India: Building Alternative MFI Model
Sabnavis, M.

The evolution of microfinance in India can be put in a theoretical context. There is a case of the existence of 'asymmetric information' where the lender has little in his armory to know that the borrower will repay the loan. In the absence of a clear credit evaluation process, this asymmetry will continue to exist. When there is such asymmetry in availability of information, we run the risk of 'adverse selection'. As long as we are dealing with communities that are known to perform, it will work. But, as we scale up this trust model, then we run the risk of selecting the wrong people.

This triggers default and the reason attributed can be high rates being charged in the face of adverse economic conditions for the borrowers. This has a backward linkage with the MFI and lending bank creating financial chaos. The MFIs cannot use strong-arm techniques to recover money. Borrowers now know that if they borrow, they do not have to repay as there is a constituency which will speak for them when the time comes. This raises the issue of 'moral hazard'.

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