INNOVATIONS IN RURAL AND AGRICULTURE FINANCE


Determinants of Microcredit Repayment in Federations of Indian Self-Help Groups YANYAN LIU AND KLAUS DEININGER


FOCUS 18 • BRIEF 7 • JULY 2010 S


ince the establishment of the Grameen Bank in Bangladesh in 1976, microfinance has boomed. As of December 31, 2007,


3,552 microcredit institutions had reached 154 million clients worldwide, about 106.6 million of whom were among the poorest when they took their first loan. Such expansion can be at least partly attributed to the widely adopted practice of group lending in microfinance programs. In contrast to individual lending, group lending (or joint liability) grants a loan to a group of borrowers, and the whole group is liable for the debt of any individual member in the group. This practice allows microfinance programs to rely mainly on accountability and mutual trust among group members rather than financial collateral to insure against default. Given that the poor often lack appropriate financial collateral, group lending programs offer a feasible way of extending credit to poor people who are usually kept out of traditional banking systems. There is considerable debate about whether such groups can be sustainable, achieving sound repayment performance while serving poor borrowers. The factors affecting repayment performance are thus of great policy relevance. This brief examines whether and how much repayment is affected by three factors: the source of the loan, groups’ provision of public goods in the form of insurance substitutes, and the monitoring and repayment rules of the federations of groups. The data come from more than 2,000 self-help groups (SHGs), federated in 299 village organizations in the Indian state of Andhra Pradesh. The SHGs under study were supported by a large World Bank program called the Indira Kranti Patham (IKP) program, with a cost of US$260 million. The program has been replicated in other states in India and may be replicated in other countries. A better understanding of factors influencing repayment will therefore help improve the performance and advance of the program.


Background of the IKP program


Building on Andhra Pradesh’s tradition of SHGs, the IKP program was launched in October 2000 to promote the formation of new groups and to strengthen existing ones. A typical program SHG consists of 10–20 women members who meet regularly to discuss social issues and engage in social activities. During these meetings each member deposits a small thrift payment into a joint bank account. Once enough savings have been accumulated, group members can apply for internal loans that draw on accumulated savings at an interest rate to be determined by the group. Once the group establishes a record of internal saving and repayment, it becomes eligible for loans through a commercial bank or IKP program funds.


An important component of the program is to support the


federation of SHGs at the village and mandal (block/county) level through formation of village organizations and county organizations. The purpose of federation is to capitalize on economies of scale in capacity building, credit, and insurance and to


ensure that public programs reach the poor. Although IKP program funds were initially made available to SHGs, they were shifted to village organizations and later to county organizations as soon as these were established.


The survey


Data for this study come from a survey of 299 village organizations conducted by the World Bank in 2006. This brief investigates 3,350 expired loans made to members of 2,147 SHGs. In the survey, all loans taken by each member SHG in the village organizations between June 2003 and June 2006 were recorded from account books of each organization. The study period started after the majority of village organizations were formed and coincided with a major drive for SHG formation. Of the 40 million rupees (about US$1 million) of aggregate loan principal, about 60 percent of the funds were provided by the IKP program, with the rest of the funds coming from banks, SHGs, and other sources. Only 63 percent of loans from the IKP program were fully repaid, compared with 87 percent repayment for bank loans and 89 percent repayment for internal loans. The survey provides information on loan terms (size,


source, length, interest rate, and repayment frequency), SHG characteristics (size, age, and membership composition), and village organizations’ monitoring and repayment rules. These rules differ in four key dimensions:


• Delinquency management policies. These policies include fees to SHGs that miss an installment and loan recovery committees to monitor SHGs’ creditworthiness (through a rating system, for example). Both would likely increase repayment probability.


• Monitoring of SHGs’ financial affairs. Here, the study looks at three variables: whether the village organization (1) regularly inspects member SHGs’ books at monthly meetings; (2) employs a trained bookkeeper; and (3) regularly audits members’ books. Again, all of these steps should help reduce defaults.


• The extent to which the village organization provides public goods. The study considers whether in-kind rice credit and marketing services are provided. The in-kind rice credit is a program whereby the village organization acquires subsidized rice in bulk under the public distribution scheme and makes it available to SHG members as an in-kind credit, with any savings from the bulk purchase passed on to members in the form of lower prices. Marketing services are the collective activities that help SHG members gain access to markets—for example, buying and selling in bulk to obtain more favorable prices or to reduce transaction costs. Because such benefits can be cut off in case of default, they should enhance repayment incentives, especially when alternative sources for these benefits are unavailable.


• The extent to which SHGs are required to deposit regular thrift payments with the village organization. The village


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