Mihir Shah

It is a sad commentary on the times we live in, that an RBI technical group looks to moneylenders to resolve the crisis of rural credit in India.

The Technical Group to Review Legislations on Money Lending (chaired by S.C. Gupta) has just submitted its report to the Reserve Bank of India. The context for setting up the group was provided by unprecedented farmers’ suicides. As the report says, since high indebtedness to moneylenders can be an important reason for distress among farmers, the group was asked to review the efficacy of the existing legislative framework and enforcement machinery governing money lending and to make recommendations for their improvement.

If you were then expecting the report to try and find ways to solve the money lending problem, you would be in for a real shock. The main purport of the report is to devise a new legislation for “incentivising good conduct” among moneylenders so that they can become part of the solution to the crisis of credit in rural India. The report summarises the history and impact of legislation to control usurious money lending across 22 States in the country. And finds unsurprisingly that legislation has been almost impossible to enforce. The report also reviews international experience from eight countries to explore the possibility of linking moneylenders to banks and concludes that any attempt to put too many onerous oversight obligations on banks will be counterproductive as the “moneylenders will not be happy.” The report notes that all national and international legislation empowers the government to notify maximum rates of interest that can be charged by moneylenders. But argues that this is “out of sync with market reality” and suggests linking interest rates to a market determined bench-mark as this will make “moneylenders view the legislation favourably.” The report also rejects existing laws that prescribe audit of moneylenders’ books by Chartered Accountants, because this is “impractical and may not necessarily add value.”

The most stunning (and revealing) part of the report is its rejection of key recommendations of the 2006 Johl Working Group on Distressed Farmers set up by the RBI. The Johl group felt that one residential house and agricultural land up to five acres must not be attached under any circumstances and should not be taken as collaterals. After all, over the years, thousands of hectares have been lost by India’s poor peasantry in this manner. But the Gupta report rejects the Johl group suggestion because it may result in denial of credit by moneylenders to small farmers. Gratifying the moneylender clearly appears much more important than protecting the vulnerable borrower. The report concludes with an outline of a “model legislation” called the Money Lenders & Accredited Loan Providers’ Bill, 2007. This bill seeks to formalise the relationship of banks with moneylenders to take advantage of their dominant presence, knowledge base, informality and easy access. Moneylenders would now be transformed into Accredited Loan Providers. Banks would facilitate them to set up business by providing required funds for on-lending. These advances will even be treated as part of the mandatory priority sector lending by banks.

Since highest authorities within the government have already started to speak in this very language, we need to carefully understand why the recommendations of the Gupta Technical Group must be strongly rejected. My colleagues Rangu Rao, P.S. Vijay Shankar and I have, in a recent article in the Economic and Political Weekly, provided a historical overview of rural credit in 20th century India. Our central argument is that the rural credit market does not operate in isolation. Its functioning is deeply interlocked with the input, output, land, labour and land-lease markets. No policy to tackle the problem of rural indebtedness can work if it does not recognise this interconnectedness. Indeed, the Gupta report actually appears to do precisely the opposite when it recommends that trade credit as also credit provided for purchase of inputs should be kept outside the purview of its proposed legislation.

We must recognise that moneylenders are able to cut the administrative costs of lending not only because they are better informed about their clients but more importantly through this mechanism of interlocked markets. After all, the only collaterals poor rural borrowers can offer are future labour service, future harvest or the right to use already encumbered land. The lender is in a powerful position to undervalue these not easily marketable collaterals. For example, borrowers are forced to sell their harvest in distress to the moneylender-trader at throw-away prices. This transfers the risk of default from the lender to the borrower. Monitoring is no longer an issue as the borrower is far more worried about losing the collateral than the lender is. And there is great incentive for charging usurious rates of interest because default will only mean that the lender grabs the asset (very often land) offered as collateral. The moneylender could even be said to prefer default to repayment. This is an extraordinarily ingenious but utterly exploitative relationship, which has sustained itself over centuries in India. Why any of these moneylenders would agree to get “registered” under the legislation proposed by the Gupta Technical Group and why they would require “on-lending” funds from banks, is hard to understand.

Indeed, breaking the stranglehold of moneylenders on the rural credit market requires simultaneous and powerful action in all the interconnected markets, to tweak the balance of power in favour of the poor. Legislation by itself can be no remedy. And in any case what the Gupta report proposes is a completely defeatist bill. The report ignores the fact that after 20 years of “social and development banking” in India, following the nationalisation of banks in 1969, moneylenders were very much in retreat. Official data clearly show that the RBI policy of “social coercion” succeeded in forcing banks to open branches in hitherto unbanked locations. A package of policy initiatives ensured that the share of moneylenders in rural credit fell from an average of over 75 per cent in 1951-1961 to less than 25 per cent in 1991. Unfortunately though, these gains have been lost in the period after 1991, when major policy reforms were introduced in banking. It is undeniable that reforms were needed to improve profitability of rural banks. But in the relentless pursuit of profits, banks have forgotten what their primary mandate was and continues to be. NSS data reveal a sharp decline in the share of the formal sector in rural credit between 1991 and 2002. The Gupta report appears to believe that since the moneylender is back, he must now be crowned.

Such defeatism is completely uncalled for. What we need is to carefully examine where the reforms package went wrong and decisively change gear. This includes implementation of the suggestions of the Vaidyanathan Task Force on Revival of Rural Cooperative Credit Institutions to make them truly democratic, member-driven, professional organisations, based on the concept of mutuality. The formal banking system also suffers from a lack of professionalism and accountability. In the 20 years after nationalisation, there was a tendency to lend recklessly, focussing on quantity, without any concern for quality of credit. Reforms must strengthen the capacity of banks to deliver high quality credit. This includes de-bureaucratisation of procedures and infusion of professional staff in areas such as agriculture, earthen engineering, irrigation, livestock development and rural enterprises. Such professionals will ensure that provision of rural credit becomes truly sustainable in both financial and environmental terms. Public sector reforms the world over now place a greater emphasis on effectiveness than efficiency. There is a shift from the obsession with getting things done cheaply towards actually accomplishing one’s goals. Which here means a focus on making low-cost credit available to the poor, rather than just ensuring the profitability of the lender.

In India, reforms since 1991, in their obsession with cutting corners, have reduced both outreach and the human resource capacity of rural banks to deliver high quality credit, while these should actually have been strengthened. For only then can banks really become profitable, while also fulfilling their primary mandate. One exciting new way this can be done is to strengthen the Self Help Group (SHG)-bank linkage programme, which can dramatically raise profitability of remote rural banks. Federations of these SHGs are a potential vehicle of macro-finance, human development and sustainable livelihoods for the rural poor. At the same time, we need to reverse the declining trend of public investment in agriculture by focussing on natural resource regeneration, as also provide market support for crops such as cotton, pulses and oilseeds, which have become especially vulnerable in the post-WTO period. It is such a package of changes rather than any desperate effort to appease moneylenders that holds out hope for the suicide-ridden farmlands of India.

(The writer is an economist by training.)