In May, Russian microfinance institutions approved 81.4 bln rubles ($921 mln) worth of loans, the highest amount over the past year and a half, according to the National Bureau of Credit Histories (NBKI). Economist Boris Kheifets told Invest Foresight about the dangers of microloans and offered some tips on safe borrowing.
— Last year, real wages in Russia grew by a record 7.8% in five years. However, MFIs’ clientele is by no means shrinking; if anything, it has expanded. Why?
— I think that the people who are increasingly applying for loans, including in microfinance, are not necessarily those who barely make ends meet due to low income; many of them in fact borrow to restructure existing debt. They use microloans to make their overdue loan payments, ‘to manage until payday,’ as they say.
But the people who see their salaries grow, as in these official data that you just cited, are more likely to be avoiding this.
Personally, I believe that in most situations, using microfinance is near suicidal. Moreover, if a person has a decent salary, they go to a regular bank when they need money; banks can issue consumer loans, not only mortgages. Banks offer credit cards with fairly large limits and long interest-free repayment periods.
So, I just think that different groups of the population use different types of borrowing options. Microloans are a solution that is mostly used by the poorest stratum, and these people are hardly seeing any increase in wages.
— Why are microloans so attractive?
— Well, they are certainly attractive because microfinance does not require many formalities, bureaucratic procedures, or substantial documentation to prove that you can repay the money you borrow.
A microfinance institution typically lends small amounts, which makes the risk of not receiving their money back low as well, especially given that strong debt collection tactics are also quite common here.
— What are the dangers of microfinance?
— Microloans are dangerous because they entail extremely high and snowballing interest. Add to this our Central Bank’s key rate, which is unusually high today – this makes even classic bank loans, in what is called conventional finance, quite expensive.
But with a microfinance company, it is much easier to get sucked into a vortex of debt than if you deal with a bank. You can get trapped in debt and thereby cause damage to yourself, and your family. This can eventually harm your social status and even cause health issues, because being trapped in debt is a nerve-racking ordeal.
— Many people call lending one of the engines of economic growth, arguing that GDP grows with the growth of consumer spending. From the macroeconomic perspective, is the growth of lending in this segment good or evil?
— It is very difficult to answer this question. I would say the dangers outweigh the benefits here. Theoretically, yes, microloans should also stimulate employment and labor productivity.
But in fact, I am not sure that this happens exactly as in textbook cases. True, there may be situations where one desperately needs money there and now, and they have nowhere to go except to a microfinance company. But whether this will eventually promote macroeconomic growth – I’m not sure about that.
— It has been noted that microloans are most popular among people with rather high incomes. Why is this so? Is this a consumer riot against inflation?
— It may be that wealthy enough people have this motivation but I have my doubts about that.
Why would this segment borrow money? Just to borrow more money? You can’t buy housing with a loan from a microlending company – they wouldn’t lend so much. Then why would a wealthy person need a microloan? To buy another smart phone? That would be rather stupid.
But consumer riot as a motive can exist per se. Inflation is quite high in many market segments. The four-percent rate that the Central Bank is promising in the near future is still very unlikely.
It is possible that somebody wants to buy foreign currency while it is still available. Also, if they have insider tips, they may be interested in borrowing “easy money” to trade in the stock market where they could double or even triple this money quickly. I still believe it is not something that microloan users usually do. Wealthy people do not generally take out microloans en masse.
— Do you have general advice for people who decided to deal with a microlending institution?
— My biggest advice is, do your best to avoid that.
Of course, one must carefully read the loan agreement, thoroughly understand the individual terms that will affect the final loan rate. You need to clearly understand what the rate will be, how much extra money you will pay and in which payback term.
Yes, we face different circumstances in life, including illnesses and other force majeure. But my personal opinion is, even in emergencies, it is better to find other ways to borrow.