Tuesday, October 26, 2010

The microfinance debate: SHG vs JLG

For last few weeks a huge debate has been brewing in the microfinance space. AP government has cracked down upon MFIs and passed an ordinance to stop them from lending to people who are part of SHGs(or self help groups), unless those SHG members obtain a NOC from their SHG.

To the uninitiated, MFI use a model called JLG (joint lending group) and government supports SHG. The basic difference between these two is the fact MFIs lend money from the banks to make loans to poor people of the JLG model. In SHG model, on the other hand, participants are encouraged to open a bank account themselves and put their joint savings into it. When they need money and SHG approves it, they get a loan. They can also get money from bank, where they have a bank account, if they need. However in most cases, such external borrowings are very little as bank doesn't reach out to them. In the end, very little money from outside the economy is pumped into the local economy.

In my opinion, SHG model doesn't work that well when it comes to poverty alleviation. Here's how I'd like to present my point:

Diwali, to many, seem like a waste of time and money. How can such a poor(?) country put up with such spend thrift traditions! In spite of all the arm-chair musings, every time it comes along, people end up spending more money than last year. In the end, it ends up circulating a lot of money from the banks and pockets of the people to the deepest & darkest(TM) corners of our country. People buy clothes, sweets, fireworks, electric lightings, earth lamps, tisi oil, shares (on diwali night) etc. Most of these goods end up pushing money from people who have it to people who need it as these goods come from the toil of the poorest of our brothers. Lets look at these goods in a little detail and look at their value chain.

Buying of clothes -> cloth shop owner -> cloth weavers -> cotton farmers
Buying of sweets -> sweet shop owner -> poor people making these sweets -> sugar seller -> sugar companies -> farmers of sugar cane etc

Had there been no diwali, any other festivals or marriages, we would end up killing our clothing industry, cotton farmers, retail cloth shops and lively hood of other millions.

Currency only makes sense if it can be spent. Similarly SHGs are not doing any good by persuading people to put most of their money in the bank. As more and more people do it, the local economy suffers from lack of liquidity.

JLG model on the other hand *pumps* money in the local economy, which spurs *real* growth. People buy more, work more to earn more and this increased economic activity in turn empowers a lot many other people in the local economy to contribute effectively and feed their families. At the end of the day when these people have enough money they will turn to banks to save it. Pressurizing them to use SHGs exclusively is just going to make more people poor. In my view government is sticking to a model which is pre 1991 and doesn't make much sense in a globalized, connected economy.

Note: This post is about my thoughts & ideas and not of my employer's.


Venkat Muvva said...

This is one of the latest topic being discussed in all Telugu Electronic and Print Media.
I would like to add some missing facts in these two schemes which are missing in the original post. My opinion is not based on Media articles and I have seen the functionality of these two schemes as I am basically from a Rural background.

Self Help Groups(SHG) is a very good idea and this encourages poor people to save small amounts and use the money cautiously in cases emergency (like unexpected health problems, natural calamities etc...) They deposit money into bank and they get the interest for that money. When ever they take loan they were charged very less rate (3% in AP) than the interest given on their deposit amount.
Chit funds, Co-operative societies also work in the same model. Group financial schemes are most successful in rural south India and proven for the past several decades.

JLG/Micro Finance Institutes This schemes failed with in very less time and the reasons are
1) High interest rates (60%)
2) Loans are easily available and people are availing loans to buy TV's, pilgrim tours, ornaments, starting small business etc.. Bust most of the money is spent on non productive areas. This money is not helping anyway to rise their income levels. People are falling into debts very soon because of high interest rates. Then MFI agent raids, Insurance, Suicides, politics etc.. continues.

I would like to add few words to the below sentence.
Currency only makes sense if it can be spent for the productive use and by the affordable people . Because this money is not coming from charities and the corporates who ever is doing business expect high returns (because of stock market expectations and greedy VC's). A person who buys a SKODA car for 30 lakhs gets loan at 7% interest rate but poor people who earn Rs.200 per day have to pay 60% from the same corporate. Poor will become more poorer becoz of these policies.

Anonymous said...

The ultimate aim of JLG and SHG is to help poor. It is not that SHG forces to save money and drains liquidity. The person who knows to save only can repay the loan. Moreover, SHG imposes discipline.
Actual difference is - SHG is volunteering JLG- organised by an MF

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