Although micro-credit has been perceived as effective in reducing poverty, in reality, its impact has been modest.[1] One reason could be that most microloans extended to the poor are term loans, which are not well-suited for borrowers with variable or risky income streams, for example, traders needing working capital for purchasing inventory, or farmers who earn lump-sum incomes after harvest. While the Indian government has been encouraging banks to provide credit in the form of over-draft, term loans continue to remain the predominant credit product.
In 2013, the Rural Financial Institutions Programme represented by GIZ and the National Bank for Agriculture and Rural Development (NABARD), partnered with Mann Deshi Mahila Bank to launch a new overdraft facility (henceforth cash credit loan or CCL) serviced through banking agents to traders and farmers selling groceries in markets in rural Maharashtra, India. The objective was to demonstrate that a financial product customized to the needs of small entrepreneurs with unpredictable income streams and capital needs could add substantial value and be profitably serviced by a small bank.
The Cash Credit Loan Product
To apply, women customers form joint liability groups of three, but each member receives an individual loan. During loan approval, the client’s repayment capacity is assessed, based on which a drawable limit of up to INR 20,000 is approved, at an interest rate of 24% plus processing fees and a tenure of three years. Customers can draw and repay any amount up to the limit, but are required to repay interest on their outstanding balance and are encouraged to turn over the estimated installment amount (of an equivalent term loan) every week.
Evaluation Findings
- Client Impact
To evaluate the impact of the CCL relative to traditional term loans (TL), we conducted a randomized controlled trial; 360 approved loan applicants were randomly offered a CCL or a TL of the same amount. The outcomes of customers in the two groups (statistically similar ex-ante) were compared six months later using data from 14 rounds of fortnightly financial diaries.
CCL customers reported significantly better outcomes compared to TL customers.
Average daily sales were INR 855 higher in the CCL group compared to the TL group. The main reason (reported by 31% in the end-line survey is that CCL clients switched to selling more profitable goods. Gross daily profits increased by INR 447 in the CCL group. The main reasons reported were the increase in sale price as the goods were of better quality, and decrease in cost price. Total business expenses per day on travel, rent, etc., excluding inventory, was higher by INR 25 in the CCL group. Personal daily consumption (including purchases and cash transfers to family members) increased by INR 37.
- Conceptual framework
Theoretically, a credit line offers more flexibility compared to a term loan. Ex-ante, the borrower is always weakly better off with a credit line. The reason is that a credit line can be used as a TL, if one so wishes, by withdrawing the full amount in the beginning and then repaying it using the schedule stipulated for the term loan. However, a credit line allows the borrower to draw more credit (say, to buy more inventory) if expected sales are good, or to repay more (or less) of the balance on high (or low) profit days. A potential disadvantage of a credit line might occur ex-post if there is uncertainty over sales. For example, towards the end of the loan tenure, a CCL borrower who has experienced a sequence of negative income shocks could end up with a large outstanding balance, which, in order to repay the loan would result in lower consumption or stock purchases, relative to a TL borrower who by then has repaid the loan almost in full. The potential risk of default may be higher for the CCL borrower in such circumstances. Another potential issue, compared to TL, is that the flexibility of CCL may make it more difficult for borrowers with low self-control to commit to repay or save on their own accord.[2] However, at this point there have been no defaults in both the CCL and TL groups in our program.
- Business case
Though it made losses of 20.7 per cent in its first completed year in 2014-15, the future outlook for Mann Deshi’s CCL portfolio is optimistic. A business case analysis was conducted [3] and it was concluded that the CCL portfolio would break even if it grows at 30 percent in FY2015-16. This appears to be achievable because the study concluded that the reported loss was caused by the product's novelty and the required initial investment in technology and staff to develop the capacity to handle the target portfolio size.
Conclusions
Perhaps the high expectations the development community had on the impact of microcredit could have been better met if the products offered were more flexible than term loans. Based on the early experience, the business case appears to be promising for a small bank with a moderate portfolio.
Note - The full evaluation report is available for download here.
1. Banerjee and Mullainathan (2010), “The Shape of Temptation: Implications for the Economic Lives of the Poor”, NBER Working Paper 15973.
2. Banerjee, Karlan, and Zinman (2015) “Six Randomized Evaluations of Microcredit: Introduction and Further Steps”, American Economic Journal: Applied Economics, 7(1): 1-21.
3. By Sunil Aggarwal, Independent Consultant