Microfinance mess: No end yet in sight

Microfinance industry is in a mega mess and its woes are unlikely to end soon. It needs regulation but is hard to regulate as it involves numerous actors at the bottom of the social pyramid in far flung regions. Meanwhile, virtual stoppage of recoveries and reticence of banks to provide funds for lending is slowly suffocating the entities that give tiny loans to very poor people at their door step without any guarantee or collateral and with minimum paperwork and delay.

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Published: Mon 24 Jan 2011, 10:47 PM

Last updated: Tue 7 Apr 2015, 4:27 AM

When SKS Microfinance went public in early August and was oversubscribed 13 times, inspiring other private firms in the business to follow its example, it seemed as if India had reinvented lending to the poor. Soon thereafter, however, came stories of series of suicides by borrowers driven to despair by exorbitant interest rates and coercive recovery methods.

Essentially, there are three critical issues that microfinance institutions (MFIs) need to address. The first is the rate of interest. MFIs charge interest at anything between 24-36 per cent and justify it by citing higher operational costs. The second is the issue of multiple lending, wherein the same customer borrows from many MFIs. This poses a problem for the customers, leading quite a few of them into a debt trap. It is also a big bugbear for the MFIs, as it brings in competitive pressures and, more significantly, obfuscates the customer’s current debt level and cash flow situation.

The third issue is group guarantee. Group guarantee has enabled MFIs to achieve a nearly perfect recovery rate, allowing them to flaunt a level of distressed assets which is far lower than that of commercial banks. On the flip side, however, peer pressure lies at the root of the coercive recovery methods, which have reportedly led to suicides. The recovery rate is one of the criteria that go into calculating the incentives for MFI field staff, so it is easy to see how pressure can build up.

A committee appointed by the Reserve Bank of India has sought to address these issues. It has recommended a cap of 24 per cent on interest rates charged by microfinance institutions, of Rs25,000 on loan for a single borrower. It has suggested creating a special category of NBFCs that will lend to low-income borrowers and exempting them from the provisions of the anti-usury laws on money lending.

Most of these recommendations, such as the ceiling on interest rates 75 per cent of loans to be given for income-generating activities, are nearly impossible to implement. Such caps have not worked in the past and are unlikely to work in the future. Worse, if these are indeed enforced strictly, they will only drive potential borrowers into the arms of usurious moneylenders.

The committee wants MFIs to ensure that a borrower is not a member of more than one self-help group/joint liability group and not more than two MFIs lend to the same borrower. The responsibility to ensure that coercive methods of recovery are not used is also placed on the MFIs. However, industry representatives have already expressed their inability to implement these recommendations.

Meanwhile, fresh disbursements have come to a standstill while the recovery rate of the NBFC-MFIs has come down sharply. Politicians are tempting borrowers with potential loan waivers. At the same time, fearing further deterioration, banks have stopped supplying capital to MFI. If things continue this way, it could be the end of the road for many of the for-profit MFIs, which constitute 80 per cent of the market and have been growing the fastest.

Views expressed by the author are his own and do not reflect the newspaper’s policy.

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