Credit problems in the Indian city of Ramanagaram hint of a broader microfinance credit bubble, says a recent Wall Street Journal article. According to the article, part of the problem is that lenders are less concerned about alleviating poverty and more concerned about turning a profit.

Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding. This change opened the door to more private-equity money. Of the 54 private-equity deals (totaling $1.19 billion) in India's banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million...

Protected by high interest rates, lenders are handing out loans without ensuring that the borrowers can repay. The excess of available funds and large number of lenders provide a opportunity for debtors to pay their interest by taking on yet more debt.

Many debtors in Ramanagaram have borrowed themselves into a trap. They take out new loans to pay the interest on existing loans — rather than investing the money or paying off the principal — and then find themselves unable to continue paying when the debt load grows too large. Lending procedures should prevent this from happening, but they haven't in Ramanagaram.

Take the example of the woman in this Wall Street Journal video. After borrowing $150 to invest in her husband's business, she took on four more loans, each to pay for the interest on the prior loan. She is now caught in a debt trap, her current debt is nearly equal to her annual income.

Lenders are responsible for checking if a borrower has excessive debt. But at least one admits to the Wall Street Journal that they only check with the largest of loans.

In Ramanagaram, over-borrowing is creating an anti-microfinance backlash. Civic leaders are questioning the value of microfinance and Islamic clerics are telling local Muslims to stop taking on microfinance loans.

Microfinance is still one of the only ways for the world's poor to access credit, a piece in the Economist reminds us. The vast majority of borrowers repay their loans. More stringent supervision of lenders should prevent a worsening of the crisis.