Informal Credit: Usury Interest or Borrower’s Games

MadibiraShopkeeper

On the issue page of this website there is a page describing the informal credit system and asking to what extent the apparent quoted 100% seasonal interest rate is an usury rate based on limited funds available and excessive profits by the lender, or does it represent the costs of doing business in smallholder communities and the games the borrowers may play in paying back their loans. The discussion was based on a limited number of interviews with lenders in Madibira, Tanzania. It describes their sometimes extensive efforts to obtain the repayments. Thus there is a real need to take a closer look at the informal credit system and see how appropriate or inappropriate it is in assisting the smallholder producers. Can the micro-finance programs providing institutional credit to smallholders and a subsidized interest rate provide sustainable competition for the informal credit system, or if the farmers are playing the same games with the micro-finance projects, will that drive up the administrative costs for administering smallholder loans to cover all the interest earned as well as ultimately consume all capital so the project collapse once external support ends.

The questions needing answers are:

  1. How common is the informal credit system? It appears to be fairly common across most developing countries with similar quoted interest rates of 100% per season of 200% annual and found in both rural and urban areas.
  2. Are the conditions mentioned in the webpage, that largely justify the “usury” interest charges, common to other countries and smallholder communities, or more specific to Madibira? I would venture they are fairly common across the board.
  3. Who are the providers of informal credit and what is their link to the community?
    1. Are they mostly permanent members of the community such as larger farmers or shop keepers such as the shop engages in comprehensive good both agriculture inputs, purchase of products and consumer goods as shown in the picture, etc., or temporary people transiting through the community?
    2. Are they strictly in the money lending business or is this mostly an aside to other business such as shop keeping and partly needed to serve the primary business?

I would expect them to be mostly closely tied to the community and thus neighbors to the smallholder borrowers involved in assorted support services for which informal credit is a service to the borrowing farmers much of which remains with the lender in exchange for services like fertilizer, market seed, or contract tillage.

  1. If these conditions are common then what is the actual interest rates or profit margin for the informal credit, after discounting for trash, time and effort in collections, defaults etc.
  2. What are the rewards, if any, for those who pay on time with a clean bag of grain? Isn’t it in the best interest for the lender to reward such payments, even if it is an in-kind reward such as fresh seed for the next crop as reported by a former lender in Zambia, fertilizer, or even consumer goods such as cooking oil, detergent, etc.?
  3. How important are in-kind payments to the repayment process compared to cash payments? I would venture the in-kind payments are repaid faster and thus preferred by the lenders. This then lead to the cost of monetizing the payment back to cash. Would that be 10% of the value for clean grain and considerable more if the lender has to re-winnow and repackage, as well as absorb any post-harvest losses between accepting and marketing.
  4. Can a micro-finance project provide sustainable competition to the informal credit system or will the overhead costs of supervising and collecting repayments exceed the interest payments and render the project unsustainable once external funding ends, after which the informal credit system becomes the default provider?
  5. Should the providers of informal credit be vilified as exploiting the smallholder farmers or acknowledged and appreciated for the services they are providing?

I hope this list of questions in sufficient for someone to take a particularly interest in the issue and undertake some more detailed studies of the informal credit system. This might be considered as an essential initial activity for a micro-finance project assisting smallholder communities. That is because it will demonstrate if the project has a sustainable alternative business model capable of surviving beyond the initial externally assisted period, and show some of the repayment problems that may be encountered that would run up the administrative costs of loans beyond what can be recovered from the interest payments. If not and a micro-finance project just jumps in under the assumption the potentially usury rates are all profit margin with limited administrative costs, could quickly result in an unsustainable business model that will collapse once external funding ends and ultimately be little more than a publicity statement of the donors good intentions, with very limited actual long term impact on poverty alleviation.

19 June 2015

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