Micro-credit: Trickling down growth or profiting from the poor?

In the past 15 years, political stability together with some good market-oriented policies, have led to an appreciable growth in real incomes in Ghana. We have also been lucky: While cocoa and gold prices have been high and stable, we have not seen very bad shocks to agriculture. Consequently, Ghana has become one of the most attractive places to invest in the sub-region; and firms are responding to the ensuing competition with innovative and affordable products. This is all good. However, we are still far from middle-income status, in part because the benefits of the growth have largely been concentrated in the top 10% of the income distribution.

The last living standards survey (GLSS V, 2005/06) shows that although those in the bottom 10% (in particular, in cocoa producing regions) have seen modest increases in their consumption levels, there has been almost no change in the fortunes of the middle 60%. Besides, about 32% of households continue to live below the poverty line. Prices in and around Accra increasingly reflect this growing inequality. Want a used car? You either pay over GHc15,000 for a decent car, or less than GHc4,000 for a “lemon.” Education for your kid? You have the choice of a good private school, with smaller classes, but very expensive; or a crowded public school class, thanks in part to the Ghana School Feeding Program. Thirsty? That will be 50Gp for bottled-water, or 4Gp for a sachet of “pure” water. Real estate? The disparity couldn’t be starker. Bottom line is, it is either very expensive or very cheap; not much in between.

The micro-credit promise

This is not surprising though. Today’s production requires a new set of skills and/or start-up capital, which the poor lacks. However, the provision of small loans to the poor, who have little or no access to formal credit, has transformed the lives of many families in the developing world. And there are several institutions (including NGOs) that provide small loans in Ghana. But are these financial services helping to spread the growth? More generally, what is the current state of lending to the poor in Ghana, and what has been the impact on their lives?



Although many have started or grown their businesses using small loans, credit is still quite expensive and inaccessible to millions of Ghanaians. Consider a woman who wants a GHc200 loan. This can make a huge difference in her life, but with no collateral, she has no chance of getting a loan from a bank. Her best option is to access a group-liability loan from a microfinance institution (MFI), or borrow from a moneylender on the (semi-)informal market. The group-liability methodology builds upon the traditional ‘susu’ system, and it is the most widely adopted. Loans are disbursed to an entire group, with repayments spread over a period, usually six months. Typically, repayments are made weekly. At the end of the loan cycle, if there is any member who is in default, the entire group can no longer access a loan from the MFI. This forces the rest of the group to pay up for any member who defaults on her weekly payment, thus minimizing the risk faced by the MFI. And since the entire group is responsible for each other’s payments, each group will be picky about who to team-up with.



So in the absence of good information on borrower-risk, group-liability reduces the lending risk, and hence, interest rates; but not much. The rates on these loans are about 3 – 6% a month, and but can be as high as 20% per month in the rural areas, where it is more costly to disburse and recover loans. But that’s not all: In almost all cases, the rate is charged as a simple interest on the principal. Note that, the standard practice is to charge interest on the declining outstanding balance. Now, for the poor, this can make a huge difference. Suppose our woman takes a GHc200 loan (i.e., 2 million old cedis) for six months, at 4% per month, to be repaid weekly. Total charges will therefore be 24% (i.e., 4% x 6 months). If the rate is charged on the principal, her total liability will be GHc248, spread over a 6-month period. That is, about GHc10.33 (i.e., 103,300 cedis) every week. If the rate were to be charged on a declining balance basis, this woman will be paying GHc9.42 per week. She would have saved about GHc21.60 (or 216,000 cedis) over the six month period; the equivalent of 6 months premium of 3 family members enrolled in National Health Insurance Scheme! And the savings increases if the interest rate is higher. Now, there is nothing wrong with high interest rates, as long as they are market-determined. But to enhance transparency, and better comparison with prime rates, I think providers of micro-credit must state, and charge, their rates on the balance of a loan; not what is owed them plus what has already paid down.


In spite of these high rates, there is still a huge excess demand. This is partly because MFIs are concentrated in the big towns, and most require some collateral, but often in the form of group savings over a 2-month period prior to accessing a loan. The savings also allows the MFI to better assess the group’s cash flows. This means loans from an MFI are only accessible to the moderately poor, with some established businesses. If you live outside the big cities, your only option is a ‘loan shark’ who charges as high as 20% per month; again on the principal. To minimize the “pain” from repayment, most moneylenders schedule repayments daily, in small amounts, to be picked up by a deposit (‘susu’) collector.

Clearly, credit will not have any meaningful impact on the lives of the poor with rates this high. Competition will certainly be helpful, but there is little competition because the risks and entry cost are very high. A moneylender, without own capital, will need an acceptable collateral to borrow from a bigger bank at 5 – 9% month, then retail to smaller clients. A related problem is that such high rates drives good borrowers out of the market. These are clients with safe projects but, on average, have lower returns. So a good starting point will be to offer better rates to clients with stellar repayment records. This is why it is imperative that the National Credit Bureau bill be implemented as soon as possible to allow financial institutions (including MFIs) to have access to an individual’s credit history in a loan contract. In addition, technology (e.g., mobile phones) can be exploited to reduce the cost of recovering these loans. For example, it should be easy for a client to repay a loan at a “Space2Space” booth, just as they would top-up phone credits. The payment can be transferred as airtime to an account (a phone number), and the moneylender can redeem this for cash. The savings on labor costs can be then passed on to the clients.

Government, the big elephant in the room

My conversations with managers of rural banks reveal that, the provision of subsidized credit by the government, although with good intentions, is not consistent with best practices in micro-credit. Most notably, the recovery rate is much lower. And due to the lower interest rates, the handling institutions (e.g., rural banks) are unwilling to spend their resources on loan recovery. For example, the Accra Daily Mail reported on February 13th 2007 that, most rural banks in the three most impoverished regions of the country (Northern, U. East and U. West), have shown very little, or no interest in accessing funds under the Social Investment Fund (SIF). Apparently, these banks would prefer to charge at least 25%, rather than the prescribed 10%, so that they can recover the costs associated with disbursing and recovering the loans.
But perhaps, the most serious problem associated with government’s subsidized credit is that it encourages moral hazard. Beneficiaries tend to perceive these loans as a gift, and their unwillingness to repay usually spills over into the loan portfolio of a rural bank (or any other institution). In fact, when a new group is being trained on mechanics of a loan, MFIs will stress that the money is not coming from the government for fear of non-payment. So, unless in exceptional cases, it will be better for governments to stay out of direct cash-lending, and rather invest in developing the institutions (such as a credit bureau, etc), that will make it both easier for MFIs to enter the industry (or expand), and be able to identify low risk borrowers. And by all means, good macroeconomic policies (as in recent years) to reduce the inflation rate, will further narrow the spread between deposit and T-Bill rates, so that banks can take some risks, including lending to small-scale businesses.

Where are the men?

As in most parts of the developing world, over 90% of micro-credit clients are women. Women make better group-liability clients because a woman is less likely to migrate out of her community. Men (in particular, young ones) are constantly in search of better economic opportunities, and therefore have a higher “flight risk.” But more importantly, women are more likely to spend earned income on their children; a fact that appeals to policymakers and NGOs, because such expenditures are essential in breaking the cycle of poverty in poor households.
But most of these men could also use some credit, if the size is right and they have the requisite trade-able skills. For example, having completed his training as a mechanic, a young man may require a larger amount of money to purchase his first set of tools that can enable him start his own shop. An opportunity for government intervention exists here. Instead of a cash loan, the government can create a program that identifies artisans’ need for tools, and provide these tools as credit. The interest charges can be in two parts: (i) a monetary component at low rates, and (ii) a second part, where a beneficiary is required to provide training for one or two people (which most artisans do anyway). And you have the collateral in the tools provided. Such a program can provide skills and employment for young men, and curb the rural-urban drift. Besides, it can be administered with the help of the District Assemblies.
Micro-credit is not the magic bullet to end poverty, so this should not be misconstrued as a call to offer every poor person a loan. In fact, many people in both the developed and developing worlds are lending-challenged, and most have committed suicide over their inability to pay down debt. But well-designed credit programs, targeted at the right group of people, can create enormous opportunities, bridge the income gap, and help sustain the economic performance in Ghana.