How Can Group Loans be Provided more Responsibly?

Nov 2014
Global, November, 20 2014 - The popularity of the joint liability group (JLG) loan, attributable to its ability to deliver credit to households that lack collateral while achieving near-zero default rates, has led to the establishment of a large microcredit sector in many countries including India. However, repayment (or its lack thereof) presents an incomplete picture in assessing whether a JLG loan actually helped a customer achieve her original goals or improve her financial situation.

For many smallholder farmers, for example, who account for a large customer segment for JLG loans, income is often volatile and dependent upon external factors, such as the price of harvested crops or rainfall patterns. The repayment plans for typical JLG loans, however, are structured and not very flexible. They require weekly or monthly payments for the life of the loan. The farmer’s obligation to make these structured repayments according to this schedule is akin to a highly leveraged position in the stock market – very risky. In a bad month when income from the sale of produce is low, repaying a loan might only be possible by making sacrifices such as eating less or lower quality food, working more hours as a part-time casual laborer, or parting with a cow for much less than it is worth. In a case like this, the farmer may have successfully repaid a loan, but at what cost? In this way, repayment behavior does not necessarily signify whether a loan enhanced a household’s financial position. At worst, it may shroud whether the loan left the household worse off.

Rather, the “interaction” of financial products with the natural cash flows of a household is crucial to the product’s efficacy in meeting household objectives. Based on a household’s characteristics and its financial situation at the time and point of a product’s sale, it is possible to evaluate the “goodness of fit” or the “suitability” of a household, in terms of anticipated outcomes. Financial service providers such as banks and microfinance institutions may naturally be in a stronger position to advise their customers on appropriate products and to steer them away from products that will likely cause them harm. Recognizing this provider obligation, The Reserve Bank of India in its recent draft charter of customer rights includes a Right to Suitability, which states that financial products offered should be appropriate to the needs of the customer and based on an assessment of the customer’s financial circumstances and understanding.

In light of this new regulatory stance on customer protection, the IFMR Finance Foundation (IFF) seeks to understand implications for providers of JLG loans, which in India are most prominently microfinance institutions (MFIs). By identifying sets of household characteristics that are fundamentally unsuited for a JLG loan, IFF will develop guidelines that would act as a “do-no-harm” filter at the point and time of sale.

Through a longitudinal survey administered in Tamil Nadu, India, a sample of 200 JLG customers and comparable non-customers will be interviewed each month for the duration of their loan. Field investigators will gather detailed information on a variety of household characteristics such as asset holding, occupational cash flows, and consumption patterns, as well as household behavior such as instalment repayment management, coping mechanisms in the face of shocks, and dynamics within JLG groups.

The primary analysis will focus on the determinants of financial stress related to the changing composition of household financial portfolios, paying close attention to the role of the JLG loan in reducing or enhancing overall financial stress. This rich dataset will also enable supplementary investigations on household economic behavior including how households use financial services to meet expenses, make investments, and manage shocks.

The findings from this study, funded by the CGAP Clients at the Center Research Fund, will set a precedent and provide a model for how JLG loan providers can be more responsible and better function in the interest in of the customers they serve. Study results are expected to be available by mid-2016.

Source : CGAP

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