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The microfinance industry, which once set out to protect the poor from extortionate moneylenders, may depend on those same moneylenders for its business success; and these moneylenders in turn may be profiting from microfinance. So reports the Wall Street Journal today.

Ketaki Gokhale is a Stanford University graduate student currently working for the WSJ as this year’s Daniel Pearl Memorial Journalism Intern. Earlier this year Gokhale reported on credit bubble tendencies brewing in the microfinance sector in India, an article which provoked controversy and some indignation among the microfinance industry and its advocates.

One of Gokhale’s interviewees reported being overwhelmed by the sudden and forceful supply of credit in her neighbourhood. “Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband’s vegetable cart. Then she borrowed more.” The lady descended into a borrowing binge, at the end of which she even bought a television. She was forced to sell virtually all of her assets and still remained in debt worth around a quarter of her annual income.

Refinancing microfinance loans through the grey market

Gokhale has now followed up her earlier investigation into the dark side of microfinance and uncovered structural complementarities and interdependencies between the microfinance business and local moneylenders. The irony and sadness of the story is that microfinance originally set out to put these same moneylenders and their practices of extortion out of business by offering the poor loans which they could afford. Moneylenders in India are reported to charge interest rates even beyond 1000 per cent annually, leading to debt bondage and other existential problems for the poor.

The entry of microfinance banks into the market may have pushed down the interest rates of some moneylenders, but paradoxically the moneylending business appears to be growing. As Gokhale reports, more than 80% of registered moneylenders in Mahabubnagar started their businesses after the year 2000, which coincides with the phenomenal bout of growth in microfinance in India in the past decade.

It appears that many microdebtors cannot afford to comply with the extremely rigid repayment schedules of microfinance banks, so they must turn to moneylenders, thereby re-financing their loans through the grey market – the market which microfinance sought to protect them from. Read the rest of this entry »