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Microfinance under severe stress by CRL Narasimhan

The accusation of ‘coercive' practices to recover the loans has been laid at the doors of some leading players

Micro Finance institutions (MFIs) that are for profits are in the news for the wrong reasons. The ‘for profit' MFIs have grown spectacularly in recent times. But along with the large profits have come allegations of sharp practices.

In Andhra Pradesh, where such MFIs have a sizable presence, the climate has now drastically changed.

It will be an understatement to state that the business of microfinance, as it has existed till now, is under serious threat. And not just from one direction. An ordinance issued by the Andhra Pradesh Government compels MFIs to register with the district authorities, avoid coercive recovery practices and multiple lending. The MFIs have not been successful in staying the operation of the ordinance but the A.P. High Court has allowed them to continue with their business after registering themselves. However, they cannot levy the high interest rates they are used to. They have been directed to desist from ‘ coercive' practices while recovering the loans. Nor should they indulge in multiple lending, giving loans to those who are customers of other MFIs, including the ones promoted by the State governments.

The ordinance, which gives substantial powers to the State government, has had the initial effect of freezing all microfinance activity at least in the State.

For the MFIs, it is unlikely that conditions that existed before the ordinance will ever prevail. With other States likely to emulate the A.P. model, MFIs will have to reckon with the regulation.

The Reserve Bank of India has appointed a sub-committee to look at the governance issues and there are reports that the National Bank for Agriculture and Rural Development may be asked to regulate the MFIs. At present, only MFIs registered as non-banking finance companies with the RBI come under the central bank's regulatory control.

There have been other developments that serve to heighten the regulatory scrutiny of the MFIs. The Union Ministry of Finance has asked public sector banks to monitor the lending rates of MFIs. Indeed, it is the high interest rate — in the region of 30 per cent — that first showed MFIs in a bad light.

The accusation of ‘coercive' practices to recover the loans has been laid at the doors of some leading players.

Although there is nothing to suggest that the practice is widespread, there are bound to be complaints and allegations of an even more serious nature such as abetting the suicide of borrowers. Even a few instances of misconduct or overzealousness on the part of the MFIs and their officials will bring the whole business into disrepute. In Andhra Pradesh, even as far back as two years, the conduct and practice of some MFIs had not gone down well.

The sudden developments that are threatening the very foundations of their business model may yet lead to a positive denouement but as of now the microfinance sector, especially its leading players, have some hard work to do.

With an estimated aggregate outstandings of about Rs.22,500 crore spread over nearly 2.67 crore active borrowers, microfinance can by no means be viewed as some fringe financial activity.

Yet, if by many parameters — volume growth and coverage — microfinance has become mainstream, it appears to be short on traits that are necessary to sustain any successful business model. High up in the list of what is missing is the inability to live with, leave alone ‘manage' the environment. Negative perceptions about their business would not have been as pronounced had the leading MFIs paid attention to the environment. Left unchecked, the negative perceptions threaten to overwhelm the sector. That will be a pity considering the altogether positive role of these MFIs in meeting the credit needs of the poor, especially in rural areas.

Check misconceptions

A few of the leading MFIs started as not for profit enterprises but over time converted themselves into ‘for profit' organisation. It is in the latter phase that they have had to straddle objectives that are not in harmony with one another. For instance, SKS Microfinance, whose share issue was hugely successful, appeared to have started a trend among MFIs of accessing the capital market, thereby widening their resources base. Nothing wrong in that, except for investors who look for dividend, capital appreciation and so on.

If the MFIs match those expectations — as indeed they seemed to be on course until recently — their financial success would be known more widely.

The process of making their shareholders happy possibly means alienating their customers (borrowers) who pay high interest rates on their micro loans?

It is difficult to convince both their shareholders and borrowers simultaneously. Already all the trappings of successful coporates, the high profit figures, employees' compensation packages and so on have led to questions as to whether they can lower their interest rates and still make a reasonable profit. It will take a long time in India that profitability and apparently social objectives can co-exist.

The interest rates

The two related issues here are estimating the interest rates on several well-defined parameters such as cost of resources, incorporating the risk premium and so on. There appears to be a case to lower the lending rates even without linking it to the cost of bank finance. By bundling other financial products such as insurance, MFIs can bring down the lending rates. Also, over time competition should work in the same direction.

A related issue is how these MFIs present their case for the high interest rates in the public sphere. Adopting a rigid stance and, say, that any interest rate below 28 to 30 per cent is not feasible will not do.

Especially now when some MFIs have chosen the capital market route and disclosed their track record of profitability and munificence to the owners and senior executives.