Macro implications of microfinance

So far as the motive is concerned,altruism is definitely welcome. Doubts about its penetration power and sustainability,however,exist. If financial inclusion is a minor issue,the social welfare approach is fine. But when it is a major economic problem,a serious economic solution is required. NGOs have definitely made a substantial contribution in the field of microfinance.

It was,however,of an experimental nature,and to prove to the professional financial sector that the business of microfinance is profitable. This is the reason that the financial sector has shown great interest in microfinance. That is why,MYRADA,the originator of Self Help Groups SHGs,has carved out Sanghamitra for carrying out its microfinance business. BASIX has a for-profit financial institution and a no-profit development institution under its umbrella. These two pioneers realised that this business cannot be expanded seriously and passionately through NGOs with a not-for-profit approach. They belong to a rare species,which could continue development and sustainability efficiently.

Until now,only about 60 of low income households have access to microcredit from the combination of SHG-bank linkage programmes and MFIs; the average outstanding credit level is a meagre Rs 4,000 per account. There is a need of i more number of institutions,ii large size of skilled manpower and iii huge amount of capital,which are difficult to be obtained through the no-profit approach. In the words of Adam Smith,it is not from the benevolence of the butcher,the brewer or the baker that we expect our dinner,but from their regard to their own interest. Profit and profiteering,however,need to be distinguished. A system needs to be put in place that allows the former but prevents the latter.

Profit levels at any organisation can be increased by bringing efficiency and having the right to charge the appropriate price,which is supposed to lie between the upper limit of affordability of the market and the lower limit of the cost of operation. Although both need discussion,the controversy today revolves around the upper limit,and there is no doubt that the upper limit needs to be reduced.

If one compares the MFI rate of interest of about 30 per annum,it is much higher than the interest rate offered by public sector banks say 15 per annum,but much lower than 8-10 per month or 72 per annum charged by money lenders in rural and semi-urban areas; or 1 per day in informal metro markets. As both MFIs and moneylenders provide services at the doorstep,there is no transaction cost for the borrowers; similarities,however,end here. In the absence of the business correspondent service,the price for banking service available at the branch may turn out to be costlier than the MFI price at the doorstep.

The interest rate,whether high or exorbitant,can be effectively reduced only by encouraging and ensuring competition,and making market friendly policies for tapping cheaper fund and smooth functioning. This will help the poor to get microfinance at a lower prices. On the other hand,if the interest rate is unreasonably capped through non-market process and the MFIs do not find the activity decently profitable,they may close down the shop. The poor will then be forced to go back to old moneylenders and unscrupulous and unregulated financial organisations that charge much higher rates. Raghuram Rajan in A Hundred Small Steps has very clearly shown how the capping of interest rates reduces the flow of microcredit. He even argued that the reduction of interest rates below market rate makes it costlier for poorer segments because of the element of bribery creeping in. A growing feeling in some quarter of vested interest groups being behind the ordinance in Andhra Pradesh may also not be completely ruled out.

A ceiling on interest rates through fiat is,therefore,no solution. Adequate lending,not over-lending; financing the need,not luring with money; recovery not coercive recovery on the part of lenders must be business ethics.

Borrowers need to be literate enough to calculate the burden and adequately educated to properly use the money and understand the importance of repayment. Policymakers on the other hand need to appreciate that some of the non-production loans like for food in the lean period,medicine,school fees or retiring old moneylenders debt are not wasteful expenditures but long-term investment loan. In the absence of proper safety net and meaningful public system for health and education the poor will be compelled to either resort to money lenders for expensive money for short-term relief or forgo the long-term benefit if formal and semi-formal institutions are advised to lend for so-called productive purposes only.

These contradictions need to be addressed by an appropriate policy framework that i defines microfinance clearly,ii distinguishes between microfinance and other financial institutions,iii brings all the newly defined microfinance institutions under one and only one supervisory system,and directly or indirectly under the regulation from RBI,iv specifies prudential norms as well as ethics of lending v ensures competition,vi differentiates capital requirement for different MFIs on the basis of their expected geographical spread and potential business volume,instead of blanket requirement,vii provides scope for tying up with a commercial bank for providing money transfer service,viii allows to work as business correspondent also for deposit mobilisation,ix makes provision for 100 deposit insurance assuming total deposit does not exceed Rs 50,000,x ensures rigorous auditing and xi makes the environment friendly for the flow of cheaper resource to this sector xii and puts a strong supervisory system in place.

MFIs need to be defined in such a way that they not only provide small financial services to the financially excluded but are encouraged to provide all the necessary non-financial services for improving the productivity of credit,which i puts both the service provider and the service user in a win-win situation and ii prevents micro credit turning into micro debt.

The author is a professor at National Institute of Bank Management. This article was written before the release of the Malegam Committee report