The Cycle of Debt: As Microcredit Institutions Grow, Some Question Their Effect on Poverty

Chakto Louk village, Baray district, Kompong Thom province – In 2000, Neth Yon, 45, took out a loan of about $100 from Acleda Bank to buy a small boat and some fishing equipment. The loan, she figured, would allow her family to catch more fish, make more money and improve their lifestyle.

Despite long hours of work, the family could only catch enough fish to feed themselves. When it came time to pay back the loan, Neth Yon pleaded with Acleda to give her more time. The bank obliged, but the pressure of debt weighed heavily on her.

About two years ago she pawned her 144 square meters of land to her neighbor for $100. She used the money to pay back some of her loan, but then could not make enough money to buy her land back. With her land lost, Neth Yon may soon have to move in with her relatives. She praised Acleda for being lenient with repayments since she has no idea how she will repay the loan.

“I do not make any money,” she said last week, wiping away tears from her eyes. “I don’t know how long it will take to pay it back.”

Her remaining debt: $16.Chakto Louk village sits about 2 km from National Road 6. Villagers live in simple wooden houses and survive through fishing and farming rice and growing watermelons.

Most took out loans of about $100 from the local branch of Acleda Bank in the late 1990s to buy farming or fishing equipment, assuming that they would be able to produce and sell more.

Then the floods came in 2001 and 2002, destroying their crops. About 30 percent of the village’s 400 families are now in debt. The villagers do not blame the bank for their troubles. Most say that if everything had worked out as planned, they would have made more money and things would be fine.

The problem is that something always seems to come up, and for poor villagers who have nothing to fall back on, the results can be grim.

In Chakto Louk, the debtors live near each other in wooden houses that overlook a vast rice field, left brown and dusty by the dry season. Each villager can list a reason why their loan didn’t work out as planned.

Meak Saing, 36, sitting in her doorway cradling an infant son, blamed the floods for her remaining $30 debt. Her neighbor, Kuoy Cheng, initially took out a loan to buy farming equipment, but ended up spending the money on hospital bills when her husband suddenly fell ill. Sitting nearby, Kiet Kim Yoeurn, 35, had the fishing equipment she bought with her loan money stolen. She owes the bank about $50.

“I am worried about the debt because we can’t make money to pay it back,” Kiet Kim Yoeurn said. “It makes life difficult.”

Rural debt has been increasing as more donors have turned to microcredit schemes giving out loans of no more than a few hundred dollars as a way to develop the countryside, prompting a debate within the donor community as to whether microcredit is reducing or increasing poverty. Proponents of microcredit insist that it helps thousands start viable businesses. Critics say it simply spirals poor villagers into a cycle of debt that hurts them more.

They both may be right.

The history of microcredit is relatively short. In 1976, an economist named Muhammad Yunus used his own money to give small loans to poor villagers in Bangladesh. Six years later, he founded Grameen Bank, which has now loaned more than $1 billion to roughly 2 million mostly poor, female clients while achieving a repayment rate of about 98 percent.

The success of Grameen caught the attention of international donors tired of giving handouts to the developing world. Copycat schemes popped up, and microcredit supported by donors appeared here on a small scale in 1989.

Throughout the 1990s, many NGOs launched credit programs as part of their development activities. Six microfinance institutions now have licenses from the National Bank of Cambodia. Twenty-nine NGOs are registered with the bank to distribute loans and about 60 more NGOs that have microfinance programs are not registered.

Acleda, the country’s largest bank network with 101 offices in 18 provinces, started as an NGO in 1993. In December, the National Bank granted it a full commercial banking license.

“We turned into a commercial bank for sustainability,” said In Channy, Acleda’s general manager, in a recent interview. “We didn’t want to depend on donors the rest of our lives.”

The bank has disbursed more than 800,000 loans totaling more than $245 million since 1993. It boasts a repayment rate of more than 98 percent. In 2003, its net profit was about $2 million, most of which the bank says will go to building up its capital base.

Since Acleda has given out so many loans, it has become the target of wrath from microcredit opponents.

The criticisms leveled against Acleda and other microlenders most often center around the high interest rates lenders typically charge. Acleda charges interest rates of about 2 percent to 4.5 percent per month, and some other microlenders charge more, pushing most annual rates to between 30 and 60 percent.

Most microcredit proponents agree that the interest rates are quite high, yet they disagree with opponents as to how to lower them. Critics, including some lawmakers, have pushed for legislating interest rate caps.

“We oppose criminal interest rates,” said Rosanna Barbero, who works with Oxfam Hong Kong, which is researching microfinance here. “No business in the world can make a profit at these interest rates. A 52 percent average interest rate? It’s ludicrous, evil and disgusting.”

Others said that if an interest rate cap is legislated, microcredit lenders would close their doors. Rural residents who could benefit from microcredit would then be forced to turn to local village moneylenders, who charge significantly higher interest rates.

“Low interest rates would be good for everyone, but only if they are sustainable for the microfinance institution,” said Adam Sack, regional manager of the Mekong Private Sector Development Facility, an initiative of the private sector arm of the World Bank, which has a stake in Acleda. “Otherwise, the microfinance institution is done. Prices will come down if there is more competition.”

A 2002 report on microcredit in Cambodia by the Consultative Group to Assist the Poorest, a conglomeration of Western donor countries and international agencies, urged microfinance institutions to fight against an interest rate cap.

“While real interest rates in Cambodia are high, [microfinance institutions] reaching out to rural areas have equally high operating costs and few…can afford to reduce interest rates without jeopardizing their sustainability,” the report said.

Sustainability comes up over and over when talking about microcredit operations, and for a good reason: If lending is not sustainable, then it distorts the market, which could destroy the microcredit sector.

The problem is that to be sustainable, microlenders must pass on offering loans to the poorest of the poorthe very cohort many NGOs say they are targeting. Microlenders need to look for borrowers who have viable business plans and some collateral to ensure a return on their investment. The very poor often lack any education, skills or collateral.

“Microfinance institutions are overrated in alleviating poverty,” said an official in a donor institution that supports microcredit. “Donors have been sold something that’s not totally true. The poorest of the poor don’t qualify for Acleda loans.”

That’s not to say microcredit doesn’t have its place in development. Poor villagers around the globe tell stories of how microcredit allowed them to start small businesses, make money and improve their lives. Those people, however, tend not to be the poorest, but the so-called “richest of the poor.”

Therefore, when talking about assisting the world’s poorest, it becomes important to draw distinct boundaries between the often blurry lines separating microcredit operations and direct assistance.

“In the absence of long-term sustainability, microcredit operations become a welfare or charity operation,” said a recent UN report of the Secretary-General analyzing microcredit. “While the latter have their own place in development in some circumstances, they should not characterize microcredit institutions.”

At its core, being sustainable means getting villagers to repay their debts on time a process steeped in complexity when dealing with very poor borrowers.

Oxfam research shows that rural households often spend money from their loans on health care and borrow from local moneylenders at much higher rates to pay off their loans. They will also, as Neth Yon in Chakto Louk did, sell land and assets to pay off loans.

In some provinces, microlenders said, local politicians have told their constituents that they do not have to repay loans, creating confusion when the credit officer show up to collect payments. Also, in group lending schemes (where loans are distributed to several villagers with no collateral) lenders complained that a village strongman often steals the funds, making collection from the exploited group a tedious, if not morally ambiguous, endeavor.

“The only way a [microfinance institution] will survive is if it gets repaid,” said Adam Sack at MPDF. “If you don’t come down hard, the rest of the borrowers lose out. They have to protect that capital.”

Despite Prime Minister Hun Sen’s accusation in 2001 that Acleda had jailed nearly 100 delinquent borrowers, which turned out to be false, the bank appears to be lenient in its collection methods. It allows villagers to pay what they can, and only takes those to court that stop paying completely for an extended period of time.

“We don’t want land or houses,” In Channy said. “We are not a real estate company.”
Villagers in Baray commune said Acleda representatives initially threatened to confiscate land or animals, but that never happened.

“In the past, Acleda demanded payment very strongly, but after they saw the difficulty of the villagers, they allowed the debtors to pay off what they can,” said Yim Yoeurn, chief of Baray commune.

While Acleda seemingly allows villagers some leeway in paying their bills, an enforcement mechanism is needed for villagers to take microcredit operations seriously. When the hammer does fall, good intentions for development clash with the reality of doing business.

“If we impose procedures of harsh collection and some poor fellow is ousted from his land and house, is he better off because of our intervention? No, he is not,” said an official of a leading microcredit operation, speaking on condition of anonymity.

His organization is a typical donor-supported microcredit lender. Donors often earmark a set amount of funds that his staff need to distribute by a certain date every year. If the donor ends up allocating too much capital for the microcredit operation to distribute, he said, credit officers end up “throwing away money to whoever will take it.”

Ideally, he said, a sustainable financial system would grow out of local capital. Villagers would save their money and then issue loans to those who need it, careful to make sure the money is paid back. Over time, as capital grows, a local bank would form, and, eventually, link to a national financial system.

The problem with that scenario, however, is that it would take many years. To accelerate the process, donors have injected large amounts of capital with requirements on how much should be loaned out by a certain date.

“Microcredit is not a bad thing, but it must be done correctly,” the official said. “Here it’s had the demoralizing effect of pushing the poorest into debt. That was not our intention.”

To administer microcredit correctly, experts say, it is essential to differentiate between sustainable lending and direct assistance. Lending should be given to those who can start businesses and possibly end up employing the poorest of the poor.

This burden rests largely on credit officers, who often have little formal training. But even if a loan candidate appears to be credit-worthy, the bank cannot force him or her to use the loan to generate income.

“The money belongs to them,” In Channy said. “It is very difficult to control what they do with it after they have the loan from us.”

While microcredit has its place in development, it is not a panacea to eliminate poverty. It can’t prevent natural disasters, sickness or theft, all things villagers often cite as reasons they are trapped in a cycle of debt.

Donors, however, should take care to implement microcredit schemes carefully, taking the necessary time to determine who could benefit from a loan and who simply needs direct help. And as a draft of an Oxfam report on microcredit suggests, donors could also shift resources to developing a viable health care system here, since hospital bills often suck up a large amount of loan money among the poorest borrowers.

“No credit program, no matter how low the interest rates and how well managed the program, will be successful at reducing poverty among families who are forced to borrow money to pay for health care,” the report said.

As the financial sector matures and donors either cut their microcredit operations or make them sustainable, the growing pains are likely to continue.

The villagers in Chakto Louk hope for better rice yields and fish catches in the next few years so they can rid themselves of debt for good.

“If I pay this off, I will not borrow again,” said Kiet Kim Yoeurn, who had her fishing equipment stolen. “I don’t want to be in debt anymore.”

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