In Chapter 7 of Poor Economics, Duflo and Banerjee talk about the economic rationale behind the wide-spread microcredit business in developing countries, especially in India and provide analysis of its current situation. The authors argue that despite of the problems associated with the program, it is an outstanding achievement that has reached a large number of people. The next step of the program should be focused on the financing of medium-scale enterprises. To reach the conclusion, the authors employ a number of statistics to illustrate their point.
When they describe the situation where households do not borrow from a proper lending institution even though interest rates from such a source is so much lower, they quote “In the survey we conducted in rural India, about two-thirds of the poor had a loan. Of these, 23 percent were from a relative, 18 percent from a moneylender, 37 percent from a shopkeeper, and only 6.4 percent from a formal source.” They also write, “Interest rates vary across sectors and countries, but the bottom line is always the same: yearly interest rates in the 40 to 200 percent range are the norm.” These astonishing numbers clearly illustrate their point that poor people tend to borrow from the people they know at excessively high rates rather than from legitimate institution at lower rates. Following the discussion, the authors introduce the idea of multiplier effect to elaborate on the difficulty with collecting interests and loans. When talking about the limits of microcredit, they quote the incident where the father has to urgently borrow 179 dollars without knowing when to start his repayment to indicate the lack of flexibility of the program. The authors quote that “India has a priority sector regulation, which constrains banks to lending 40 percent of their portfolios to the priority sector, consisting of agriculture, microfinance and small and medium enterprises, which can include quite large firms.” This statement was used to show the increasing attention focused on financing medium-scale companies. The chapter is very illustrative in the way that it provides a detailed analysis of the microcredit sector in India. I am really surprised to see the triple digit interest rates charged to poor people and their reluctance to borrow at lower rates because they tend to borrow from familiar people.
Also, the way institutions prevent default through signing contracts with a group of people is quite innovative. However, I do have a question remaining. I think this method works in India rural area because in Indian culture, it is very inappropriate to be the person hat drags the group back. However, in some culture, people tend to be more selfish and do not care much about the negative impact on the collective good. Therefore, how can microcredit work in these developing countries? Personally, I do believe in the power of microcredit but definitely it can improve in many ways.