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Some Macro Changes For Microfinance

MFIs are a good idea. But in India, the concept needs tweaking.

Some Macro Changes For Microfinance
Some Macro Changes For Microfinance

The usurious moneylender was well-known, even in colonial times. “The ryot cannot cultivate without borrowing because his crop goes largely to the long-term creditor,” says the Central Banking Enquiry Committee Report of 1929. India’s poor still remain vulnerable: 51.4 per cent of all farmers are excluded from both formal and informal sources of finance. Thirty-one per cent of rural households are indebted, and the average debt per household (NSSO, 2014) is `32,522. This is a result of the interlocking of the credit market with imperfect markets (land, input, output, labour and land-lease markets), a sure pathway to peasant pauperisation. With little access to formal financial institutions, India’s poor end up investing in chit funds and ponzi schemes. Free from regulation, over 30,000 unregistered chit funds have emerged as sources of liquidity. Fraud is frequent. Saradha group agents in West Bengal promised 10 times the investment in 14 years while charging commissions of 15-40 per cent. The company would pay out dues with money obtained from new investors rather than from profits. Regulators like SEBI and RBI find themselves judicially constrained from regulating such entities. Penalties are low: in Delhi it’s `5,000, and Haryana doesn’t penalise at all!

Microfinance came as another avenue. But its extreme consequences, as attested by suicides in Andhra Pradesh, can lead to an explosive situation: there are reports are farmers borrowing from moneylenders to repay micro-finance groups. Abusive collection practices—weekly meetings in front of the defaulter’s house, encashing signed blank cheques, putting up loan notices—create huge pressure.

Rural credit, ideally, would be a cushion against such practices, smoothening out the asymmetry resulting from delayed earnings. However, the moneylender dominates: only 17 per cent of rural households have got credit from institutional agencies at moderate rates. Non-institutional agencies, lending at rates above 20 per cent, reach 19 per cent of rural families. Only eight per cent of Indian adults have loans from formal financial institutions, just 35 per cent have bank accounts (excluding Jan Dhan Yojana) and more than half of these are inactive or semi-active. There’s only one bank branch per 14,000 customers, one to a dozen villages. Constraints of money, distance, cost and lack of documentation restrict India’s masses from banking. The moneylender, on the other hand, is always around—as a source of credit, as a crop buyer, an employer of labour and a land lessor. Borrowers who can only offer collaterals of land, future harvests, future labour gravitate to the money-lender.

Restructuring rural credit has always been difficult. The historic All-India Rural Credit Survey (1954) highlighted that formal credit institutions provided only nine per cent of rural credit needs; 75 per cent was provided by moneylenders, traders and rich landlords. Coope­rative credit societies were encouraged and by 2007, they covered 50 per cent of rural loans, servicing farm input and crop production, processing and marketing. But these societies ended up becoming a “borrower-driven system”, controlled by the rural elite, politicians and state governments, and beset by conflict of interest.

Banking, pushed through priority lending and social coercion, has not met expectations. Banks continue to have an urban bias, with the distribution of credit skewed in favour of large borrowers. With greater profitability requirements, servicing illiterate customers with high cash requirements would lead to higher idle cash reserves and lower profitability.

The Integrated Rural Development Programme offered cheap bank credit for over 4 million households (1987), promoting a deep dependence on corrupt government officials (Dreze, 1990), while classifying millions as bank defaulters, barring their access to the formal credit sector. The official loan waiver of 1989 destroyed all credit discipline. Public sector banks, already burdened by low profitability and high non-performing assets, utilised liberalisation and consolidation trends to march away from rural credit markets. The state withdrew from rural credit.

This vacuum encouraged microfinance, broadly defined as self-help group (SHG)-bank linkage (SBL) and micro-finance institutions (MFIS). India’s regulated microfinance market today has over 28 million clients, served by around 50 regulated institutions. The sector grew its gross loan portfolio by 35 per cent in FY14, attracting 4.7 million new clients, despite its murky record in Andhra Pradesh.

With a degree of regulation and oversight, MFIs and SHGs could speed up financial inclusion for the weaker sections.

MFIS consider rural markets as business opportunities, offering professionalism and innovation in credit lending. Microfinance offers several strengths, making finance accessible and available, along with “freedom from collateral”. However, it is no magic bullet. MFIS need high interest rates to justify transaction costs and low scale of operations, which attract high-risk customers—with higher default rates. This market failure, with information provision a natural monopoly (Sen & Vaidya, 1997), requires intermediation. The Malegam Committee Report (RBI, 2011) sought a separate category of NBFC-MFIS, with margin and interest rate caps on individual loans, along with restrictions on multiple lending to the same individual and the establishment of credit information bureaus. The Micro Finance Institutions Bill (2012, now lapsed) envisaged the RBI providing a statutory framework of regulation. Monitoring can be done through councils and committees. An RBI-managed micro finance development fund could be used for loans, refinancing and investments in MFIS. Every MFI would have to create reserves, with RBI specifying the percentage of net profit added annually to the fund and providing permission for appropriations. The RBI could set maximum annual percentage rates and maximum margins. MFIS could be incentivised with the prospect of banking licences.

The SBL approach requires the formation of self-help groups, usually women, who save money that is placed in a local bank. By creating a safe avenue for savings (Hashemi et al, 1996, Rajasekhar, 2000), the SHG functions like a small bank, lending money to members. Its positive economic impact is well attested. However, by virtue of being a government-pushed model, it suffers from bureaucratic infirmity. Banks have mostly failed to recognise their self-interest in promoting SHGs. The linkage between SHGs and the banking sector is critical for providing economies of scale. Studies in Andhra Pradesh and Tamil Nadu (Nair, 2001) have shown that SHGs can become financially viable by forming federations, achieving enormous economies of scale. Bank branches can become economically viable entities by doing business with SHG Federations (SPS, 2006). The SHG-bank linkage model can be scaled for specific requirements—distress cash needs and so on, while bolstering women empowerment.

To meet rural credit requirements, India needs to focus on four key reforms. Public-sector banking needs to focus on high quality credit, by de-bureacratising procedures and personnel and infusing new talent. It should reform the cooperative credit structure towards democratic, member-driven, professional organisations focused on mutuality. The SHG-bank linkage programme needs to be strengthened, with NABARD bearing promotional costs initially. MFIS should be encouraged to expand on a level-playing field.

India’s financial sector is currently undergoing fundamental changes, with RBI playing a leading role in driving its development. Taking bold decisions such as promoting MFIS and SHGs as vehicles for financial inclusion is necessary to consolidate this growth. MFIS need to be encouraged to evolve into well-regulated institutions that can offer a full range of financial services to the poor. Replicating the successful model followed by Kenya and Peru, this sector’s expansion could lead to broad financial inclusion.

(Feroze Varun Gandhi is the BJP MP from Sultanpur.)

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