It seems incredible that the fortunes of the microfinance industry, especially of the companies at the top, should have changed so drastically in just a matter of months. Though new to organised finance, microfinance has grown rapidly in recent times, particularly in the southern States, with Andhra Pradesh in the lead. With an estimated Rs.22,500 crore lent to some nearly 2.7 crore active borrowers, it has entered the mainstream. Microfinance institutions (MFI) have been active in remote places where commercial banks do not exist. Their claim of providing “the last mile connectivity” and that too to the poorer sections is not without basis and this is extremely relevant in the context of the policy thrust on financial inclusion. In several ways, the MFIs complement the commercial banking system. Banks lend the MFIs the money. Since these loans fall in the priority category, the banks have an additional incentive to lend them. The MFIs have a very good track record of recoveries, having successfully adapted the traditional bank loan documentation model of joint liability for the group. A default by a single borrower impairs the ability of the group to receive credit.
The average size of individual loans of the MFIs is small and the typical rural borrower is one without any security to offer. Yet these have not stood in the way of the MFIs making a commercial success of their activities and earning huge profits. In fact, it is the high level of profits earned by the MFIs and the general lack of transparency that have shown the business in a bad light. In the past, some of the MFIs have justified the high rate of interest on their loans — in the region of 30 per cent — by citing the high costs of funds available to them and the high default risk they have to reckon with. However, the abnormally large profits of the industry leaders and the high monetary rewards accruing to the promoters and senior executives, among other factors, strengthen the case for lowering the lending rates. The Andhra Pradesh government has, through an ordinance, required all the MFIs to register with the district authorities and avoid coercive recovery practices and multiple lending. The RBI has appointed a committee to look into the governance issues. There are reports that Nabard might be asked to regulate the industry. It is obvious that the MFIs face an extremely challenging environment. They should welcome uniform regulation, more transparency in their operations, particularly interest rates, and governance. They are providing a valuable service, and only by being transparent and sprucing up their governance can they acquire legitimacy in the financial mainstream.
Comments:
It is far easier to put restrictions on Micro Finance Institutions (MFIs)than to manage them or arrange for credit to small borrowers who have no security to offer.While there can be no justification for the MFI's excessive rates of interest, which we have seen takes different forms like administrative charges, there is little that the State governments do provide credit to the needy. Therefore, it is necessary to provide unambiguous guidelines to MFIs about the rate of interest as also business methods that are permissible and then have only supervision to ensure that the guidelines are really followed. If some MFIs are doing good work, let us not put them out of business by imposing unreasonable restrictions.
RBI must formulate regulatory system to prevent opaque dealing of Microfinance Institutes.Corruption must get instant blow to enhance progress of the nation.
The point that the author missed here is that in most parts of the world the MFI's are financed by the philanthropists, who care less about what happens to their money once its been donated and thus the high profits data mentioned here is unrealistic. MFI in no doubt are doing a good job by providing loans to people whom no one else will finance due to high default rate. But their actual help provided to poor is not mentioned here which may depend on several factors. for example a MFI provides a loan to poor to set up his own fruits stall and if he is actually able to make profits from it or not. These end results can only be improved by more government involvement in the matter.
The absence of banking sector in the remote rural areas is the fallout of overwhelming growth of MFIs. Also the rigid and complicated procedures being adopted by the banks like collateral security is another cause. Furthermore the life of the borrower is insured by the MFIs and so the MFIs get their due even if the borrower commits suicides. So many farmers who avail loans from the MFIs commit suicides. The AP government's move to regulate the MFIs is welcome.
The high rate of interest for the money procurement and the high salary of their executives do not give the MFIs the certificate to charge so high as 30% interest on the poor and down trodden. It is a reincarnation of the 'saahukaar' of the old days. Those who are interested in social service in true meaning of the word should be allowed to enter in the field of MFI. Those who want to make such exorbitant profit they should look for other avenues.
There is no defence against the fact that the MFIs have been extracting interest at an exorbitant rate. The unlettered poor are grist to their mill. In their anxiety to tide over their ever incresing pecuniary miseries, they hasten for multiple loans and land themselves in trouble. The implementation of rigid norms to preclude despicable exploitation of these vulnerable sections must be ensured. After all, as Paul Krugman avers, "The borrowing made world as a whole neither richer nor poorer: one man's debt is another person's asset."
Though regulation is necessary, it should not defeat the primary purpose of MFIs. One thing need to be observed here that the MFIs reach the poorest of the poor where the banking sector has not reached. If banks extends its credit facility to poor, then there will be healthy competition between MFIs and banks and ultimately poor wiil be benifited. Therefore further action on MFIs should carefully caliberated.
As mentioned in this article and also as boasted by many MFIs, the default rates in this sector are extremely low and recovery rates are on par with mainstream banking sector. Therefore, it is unjustifiable to charge such high interest rates from the most vulnerable sections, especially by the MFIs receiving interest free funds from philanthropists.
The MFI's are authorized by government to decentralize the money available with the people and to share it mutually to improve livelihood. But today they are becoming the traditional moneylenders, whose aim is to make profit not mutual welfare. The government action to handle this sector through Nabard as regulating body is welcome, but it should also need to be monitored by RBI. These regulating bodies may make MFIs to operate under stringent rules, but it is necessary to save the deprived classes of society.
MFIs are mostly promoted by NGOs who came to the field with a commitment to enable the poor to get their due share of development assistance from the Govt without any harassment. Secondly, these MFIs/ NGOs are supposed to collaborate with the Banks and make easy access of credit to the poor. Thirdly many of these NGOs or NGO-sponsored MFIs have received huge funding from many donors with the sole idea that easy credit should flow to the rural poor so that the poor will be free from the clutches of the money lenders. Unfortunately, in reality all these MFIs have become true money lenders by replacing the old money lenders, whom are considered by the society as the "lender of last resort." The MFIs offer credit with the same conditions as if a money lenders offer the loans . This is nothing but old wine given in new bottle with new label. Fortunately, these MFIs have recruited/ offered many good positions to the retired GOVT/ RBI officials in their Boards and hence even GOVT/ RBI hesitate to take any stringent actions against these MFIs. It is better that the Govt brings an legislation putting an upper limit of 12 % flat rate of interest and the payment should be on monthly basis and not on daily/ weekly basis.
I was somewhat surprised at the Micro-finance industry's problems in AP. I don't see reports of similar from other states. Perhaps this is AP's unique ability to take anything - even a good idea like MFI - and find a way of corrupting it. Yes, regulation is required, but as usual it will only slow down people and institutions who want to do good, and the people who need to be regulated will bribe their way out of it. The unfortunate aspect of this is that the MFI's that were doing micro-finance correctly will also be painted with the same brush as the ones who are using coercion.
Interest rates: The Poisonous Fangs of MFIs. MFIs were touted to provide the poor access to affordable credit, reduce poor people's need to use moneylenders and indebtedness. In short, provide a much kinder, cheaper alternative to the village loan shark. Instead, they evolved as the new class of institutionalized loan sharks which neo-liberals gave respectability to. MFIs did improve access to micro loans but failed in their touted mission to provide affordable and gentler credit and above all, one that lifted people from the clutches of poverty. Objects of institutional financial sustainability exhort them to charge interest rates and fees high enough to cover the costs of their lending and other services. MFIs argue that they need a spread apart from all costs to provide for contingencies and growth. Fine but the moot question is how much should be this spread. MFIs argue that economies of scale and competition will drive interest rates down. This remains only a theoretical argument.If at all, the average Indian MFI interests rates appear more benign than in Latin America or Nigeria, it is simply because other than factors internal to the MFI industry, the sector faces strong competition from governmental and NGO SHG micro-saving programmes in the absence of which, these MFIs would have formed a cartel. Past angry public and government reactions that resulted in a backlash against them, which included the arrests of MFI top leaders, like Uday Kumar of Share Microfinance Ltd as in 2007, keeps their profiteering impulses under check. The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. By 2014, they target to reach 110 million borrowers. Remarkably, despite two decades of operations, if statistics are to be believed, these MFIs only reach just 20 million people in the country, a good proportion of them, multiple counted. Yet, they succeed in gaining an attention, so disproportionate to this minuscule reach. Act now to prevent they becoming an epidemic in the country. Act now, when they are most vulnerable. How do know they are vulnerable? Because Vijay Mahajan, the father of MFIs in India tells us so: “We are facing collapse. Unless something changes on the ground, the industry as we know it is basically gone.” Mahajan, we have news for you. The day when the likes of you are gone, that will be the turning point for the fight against poverty! What’s wrong with Micro-finance Institutions? Practically everything as the case of SKS illustrates. Read More: http://devconsultgroup.blogspot.com/2010/10/whats-wrong-with-micro-finance.html
MFIs should not just be profit making institutions. Their identity comes from the objective ie to grant monetary help to the poor so that they can earn their livelihood. All the decisions should be made in alignment with the ultimate objective in mind. There is no point in having MFIs if the borrower has to borrow money from somewhere else to pay back the to the MFIs. Government should come forward with schemes which help the borrowers in using the sum profitably.
The MFIs are in the news for all the wrong reasons now. We may perhaps find out the correlation between the waning interest of banks in the SHG lending because of the inclusion of MFI lending under priority sector (who would be interested in lending to 100 SHGs Rs. 5 crore when he has an option to lend one MFI Rs.5 crore where the returns are almost certain) and the present crisis. Further world wide the MFIs are funded by philanthrophists through MFIs using 'mpay' (which again is the most effective mechanism of money transfer,) and the return of the funds are not bothered much. (Even when it returns the same is again recycled). To cut a big story short, why not we make try the Kiva model followed in Ruwanda with high degree of success. The model could be tried out under Financial Inclusion Fund with NABARD taking the lead. I give below the link to this model, (which probably many are already aware) http://www.kiva.org/about/how.