In February this year, The Hindu published a detailed account of how small loans led to debtor suicides. In response, a micro finance representative says the industry now has safeguards against malpractices.
Though micro finance has existed in India for a long time, it has emerged as an organised sector only in the past decade or so. Micro finance is about giving small loans on reasonable terms to people, mostly women, from low income groups who do not have access to loans from banks. Most people from low income groups are self-employed and tiny loans help them meet the working capital needs of such activities, besides consumption smoothing.
In the aftermath of Bangladeshi economist and founder of the Grameen Bank Prof. Muhammad Yunus receiving the Nobel Prize for Peace in 2006 for developing the concept of micro finance, this model grew around the world as a good alternative source of loans for low income groups, caught between banks (who lend to them only under the extreme pressure of Priority Sector Lending targets) and local moneylenders (whose interest rates could be in high double digits). However, the micro finance concept has fallen from grace due to a combination of promoters' greed, high growth without commensurate systems and controls in place, and the unsecured nature of lending which leads to the high possibility of clients borrowing beyond their immediate need or capability to repay.
And just as in cricket where we alternate between holding our beloved cricketers either as demigods or trashing them based on their last match performance, so too in micro finance we have gone the whole hog from holding micro finance institution (MFI) practitioners as being the messiahs of the poor to blood suckers now. As in everything else, the truth lies somewhere in the middle.
Three reasons for the fall
The three reasons often cited by critics of micro finance for its fall from grace are the high interest rates charged, over indebtedness and coercive recovery practices. Rather than dwelling on the past, I will attempt to highlight sectoral and structural changes which have happened over the past year on these three crucial concerns.
The cost of delivery of the loan and collection is high, around 12 per cent due to the doorstep model. And with the cost of funds from banks at around 14 per cent and bad debt provision around two per cent, lending rates of around 30 per cent become necessary. It is a fact that some MFIs did charge an all-inclusive effective cost of over 35 per cent and further compounded the same by not being transparent to the client about the real interest rate.
However, through two regulations, on May 3, 2011 and December 2, 2011, the Reserve Bank of India (RBI) has put a cap on the lending rate of MFIs at 26 per cent per annum and a margin cap of 12 per cent over their cost of funds, whichever is lower. And today, through the Micro Finance Institutions' Network's (MFIN) internal whistle-blowing mechanism, we have ensured that no Non Banking Financial Company (NBFC)-MFI which is a member of the MFIN charges beyond these rates. Thus, there is no more a possibility of any MFI charging usurious interest rates.
Database of borrowers
The other charge is that MFIs lend to the same clients beyond their ability to repay. In the past, there were no regulations on this aspect. And MFIs had a genuine difficulty in finding out the existing borrowings of a client because the client rarely revealed the true position. The RBI has now laid down a rule that only two MFIs can lend to one borrower and both together cannot provide loans beyond Rs.50,000. Thus, this prevents the possibility of over-lending.
The MFIN has worked closely with its members and High Mark, an RBI approved credit bureau, to create a database of micro borrowers in the country. This consists of over 30 million micro borrowers and about 60 million loan accounts. Whenever a person applies for a loan, the MFI can, at the click of a button, know all the previous borrowings of this person, even if such persons reside in a remote village. MFIs are tapping this and ensuring that not more than two MFIs lend to one client subject to a ceiling of Rs.50,000.
There are a few critics who would like to hold that the credit bureau's accuracy is not good enough. The report we get is about 80-90 per cent accuracy, which is a fair rate. But more than the direct benefit is the indirect one. In early May 2011, in Equitas, when we accessed credit reports for the first time, we found the clients' self-declaration of earlier borrowings to be at variance with the bureau report in over 80 per cent of cases. Since then, we have been informing them about the existence of a “computer” which has all the information and then exhort them to reveal the truth. Today, we find this variation to be less than five per cent. The bureau has had a significant indirect benefit in terms of a fundamental shift in the attitude of clients because of the “know-all computer”!
Many MFIs undertake significant social activities across health, education and skill development on a non-profit basis.
While dwelling on the past, warts and all, doesn't help anyone, we can state with confidence that through a combination of a sound regulatory framework and proactive steps of self-governance by the MFIN, we can look forward to the MFI sector supporting low income groups through access to finance on reasonable terms, in a sustainable manner.
(P.N. Vasudevan is vice-president, Micro Finance Institutions Network and managing director of Equitas Micro Finance.)
Keywords: RBI, Micro finance
Thanks for the comments of Mr Vasudevan. Yes, I quoted some of my previous experiences in India at the time even I was not permitted to enter the computer room. But then my point is practically its cumbersome process to identify all defaulters/borrowers for various reasons. Well, I was working in Africa and Pacific from 2003 to 2010. We encountered the similar problem viz.defaulter applied in other names of the family, in nick names, different address and so on. Defaulters are so ingenious! As a Director of Reserve Bank in Lesotho, I had the opportunity of reviewing the works of Credit Bureaus of CMA Countries and we observed similar problems. Thanks Vasu for the invitation, its my pleasure to visit you when I visit India next time. I can be contacted on ckannapiran@yahoo.com.
I read with interest the comments of Dr Kannapiran given above. His knowledge seems to go back a few decades and so naturally we respect his comments, especially since my own knowledge of micro finance runs back to just a few years. However times have changed. He feels that computers cannot work efficiently and produce acceptable quality of reports when people's names are written differently etc. He cites a report handed over to RBI in 1989. i remember in late 80s' computers were put in AC room whiile the rest of us sit outside. We had to leave our shoes outside before entering the room hosuing the computer! but things have changed a lot since. I claim accuracy levels of 80-85% in matching customer data base out of my practical usage of the bureau over the last one year. i am afraid that is no 'arm-chair' comment. But to dismiss this summarily does not seem appropriate. i welcome Dr Kannapiran to visit us and see for himself. my phone no. is 99405 77800
When I was secretary,Women’s Entrepreneurs Association of Tamilnadu (WEAT),I had the opportunity to interact with women micro-entrepreneurs who were beneficiaries of the financial services and social activities of Equitas Micro Finance in a Entrepreneurial development Seminar. Intially excluded as loan candidates, these women had been groping in the dark. Thanks to the simple system of taking loans and repaying them they had become secure and successful micro-entrepreneurs whose efforts have raised their family’s living conditions. MFI is a unique funding model that is one of the vital tool for poverty reduction. It also empowers the poor to realize their potential in the business community. This creates win-win situation for both sides provided MFIs follow the safeguards and the people approach the right MFI.
The article appears to me as an arm chair defence for MFI with no practical utility. First, the Bangladesh Grameen Bank (BGB) model is not a good model to be replicated elsewhere. I did an analysis of their operation in 1992 and found (published in various papers) that 1. The BGB has been availing highly subsided credit (around 3% pa) from Donors and therefore their cost of fund is much cheaper than the market rate. 2. Almost 40% of these funds from the donors were deposited in commercial investments with return of more than 14% (11% profit) instead of lending to the poor; 3. The repeat loan, otherwise termed “Greening of loan”, was widespread that created perpetual borrower rather than profitable enterprises. Given that scenario, the BGB microfinance (MF), for that matter other MF initiatives, can at best be classified as yet another social security measures to help the poor. Similar trend has been prevalent in India for more than half a century and some of these aspects were reported in our study on “Rural Lending” submitted to the RBI in 1987.
The three reasons often cited by critics of micro finance are still valid!
First, financial analysis often revealed that there is no micro enterprises financed by MFI will be able to generate a rate of return of around 25% to service a MF debt at 25% or more interest rate. So either they end up with repeat loans or perpetual borrowers (Published papers available).
On the database on borrowers, under the much publicised “Service Area Approach in Rural Lending” (1989), RBI guideline was that only one bank can lend to all borrowers in their service area (Villages) and people like me who worked on the field knows how effectively that prevented multiple financing, leave alone the idea of two MFIs lending to one borrower. It’s a myth to assume that the “know-all computer” is omnipotent! Names in villages are often distorted knowingly or habitually, for example sometime they add their caste name or nick name or shortened version of their names and so on so forth and it’s a herculean task to introduce a pool proof system.
but still many roadside venders like tea stalls,shoe polishers etc are depended upon indeginous creditors (people who give loan on interest ).the reason being they demand no collateral and terms are more flexible like daily installment and flexible amount of installment.
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