most MFIs put all households on a treadmill of continuously increasing loan size and insist on a fixed repayment schedule. While an easily accessible loan may seem attractive to a cash‐starved poor household, its resource profile and the wider economic and policy environment impose limits on the marginal return to capital. Credit escalation under these circumstances increases the likelihood of cross‐financing to sustain the MFI's line of credit. Target‐group households, in particular, resort to extensive cross‐financing of their loans. It is argued that cross‐financing can have a deleterious effect on the household economy in the long‐run if households continuously manage loan repayment without having the ability to repay. It is suggested that MFI lending technology be redesigned to be sensitive to household initial conditions. Only then can MFIs seriously compete with the informal lenders.

The Role of Farmers and Informal Institutions in Microcredit Programs in Tigray, Northern Ethiopia

“…At a more general level this paper corroborates earlier findings (see, among others, Bezabih Emana et al (2005), Sinha and Matin (1998) and Tsai (2004)) that microcredit influences informal finance without substituting it. Besides, it gives insights into how local informal lending practices may inform people's microborrowing behavior.…”

“…41 Borchgrevink et al (2003) and Woldeab Teshome (2003) also observed this type of money lending in Tigray. Rahman (1999) and Sinha and Matin (1998) describe similar practices in Bangladesh. 42 Similarly, Perry (2002) found that female microcredit clients act as moneylenders in rural Senegal.…”

Microfinance and Moneylender Interest Rate: Evidence from Bangladesh

“…Sinha and Matin (1998) point out that due to the large increase in MFI lending some internal cross-financing was taking place in which the proceeds from one loan were being used to repay another. Clients borrow from informal sources so they could maintain high repayment rates with MFIs and become eligible for larger future loans.…”

“…However, there is widespread evidence that MFI clients borrow from informal sources as part of their financial management strategy. Sinha and Matin (1998) report that about 87% of rural households in the northern Bangladesh borrow from informal sources and the percentage is higher among the MFI borrowers. Husain et al (1998) find that 11.6% of borrowers from BRAC also borrowed from moneylenders.…”

Good intentions pave the way to … the local moneylender

“…Zeller et al (2001, Table 4.12, 59) report a 62 percent default rate on non-MFI formal loans compared to below 7 percent for the Grameen Bank. In the Bangladeshi village investigated by Sinha and Matin (1998, Sinha and Matin (1998, Table 4, 75) for the relatively less poor non-target group MFI borrowers, by Zeller et al (2001, Table 4.10, 57), and by Jain and Mansuri (2003, Table 3, 260) for small informal loans. Field studies provide telling evidence: Rahman (1999, 77) reports the case of a household which "became heavily indebted not only to the [Grameen] Bank but also to moneylenders in the village"; and Woolcock (1999, 28) recounts the case of a woman who explains in a group meeting "how the shame of not being able to repay her Grameen loan had driven her to the local moneylender, which in the long run had only intensified the desperation of her situation".…”