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Is It Micro Usury?

Ethics runs smack into profit in the debate on the small loan business

Is It Micro Usury?
Siddharaj Solanki
Is It Micro Usury?

Micro Gain, Macro Pain
Microfinance institutions make big claims, but critics point at the holes.

Financial inclusion    Opaque benefits

  • By March-end 2009, over 22 million people were beneficiaries
  • Rs 25,000-30,000 crore deployed in the system
  • Large funds flowing to sector from banks and equity investors
  • Reach out in areas where banks have been tardy in providing service
  • Rapid scaling up through innovation/ technology to cover remote areas
  • Loan repayment remains over 95%
  • A significant percentage of clients exist only on loan books
  • Poor may be benefiting but high MFI profitability raises questions
  • Steep interest rates, sometimes over 40%, defeat purpose of helping poor
  • Tight schedule of weekly repayments putting tremendous pressure
  • Proxy agents flourishing due to lack of checks and balances
  • No data available on indebtedness

India’s microfinance institutions (MFIS) have often hit the headlines. But this time, they are doing so not necessarily for the right reasons. They have been accused of making huge profits and ensuring their own topline growth at the cost of the poor whom they aim to help with easy and affordable credit. SKS Microfinance, one of the biggest MFIS, hit the high streets with a very successful IPO and listing in August. But this raised questions about the firm’s operations and profit motives. What particularly drew strong criticism was SKS chairman Vikram Akula and other top management making millions through stake sale and ensuring high returns to equity investors. This criticism came from none other than the father of modern microfinance, Nobel laureate Mohammed Yunus, with whom Akula first worked at Grameen Bank in Bangladesh. Questions are also being raised about the coercive tactics used in many cases to ensure weekly repayments and the steep interest charged by the MFIS, sometimes over 40 per cent. In what way are these charges justified?

Though the avowed intention of MFIS and banks providing microcredit is to help small borrowers, there is increasing evidence to show its cumbersome processes are forcing landless farmers and traders to seek out the traditional moneylender. On the flip side, loan beneficiaries often face undue pressures. Last month,  over 1,000 women members of 50 self-help groups in Bhubaneswar protested against the high interest charged by MFIS. The first farmer suicide in drought-hit West Bengal this year is also traced to the harassment over loan repayment.

“The constant hounding and abusive language are getting too much. I sometimes feel death alone will offer me respite from this hellish loan cycle.” Bouthu Swarnalatha, Warangal

A farm labourer, Swarnalatha is one of many in Seethampet village of Warangal district who sometimes contemplate suicide. Hounded regularly for falling behind on repayments for the Rs 15,000 she had taken from an MFI, Swarnalatha says she can’t afford to repay the weekly instalment as her daily earnings are not even sufficient to meet her needs.

“The big MFIs restrict themselves to safe terrain. The small and medium or start-ups seek difficult terrain.”
Mathew Titus, Sa-Dhan

On October 5, the Andhra Pradesh Human Rights Commission ordered a probe into the functioning of MFIS in the tribal and Dalit-dominated areas of Warangal, Anantapur, Karimnagar and Rangareddy districts following six suicides in three months by debt-trapped farmers and labourers due to the alleged excess by MFIS. All this is a rude shock. Just a few years back, MFIS were being lauded for helping the poor get access to credit.  Today, horror stories abound across the hinterland about MFIS adopting the same tactics and goals of big banks and money-lenders. What has gone wrong?

In a complaint to the state government in February, Khammam district collector V. Usharani had alleged that MFIS have not only been violating state regulations for tribal areas but have also been indulging in unfair practices, including taking their property as collateral. “Due to coercive recovery methods,” she said, “certain borrowers have committed suicide.”

Prof K. Venkata Narayan of Kakatiya University, Warangal, substantiates this, pointing out that as each of the 7-10 members of a self-help group are held responsible for ensuring other members repay the weekly instalment on time, defaulters face the humiliation of others staging a dharna in front of their houses to put pressure. Often, they are forced to sell off their belongings to fund repayment. In Palivelpula village of Warangal, Banda Elisa sold her mangalsutra and mortgaged her house for Rs 30,000. Today, she pays Rs 600 as rent to live in her own house and has even mortgaged her ration card. Reports of harassment and suicide have also emerged from different parts of the country, particularly from states like Orissa, West Bengal and Uttar Pradesh.

MFIs justify their high interest rates, saying the cost of delivering and collecting small loans is very high.

Driven by reports of malpractices, the Reserve Bank of India and the finance ministry have woken up to the issue. Last year, the RBI completed a study on how to improve the reach of microcredit and ensure greater operational transparency. “MFIS have no doubt been able to provide access to finance to segments of people left behind by the formal financial sector. The high interest rate charged by them, however, remains a contentious issue and banks funding these entities need to be sensitive to this issue of public policy,” says an official RBI response to Outlook. Recently, the finance ministry issued an advisory to public sector banks, giving funds to the sector to “try to persuade MFIS to restrict the lending rate to 20-24 per cent all inclusive”, official sources state.

Obviously, MFIS defend their actions, specially the high interest rates. Mathew Titus of Sa-Dhan, an umbrella organisation for MFIS in the country, points out that the smaller the loan size, the bigger is the cost of delivery and collection. As such, it is easier for big players (with average loans of Rs 5,000-20,000) that have reached a critical scale of over 1.5 lakh clients to reduce the interest rates “but for small ones lowering even 0.5 per cent interest rate may be a challenge”. Rather than putting a cap on interest rate, Titus moots fixing a rate “band”.

“Banks make you feel really small...the attitude is you will run off with the money and never pay back.” Ripan Sarkar, Siliguri

When Sarkar thought of starting his artificial flowers kiosk in Siliguri, he approached banks for a loan, but found their eligibility criteria impossible to meet. “I had no proof of permanent residence,” says Sarkar, whose family migrated to Siliguri from Assam. So he joined a private loan scheme called Bandhan by depositing Rs 1,100 as security for Rs 10,000 borrowed with full repayment in 45 weeks. “You would end up paying about Rs 2,000 as interest, which is better than the documentation headache.”

Interestingly, a study report covering 60 MFIS in 2009 by M-Cril, a global rating agency of microfinance institutions, revealed that while their yield has increased from 18.8 per cent in 2002 to 31.4 per cent in 2009, their operating expenses ratio (OER) has come down from 19.9 per cent to 11.5 per cent during the same period. What’s more, the report indicates that ‘portfolio at risk’ has also come down from 12.2 per cent to just 0.5 per cent in the same period.

“These two factors have improved the return on assets significantly across the sector from an average of -1.5 per cent in 2001-02 to 4.3 per cent in 2008-09 as compared with the global average of 1.5 to 1.8 per cent. Based on the above data, it can be said there is room for reduction of interest rate,” is the official response of the state-run National Bank for Agriculture & Rural Development (NABARD). It stresses that larger MFIS, which cover nearly 80 per cent of the market, “need to take a lead in this”.

“Though large MFIs are paying investors huge returns, they’ve been tardy in bringing down lending rates.”
Harsha Moily, Mokshayug Access Society

As expected, the government’s move to cap the interest rate has not gone down well with most players. Akula says “an interest rate cap would hurt fledgling MFIS the most” as providing microfinance to the rural poor is a labour-intensive and costly affair. But G. Padmaja Reddy, founder and MD of Spandana, one of the biggest MFIS, says it “will overall sanitise the sector from the accusation of charging high interest rates.”

Reddy buttresses her point to state that “as per traditional wisdom, if we add up 12 per cent cost of funds, 10 per cent cost of doorstep delivery of service and 2 per cent risk, overall interest rate chargeable amounts to 24 per cent just to break even”. This thumb rule applies to all MFIS with the doorstep delivery cost being determined by the number of borrowers.

“Both banks and microfinance people want a shop address before they sanction a loan. How do I get that?” Kanu Das, Calcutta

Kanu Das, 35, a garment hawker in Calcutta’s busy Gariahat market, doesn’t believe in microfinance schemes from nationalised banks or mfis. “These schemes are worthless. They want a shop address before sanctioning loans. How do I get that?” he asks. So this Durga Puja season, Kanu went to the local moneylender for the Rs 30,000 loan he needed for procuring stocks. Now he needs to pay Rs 800 a month. “There is no pressure to pay back every week, something mfis insist upon,” he says.

This is where the catch lies. Experts admit there is no verified data about the number of clients each mfi has. Many clients also borrow from multiple sources to meet their needs or even juggle the weekly loan repayments, thereby getting sucked into the vicious debt cycle. Another worrying issue—that of “ghost client” and “proxy” agents—has also surfaced in recent years. Ramesh S. Arunachalam, a microfinance practitioner, has detected 7-9 per cent ghost clients in many sampled portfolios and 6-12 per cent of portfolios in non-microfinance clients. He suggests a large group can visit randomly selected MFIS and concurrently perform a rigorous client, portfolio and systems/mis audit in their operational areas—including following the entire trail of money and process flow (back and forth, right up to HQ).

Also, the emergence of broker agents (who supply joint liability groups to MFIS) is a scary phenomenon, as their presence makes traceability of priority sector funds rather difficult. Arunachalam recalls first coming across a broker agent in 2005. Today, they are in many fast-growing and urban areas. “The excesses attributed to MFIS are perhaps due to broker agents, who are not accountable to the microfinance system in any way,” he underlines.

“Most MFIs have very high operating costs. Salary packages and ESOPs are higher than in financial firms.”
Vijayalakshmi Das, Friends of Women’s World Banking

Some of the MFIS admitted that there could be fraud cases of “proxy borrowing”, and even some bad characters emerging as ringleaders or “brokers” who help push loans in some areas and use strong-arm tactics for recovery.

Suresh K. Krishna, MD of Grameen Financial Services, points out that “it’s a people-intensive sector. There is need to have a regulatory system. Of course, that would add to the costs.” Krishna has been trying to minimise bad practices through audits and staff transfers.

NABARD, a major funds provider to self-help groups through NGOs and banks, has been promoting the concept of “savings first” before providing credit. This is a concept most NBFCS and NGOs would like to promote but are barred under present RBI rules. There could be a change if any of the NBFCS or MFIS are able to get banking licences. At present, while there is a divide on whether MFIS have added to the agrarian crisis and contributed to the suicides, experts like Arunachalam feel that “the burgeoning growth of microfinance, coupled with the decentralised model, is perhaps responsible for a serious deterioration in portfolio quality.”

“We are in a tight squeeze and don’t know how to repay the money. Some of us have sold the buffaloes to repay the loan.” Naresh Chand (left, foreground) Jeevana village, Muzaffarnagar

Naresh Chand rues the day he took microcredit to buy buffaloes. In 2006, the Punjab National Bank first made credit available to his 10-member self-help group. Prompt repayments helped get Rs 2.90 lakh to buy cows and buffaloes. “We paid back Rs 1.29 lakh. We stopped when the government started a loan waiver, which we did not get. Now, the bank has served notice to repay Rs 5.51 lakh,” he says.

MFIS are looking forward to the upcoming microfinance credit information bureau to help them reduce risk of default and people getting into debt traps. Privately though, a few MFIS admit that if there was a freeze in lending activity, there could be a default of 50 per cent. That would be catastrophic, as some Rs 30,000 crore has been spread over 22 million people. Are we then skating on thin ice when we claim that microfinance is robust and growing?

By Lola Nayar with Madhavi Tata from Hyderabad and Dola Mitra from Calcutta and Siliguri

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