Can146;t waive them away

Thanks to the farm debt waiver, our attention has again turned to the despicable act of money-lending. Here are some facts worth remembering. First, the All-India Debt and Investment Survey 2002 showed an increase in the share of money lenders in total dues of rural households from 17.5 per cent in 1991 to 29.6 per cent in 2002. Money-lender shares were highest in states like Bihar, Manipur, Punjab, Rajasthan, Tamil Nadu and Andhra Pradesh. This list includes Tamil Nadu and Andhra Pradesh, where banking penetration is not bad. Second, in April 2006, the RBI announced the setting up of a technical group to examine legislation on money-lending. That report is now available. Third, the RBI survey found that the number of registered money-lenders pawn-brokers are different increased from 12,601 in March 1995 to 19,627 in March 2006. Even in the reform era, with talk of financial inclusion, we have not been able to eliminate money-lending. Fourth, the average size of a loan varies between Rs 1,000 and 30,000. Typically, these are small loans. Fifth, the average annual interest rate varies between 18 per cent and 36 per cent. Figures like 150 per cent are gross outliers. And indeed, 18 per cent to 36 per cent doesn8217;t compare unfavourably with what richer sections of society pay for credit card dues. Is it better to get the loan at 36 per cent or not get it at 7 per cent?

Why do money lenders remain, despite attempts to eliminate them? The answer is obvious enough. First, their products are more flexible than those of the formal credit system, including consumption loans and credit for social occasions births, marriages, deaths. Second, they are available 24/7 and provide doorstop credit. Third, formal institutions bypass the small, because administrative costs are high. Fourth, procedural requirements including collateral of money lenders are simpler and recovery is also more efficient. In a speech delivered in December 2006, the RBI governor said that rural banking was a monopoly of money lenders till 1904. If we take that as a threshold, we have attempted to eliminate money lenders since 1904 and have not succeeded more than one hundred years down the road. It is far better to recognise that formal mechanisms will never be able to supplant money lenders. Instead, let us legalise and integrate money lenders with the formal system. In the survey, money lenders said they needed an average margin of 6 per cent, to cover costs of transactions. If that is the case, we should be able to ensure that rural credit is available at around 13 or 14 per cent, by integrating the informal with the formal. One should also remember that money lenders are not banks. They cannot accept deposits. And that jacks up costs of lending. But it is also clear that the spread of micro-finance and self-help groups, both yet to uniformly spread geographically, will reduce the importance of money-lending.

Ostensibly, the legislations of several states the report mentions 22 seek to do precisely this, the integration of money-lending with the formal system. Typically, there are requirements of registration and licensing and maintenance of proper accounts. There are caps on interest rates that can be charged. Procedures are prescribed for default and debt recovery agents are sometimes frowned upon. Yet, most money lenders are unregistered and laws are not enforced. As so often happens with our laws, the answer lies in complicated transaction costs associated with the registration process. It is not remarkably different for small-scale industry registration. Registration brings benefits. But there are significant costs and it is a conscious decision not to register, because benefits are not commensurate with costs. To some extent, this is also true of birth registration. Failure to register births is often not an inadvertent oversight. It is a conscious decision, because the costs are too high. The best way to incentivise registration of money lenders is to reduce these bureaucratic-cum-procedural costs. Perhaps the government will take greater interest once money-lending registration costs also figure in the World Bank8217;s 8220;Doing Business8221; database. How about involving panchayats in the registration process? But the first step in doing all this is the recognition that money-lending is not evil. It performs a useful function.

The RBI8217;s technical group has now produced a draft money-lending legislation. This is the Money Lenders 038; Accredited Loan Providers8217; Bill, 2007. A section of the report, on interest rates, should be quoted: 8220;From a survey of the state legislations, it was found that some of the legislations themselves prescribe the maximum rates of interest that can be charged by money lenders. The Group is of the view that the existing ceilings prescribed under the legislations are out of sync with market reality8230; the state government in consultation with the State Level Bankers8217; Committee could link the rate to a benchmark with a maximum mark-up permitted over the benchmark to factor in other costs, ease of access, doorstep delivery and reasonable margin. While determining the maximum mark up, it would also be reasonable to look at the range of interest rates being charged by micro finance entities in the area as well.8221; This is eminently sensible, as are the other suggestions, incorporated in the bill. But hell will probably break out at this attempt to legitimise money-lending.

The writer is a noted economist

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