Tuesday, September 11, 2007

Micro-Finance in Urban Areas

Micro finance has not been successful so far in helping urban poor due to many reasons. Obviously just giving money is not THE SOLUTION. We need a lot many other support structures/reforms so that the poor people can exploit the opportunities better. A big list of such support structures and reforms could be made, but most of those things will be under the control of government. Here in order to just think of a market based solution for making these initiatives successful, I would like to address a specific problem which micro-finance institutions (MFIs) face in urban areas.

When we consider the incentive for MFIs to go an lend money to poor people in urban slums, they have a big discouraging obstacle, i.e. repayments. Repayments in micro-finance are dependent on factors like how stable (location-wise) the population under the experiment is, community ties, shame factor within neighborhoods etc. Urban slums in India and probably everywhere in the world would score badly on these indicators. Population is very dynamic, as in many new people keep coming in to the cities from rural areas looking for jobs and many leave to go to other cities or their villages or somewhere else within the city. Social or community ties are very weak because most people are recent acquaintances only and otherwise also they are not relatives or close family friends since decades as it would be the case in villages. Hence people have no shame in defaulting loans because they don't care about their neighbors.

All these reasons are expected to lead to a very low repayment rate in urban slums for MFIs. Hence they would not like to roll out their operations in these areas. One possible solution for this could be to invest in human capital or people. What I mean to say here is, the micro-credit loans should be given to learn new skills to start a small service or to look for jobs. Borrowers should be required to make a PAN (social security card equivalent) in order to qualify for the loan. And most importantly, a accreditation and job-search assistance service should be run along with. So even if someone wants to take loan and work as maid at any middle-class family's house. MFI can confirm on receiving a call that their new employee belongs to the MFI's borrower network and hence can be trusted relatively more than any other person. This is a good incentive for the borrower to stay connected and make repayments on time as her/his livelihood becomes more certain.

Similarly, because an MFI can start and manage a job-search assistance service, if they do so (or outsource that), they give the borrowers all the more reason to remain a part of the network by keep repaying the loans on time. Additionally an insurance premium could be added to the interest rate in order to cover the borrowers from unfortunate circumstances where they don't get any jobs or are not able to sell their services, due to which they won't be able to repay the loans.

This idea is not in perfect shape but it definitely provides a good line of thought to approach this problem. There are some catches and I am sure innovative solutions for those could be thought of. Anyways, urban poverty is a fast and steadily increasing phenomena everywhere and we need to come up with new ideas to tackle this problem. I hope this could be one way to think about it, because at the end of the day these poor people come to big cities in order to earn more than what they could earn in their villages. So we should probably just focus on how we can help them achieve their goals and in return they need to just repay their loan, which enables them to remain in the network which opens door to more opportunities and a possible support mechanism in their unexpected bad times in future.

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