Reconsidering the villain of all villains – the village money lender

Source: Yesu Garden

The textbooks often state that the village money lender charges usurious interest rates. The interest rates mentioned range from 50% per annum to 75% and even 100%. Now with such interest rates, the money lender should be an extremely rich person. The reason is simple. The power of compounding is very strong. To put this in perspective, the return rate for a legendary investor like Warren Buffet in the US is ‘just’ somewhere 25% and 30%. And Warren Buffet is amongst the very richest people in the world. So, the village money lenders in India should be much richer than Warren Buffet. But are they?

Not only are the village money lenders not richer than Warren Buffet and the likes, they are nowhere among the top business families within India. In fact, they are hardly anywhere in the hierarchy of the rich in India. Have you ever heard of a village money lender who is very rich in the sense that he is comparable to the Ambanis, the Tatas, and so on? No. Then what is going on?

It is true that money lenders often adopted strong arm tactics to recover the money they had lent.

The simple fact of the matter is that the village money lender has high costs. Usually he ensures that money is available on demand. This means that he holds a lot of cash as an inventory most of the time. Now cash earns zero interest. So the overall return to the money lender is the average of what he charges and the zero interest that he gets on his cash holdings. The average return drops. Then there is the risk of default, which is one important reason why the interest rate is high. This further reduces the effective net return to the money lender.

Next, consider factors like robbery, kidnapping, extortion, and so on in a country like India. These reduce the capital of the money lender drastically, when they happen. It is well known in a rural area who the money lender is. He is vulnerable. It is not just financial risk. In a robbery, it is quite possible that there is injury, even severe injury. There can be fatal cases in which life is lost. It could be loss of life of the money lender himself or his family members. So, this loss needs to be added to the financial loss due to robbery, etc.

All this is actually very obvious. The business of a money lender cannot be very profitable in the long run? Why else is it the case that more and more people do not become money lenders? It is true that many people would not like to become money lenders; they dislike the work. But there are many who would be interested in big money, provided there is indeed big money. But there isn’t.

So many Hindi films including some very reputed films have given us the picture of a money lender in a village. They have provided a vivid picture but often an incomplete picture. The complete picture is that the money lenders have problems of their own. It is not a bed of roses for anyone including the money lender.

It is true that money lenders often adopted strong arm tactics to recover the money they had lent. However, even here, there is another side to the story. In a country where contract enforcement by the government is effectively weak for a variety of reasons, the money lender needs to ensure enforcement of contracts on his own. Suppose the money lenders did not have credible threats to enforce contracts, then it is not clear how many borrowers would repay the loans! Default on a loan is possibly the default option, if contracts are not enforced. Now contract enforcement or the threat of it adds to the costs of the money lenders.

For the first three decades or so after independence in 1947, the prevailing ideology (or fad!) was socialism. That meant government intervention in markets, planning, nationalization, protection to industry, and so on (socialism did not mean a large tax-GDP ratio, meaningful regulation, well targeted subsidies, and so on). In that setting, it is not surprising that the rural, rustic, unpolished money lender was an identifiable villain in a big system. It was too much to understand how the system as a whole kept the people poor.

It is encouraging to see that micro-finance institutions in recent years have been successful in providing loans without adopting strong arm tactics and without charging interest rates that are comparable to those charged by money lenders. However, it is important to keep in mind that many micro-finance institutions rely on some kind of subsidies. Also, micro-finance institutions have relied on an innovation, which is that it is better to have group lending rather than individual lending. Besides, many micro-finance institutions rely on economies of scale, on diversification, and on somewhat modern methods of management. These were, it seems, not in the know of the traditional money lender. He was typically simple, unsophisticated and also inefficient. He simply charged a high interest rate to make finance work.

All this is not to say that the typical village money lender was not exploitative or that he was a man of any great virtue or competence. This was often not the case. But we need not go so far as to exaggerate his follies. Because this can breed hatred. People can turn violent in grotesque ways to take revenge on perceived villains. It is important to have a perspective. It helps in achieving peace even as we have economic development. In Germany, one reason why many people acquiesced in the war crimes against the Jews was that the latter were viewed as unscrupulous money lenders who charged high interest rates and exploited people. One hopes that kind of a phenomenon does not happen against money lenders or against anybody in India.

Profile photo of Dr. Gurbachan Singh
Dr. Gurbachan Singh is Adjunct Faculty, Indian Statistical Institute, Delhi Centre.