Getting it right on microfinance

There is a strong case to support Dr Y V Reddy's thesis that for-profit MFIs should be regulated on par with moneylenders.

The recent microfinance crisis in Andhra Pradesh has laid bare a fundamental mismatch between instruments and objectives. Directed credit such as microfinance or its broader counterpart called the priority-sector lending is economically justified only if the beneficiary entities use it to finance projects that are profitable at the market rate of interest but go unfounded by the market. When this condition is satisfied, on average, we would observe the same default rates on directed credit as on market-driven credit.

But the high rates of default and repeated loan waivers point to the failure of microcredit to satisfy this condition. Indeed, prima facie, the availability of profitable projects in rural Andhra Pradesh at the market interest rate on a scale commensurate with the current volume of microcredit lending would seem to be highly improbable. A plausible conclusion is that at least in rural areas the principal aim of microcredit is not to correct a market failure in the credit markets.