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Why microfinance is not half the villain it seems to be by R Jagannathan

A man, crawling on all fours, is searching for something under a tree on a hot summer’s day. A curious passerby stops and asks: “What are you looking for?” The man replies: “I’ve lost my watch.” The passerby asks: “Are you sure it fell near this tree?” The answer: “It’s cooler looking in the shade”.

Governments work something like this. They do what they think is easier to do rather than what is right. When confronted with a problem, they do one of these three things. They will either ban it (or threaten to), or they will throw money at the problem. If they don’t know what they want, they will appoint a committee.

Two recent developments — in the world of microfinance and airline fares — serve to illustrate this point. Ever since the media began reporting on the usurious rates charged by microfinance lenders, the latter have been put in the doghouse.

In October, the Andhra Pradesh government, rattled by reports of suicides by borrowers, issued an ordinance to ban recovery agents from using coercive techniques to collect dues. Of which more later.

The civil aviation ministry and the directorate-general of civil aviation have been hassling airlines for charging super-high fares from last-minute passengers. They haven’t banned anything, but are asking airlines to fix fare limits and put them on their websites. Now why should governments worry if a last-minute passenger pays Rs40,000 for a one-way ticket? Flying is usually for the better off.

What is the need to protect them? If fares stay up too high for too long, no one will use the airlines anyway.

If the airfare intervention was an effort to solve a problem that wasn’t quite worth solving, the microfinance issue is more nuanced. The Andhra crisis had less to do with the rates charged or the coercive methods used than with unbridled marketing of multiple loans to the same indebted people.

Milford Bateman, a stern critic of microfinance, believes that microfinance is being thrust down our throats by “neoliberals” seeking to find a capitalist way of reducing poverty.

This is, of course, an extreme ideological view, but the stats he quotes are interesting. He says: “Andhra Pradesh is now second only to Bangladesh as the most microfinance saturated place on earth, with a full 17% of the population in possession of a microloan account.”

He adds: “The number of multiple loans was already a huge 82% in 2006, and it’s known to have risen even further since then…”. The net result: microfinance companies are into hardsell, trying to push loans to the poor which the latter use to repay earlier loans.

A random event also seems to have triggered some suicides. Due to unexpected floods in the state, bimonthly NREGA payments got delayed in some parts, prompting many microfinance defaults.

This, in turn, set off efforts to collect dues through unfair means. This brings us to the core of the issue: why microfinance rates are usurious, why a small trigger can have big consequences, and why hyper-competition to increase loans creates an environment for default.

First, rates. When you lend Rs100 to a vegetable seller and tell her to pay Re1 interest every day, it doesn’t seem like a big deal. If she sells Rs130-150 worth of vegetables, paying Re1 as interest is no problem.

But try and put that in percentage terms, and you will choke. Re1 daily interest is 365% annualised. Scandalous? But if you want to collect Re1 from scores of people, consider the cost of collecting it on a daily or weekly basis. Rates are high because of this. Microfinance rates should thus not be seen in percentage terms, except for academic purposes.

The NREGA delays created a cash flow problem for some poor borrowers. When cash flow stops suddenly, you can’t pay the weekly microfinance collector. Lenders like to collect money at frequent intervals because leaving money is the hands of the poor leads to spending temptation and default. Now, add the cut-throat attempts to give out more loans than the market can bear, and it is obvious that something had to give. It did.

Overborrowing and the cash flow crisis led to the inevitable: defaults, and even suicides.

Does this make microlending intrinsically bad? While the jury may be out on whether they actually help reduce poverty, they certainly grease the wheels of commerce among the poor. They may get crushed under the same wheel if there is a sudden crisis, but the answer is to anticipate potential problems and seek solutions.

The Andhra ban on coercive collections is a palliative, but the real solution lies in regulating the sector better, and creating a collective safety net for the poor so that they don’t fall into deep debt and consume pesticides.

Another option is for government to subsidise interest payments within a ceiling. If interest rates were, say, 18-20% instead of 36%, such a subsidy would serve as an incentive to microlenders to offer reasonable rates.

It is foolish to talk of inclusive banking and then try to tie down the only bankers who are willing to lend to the poor.