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Micro finance, macro objectives by Krishnamurthy V Subramanian

Sample some data on the microfinance performance in India: According to the data provided by www.mixmarket.org, microfinance in India reached close to 270 lakh active borrowers in 2009, with the average loan size close to Rs 8,000. This translates into total borrowing to over Rs 20,000 crore. Though this number seems large, it represents only 0.3% of our GDP. Thus, large swathes of poor, both in our villages and urban areas, need a helping hand as they endeavour to alleviate themselves from poverty.

Seen in this light, the sub-committee set up by RBI under YH Malegam to study the microfinance sector in detail is a welcome move. The sub-committee has been set up after the Andhra Pradesh government passed an ordinance putting onerous restrictions on MFIs, following incidents of MFIs pressurising borrowers through strong-arm tactics. This chain of incidents presents both an opportunity and a challenge to the sub-committee. The opportunity is to smoothen the wrinkles that have developed during the phase of extraordinary growth in the microfinance industry. The challenge however is to ensure that the industry is not shut down. To grab the opportunity and surmount the challenge, the government needs to play a role as an enabler of microfinance rather than a disabler.

All well-meaning politicians and bureaucrats need to recognise that neither the charitable hand of the government nor that of the NGO has succeeded in ameliorating poverty. Large-scale poverty alleviation can happen only by encouraging “well-functioning” markets. The current incidents indicate that the market may not be operating smoothly. The government must respond by instituting measures that smooth the wrinkles.

The ordinance issued by the AP government halted all MFI operations until they register with the district authorities. Knowing the speed at which government infrastructure typically operates, a week is too small a time span for all of MFIs to register. Till they register, an MFI cannot recover its existing loans. Since microfinance loans require weekly repayments for subsequent disbursements, the ordinance effectively forced MFIs to shut shop.

Even though I have absolutely no vested interest in the MFI industry’s success or failure, their predicament forces me to ask a few questions. Did we outlaw the information technology industry because a certain unscrupulous promoter at Satyam Computers cooked books under our very nose for more than a decade? Did we ban the stock market after deceitful entities like Harshad Mehta or Ketan Parekh swindled the small investors of their precious savings and pushed a few of them to commit suicide? Did we bar all consumer loans after it was reported that a certain bank used strong-arm tactics to recover its loans?

Then, why was the AP government imposing such onerous restrictions on microfinance providers as to effectively shut the industry down? Is it because in each of the above instances the entity in the wrong happened to be one with a voice/influence with the political establishment, while the poor whom microfinance benefits hardly have a voice? Is it because the local moneylenders, who may be the operating arms of dubious politicians, lose the power to exploit the destitute when microfinance lenders offer them loans at significantly lower interest rates?

An anecdotal incident suggests to me that this may be the case. As part of my effort to understand the mechanics of microfinance, I recall attending a Friday afternoon meeting of a group of 50 women borrowers in T Nagar in Chennai. Mistaking me for one of the loan officers of the microfinance institution, the women were requesting me to expedite the next installment of their loan so that they could pay their children’s school fees. Since I was curious, I inquired how they would pay the school fees if the microfinance loan did not materialise in time. As one would expect, the answer was the local moneylender. On further inquiry, I gathered that the annual percentage rate of interest charged by the local moneylender varied from 250% to 400% depending on the desperation of the borrower. Of course the microfinance institution’s 35% rate of annual interest seems exorbitant to a populace that pays 12% to 15% for their consumer or home loans. However, compared to the moneylender as an alternative, the 35% rate of interest charged by the MFI represents the difference between night and day to the poor folks. Also, one needs to remember that given the fixed costs of servicing a loan, which does not change with the amount of the loan, the operating costs for MFIs are much higher than the operating costs for a typical bank servicing a home or corporate loan. Given these high operating costs, the loan rates of 30-35% may be necessary to enable the MFI to recoup its costs.

To create a well-functioning market for microfinance, first, apart from restraining those entities that indulged in uncivilised tactics, the government needs to institute appropriate penalties so that such practices are not repeated. Second, in conjunction with the UID project, the process of creating a credit registry needs to be expedited. This will ensure that borrowers are unable to get loans from multiple lenders simultaneously, increasing their ability to repay. Third, any predatory lending practices by MFIs need to be investigated and stopped.

Finally, since strong-arm tactics to recover loans have always been a practice of local moneylenders, it is possible that the current incidents may have been caused by unscrupulous moneylenders masquerading as MFIs. Such dubious elements need to be weeded out. In sum, the teething baby must be tended to and not thrown away with the bathwater!

—The author teaches finance at the Indian School of Business, Hyderabad.