Ban on micro-finance; Consumption drops 20% in AP

Aug 10 2013, 02:31 IST
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SummaryWhile the ban on micro-finance in Andhra Pradesh was initiated by policy makers under the claim that this would help poor people, it has hurt everyone

In recent decades, there has been a rapid growth in the micro-credit business by financial firms utilising business models such as the joint-liability structure to lend to low-income households. The higher levels of credit access ought to have been an unambiguously superior outcome. In reality however, these developments have been marred by concerns about consumer protection. Policy makers have grappled with these questions worldwide, and have often implemented a variety of interventions, ranging from relatively subtle rules on consumer protection to restrictions. The role for new kinds of micro-credit firms, and the optimal public policy response to these, has relevance worldwide.

The existing research evidence on these questions is drawn from three strategies: randomised trials, general equilibrium models and natural experiments. Randomised trials are inevitably limited by the magnitude of research budgets, general equilibrium models do not examine all channels through which credit can matter, and the existing papers which utilise natural experiments are often forced to use proxies for consumption. The contribution of this paper lies in utilising a large natural experiment—a complete ban on micro-finance in the Indian state of Andhra Pradesh (AP) that has the population of Germany—and in having high quality measurement of consumption through a panel dataset of 150,000 households observed every quarter all over the country. The ban was imposed in only one state, giving us controls from other locations in the country.

The results suggest a fairly large negative impact of the ban on micro-finance. In AP, consumption dropped by 19.5 percent over the first four quarters after the micro-finance ban. The impact of the ban is visible across all income classes—including those which use little micro-credit themselves—which suggests general equilibrium effects. While the ban on micro-finance was initiated by policy makers in AP under the claim that this would help poor people, it has hurt everyone.

There are intriguing analogies between the experiment in AP—where a subset of society that was using micro-finance abruptly lost credit access—and the macroeconomics and finance literature on deleveraging (Eggertsson and Krugman, 2012). The deleveraging literature focuses on what happens when some borrowers in a country are highly indebted and face an abrupt shock to credit access. The difficulties faced by these borrowers impacts the economy at large, and the consequences are not restricted to just the set of borrowers. The natural experiment that we have examined in AP appears to have some similar characteristics. Only a subset of the

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