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In India micro lenders are strictly regulated by the Reserve Bank of India; borrowing customers are barred from having more than two simultaneous loans with a combined value of Rs. 50,000, the burden is placed fairly and squarely on the micro lenders to ensure that this regulation is complied with.
The micro finance industry has in operation two credit bureaux, with around 160 million client records in its data base. Micro lenders are able to check up prospective borrowers past history and current obligations from these bureaux. The Reserve Bank of India has also placed limitations on the profit making of micro lenders by capping gross interest margins for larger micro lenders at 10% and at 12% for smaller operators. As a result India’s average micro loan lending rates are now around 23 % to 24%, said to be among the lowest in the world.
Alok Prasad, Chief Executive of the Microfinance Institutions Network, which represents India’s 48 largest microfinance companies, says: “They are making decent money. The distinction is between profiteering and making decent profits. You are looking at a reformed industry. We are once again looking at a pretty rapid growth story. But this time the quality of growth is superior.”
Microfinance crisis
In October 2010, Indian micro lenders and their bankers and investors, were sent into a tailspin when State authorities in Andhra Pradesh ordered an immediate halt to all microloan recoveries, after a spate of suicides by over indebted borrowers. At that time more that 30% of India’s total microloan portfolio of Rs. 200 billion was concentrated in the state. Several large players essentially collapsed.
The crisis exposed how some unscrupulous micro lenders had aggressively chased growth by pushing loans to many unsophisticated customers who were already obligated to other micro lenders – and were in effect using funds borrowed from a recent lender to pay off older debts to other micro lenders! The decision to impose a regulatory regime was taken after this crisis hit.
The recent restrictions on MFI by the political and administrative authorities in Batticaloa District reflect this worry of over-borrowing, which is said to be an issue in Lanka too.
Indeed the Indian micro lending industry has come so far that recently the Reserve Bank granted in principle approval to a West Bengal-based micro lender – Bandhan Financial Services – to obtain a much-coveted banking license.
The Reserve Bank is now finalising rules for a new niche category of ‘small banks’ to serve the poor, and has promised qualified institutions that they will be have licenses virtually on tap, once the scheme is finalised. The founder of Bandhan Chandra Shekhar Ghosh, who started the micro lender in 2001, says: “For a microfinance company getting a banking license is like achieving the Holy Grail.”
Raghuram Rajan, the Governor of the Reserve Bank of India, wants these new ‘small banks’ to penetrate poverty-hit rural areas to promote lending and saving among farmers, small businesses and others whom traditional banks have been reluctant to serve.
These borrowers have to resort to exploitative village money lenders who charge up to 200% a year as interest for loans. Bandhan plans to open 700 branches in 22 states and start with at least 10 million savings accounts. Under the banking license conditions, one in four branches must be in towns with fewer than 10,000 people.
People’s Wealth program
At present just 35% of India’s adult population of 1.3 billion people, have bank accounts. A situation which the RBI has called ‘pathetic’. Recently Prime Minister Narendra Modi launched a People’s Wealth program, targeting the opening of 150 million new bank accounts. The plan is to have two accounts per household, including one in the name of a woman. The target is the 75 million poor Indian households.
Each account will have a local debit card – ‘RuPy’. The accounts will offer an Indian Rs. 5,000 overdraft facility after six months. Governor Rajan of the Reserve Bank has described this crusade of including the poor within the umbrella of the formal banking system as a ‘moral and economic imperative’.
Analysts say PM Modi is promoting the scheme because he wants to prepare for an eventual introduction of direct cash transfers of social welfare benefits to the poor. The current subsidy regime for food and fuel for the poor is inefficient and abused by the corrupt and bloats India’s fiscal deficit. A shift to cash deposits into a bank account will reform the system and make it more efficient.
Jahangir Aziz, Chief Economist at JP Morgan, comments: “This is a critical step towards using cash transfers for the poor as a means of delivering poverty alleviation benefits and subsidies. The urgency and speed with which it is being rolled out is because this is the easiest way of reducing subsidies without running into political opposition.”
PM Modi has personally emailed more than 725,000 branch managers of State banks emphasising the importance of financial inclusion and appealing for their cooperation. Alok Prasad of the Indian Microfinance Institutions Network comments: “It is a big ambitious goal, and a lot of push is being given to this, with the Prime Minister personally investing equity in the matter.”
India’s micro lenders, who have a combined $ 5.5 billion outstanding loans to more than 30 million borrowers, but are barred from holding customer deposits, have pledged to help banks open accounts for all their existing customers. Many are expected to become ‘Banking Correspondents,’ essentially bank agents empowered to open accounts, take deposits and allow cash withdrawals on behalf of partner banks.
Sri Lanka
The present situation in Lanka, where micro lending by institutions other than licensed commercial banks, co-operatives, finance companies, pawn brokers and money lenders is virtually unregulated, needs to learn urgent lessons from the Indian experience.
The Finance Business Act has placed restrictions on use of the word ‘Finance’ by entities and provided some exceptions or extensions of time by a paper notice by the Monetary Board, which some analysts say amounts to a de facto amendment of the Act! As a result, deposit taking by micro lenders which are not in the categories mentioned above are in a legal vacuum. This is not sustainable. Sri Lanka has to draw lessons from the Indian experience. This is a great pity as micro lending has a long history in Lanka, a positive one in the context of alleviating poverty. The regulatory lacuna is a huge drawback.
In Sri Lanka, Co-operative Rural Banks were introduced to promote savings among members and began a small loan scheme, to support the standard of living of the borrowers and also what was then called cottage industries to fight the curse of rural indebtedness to the usurious village money lender. Primarily these were traditional crafts or service providers in the community who needed to raise operating capital and found the Co-operative Rural Bank a more reasonable affordable alternative source of funds to the usurious village money lender or the pawn broker.
The first co-operative Rural Bank opened its doors in Menikhinna in the Kandy District in early 1900. With the co-operative movement being allowed to run autonomously with the light hand of the State in a regulatory mode, the movement spread rapidly to all parts of the island. Leading and respected members of the community were involved in developing the co-operative movement.
However, in the early 1960s, the autonomy of the movement was negatively affected by the Commissioner of Co-operative Development being given enhanced discretionary powers over the co-operatives by an amendment to the law. The increased politicisation of the administrative machinery of the Government led to unprecedented political interference in the co-operatives and resultant corruption, nepotism became rampant and decent citizens refused to get involved, leaving the field to political stooges. This is the sad story of development in many fields.
While the Co-operative Rural Banks paid an important role in poverty alleviation, it is debateable whether their target was the absolute poor and marginalised or the more well off members of the community. However, the importance of the Co-operative Rural Bank as a secure place where the poor could save money securely in the community itself and raise a loan in an emergency or for economic activity should be noted.
Fortunately around the time the co-operative movement was losing its credibility and the unavailability of a secure institution to save money and draw emergency loans or funding for economic activity was becoming an issue, two parallel developments took place. State-owned banks went on a huge binge of opening branches and one of them the National Savings Bank, the successor to the Post Office Savings Bank, aggressively canvassed the opening of savings accounts among the rural and urban poor.
Again, whether it was the financially better-off members of the community who engaged with these institutions is the issue, rather than the poor and marginalised. I recall one rural farmer telling me that he felt challenged by the need of getting passed the armed security guard at his local branch of the State bank to get inside!
Entry of non government institutions
The other parallel development was the emergence of non government institutions into the area of micro finance. These interventions were based on the highly-successful Grameen Bank intervention by Prof. Yunus in Bangladesh, in 1974. It was based on collateral free, group lending with inter se guarantees and market rates on interest.
Women basket weavers living in poor communities around Chittagong University, where Prof. Yunus was teaching economics were borrowing operating finance from uncurious village money lenders and this left them hardly any profit and the end when they marketed their produce. Prof. Yunus advanced them the cash, $ 27 to 42 impoverished women, to buy raw material, at the going commercial rate of interest, was far below the local money lenders usurious rates, and the women were able to repay the loan to the Prof. after making a much better profit.
Instead of collateral, the security for the individual loans was the group guarantee, the small group of basket weavers provided the certainty that they would not let a member default, and in the event of a default, due to death, sickness or such economic shock, the others would contribute and support the defaulting borrower. Yunus and the Grameen Bank won the 2006 Nobel Peace Prize.
Now micro lending has morphed into a global enterprise having an active loan portfolio of $ 81 billion and involving 91 million borrowers, according to the Microfinance Information Exchange.
In Lanka the community development organisation Sarvodaya was the pioneer in setting up such a savings and credit movement for the poor and marginalised members of the communities they worked in. International donor agencies both government and private supported this initiative and in time it developed into an organisation called Sarvodaya SEEDS. Today it is registered as the Deshodaya finance company and is among those being ‘consolidated’.
Smaller initiatives
Other smaller initiatives of this nature were also being developed in various parts of Lanka. The other Government-led initiative resulted from the expansion of vocational and technical training in the late 1970s by the expansion of the National Apprentice Board (NAB), the National Youth Services Council (NYSC) and other vocational and technical training institutes.
When the output of these programs reached the market, the economy had not expanded quickly enough to absorb their skills. It was only when the Accelerated Mahaweli Development Scheme, the housing development programs and foreign employment in west Asia hit full pace, were they absorbed fully.
In the interim, it was decided to provide to those who interested, among these skilled trainees with funding to start up their own small scale service businesses. The National Youth Services Savings and Credit Co-operative (NYSCO) was begun with this idea, skilled youth invested in shares in NYSCO and they could borrow in proportion to their investment, on a collateral free, inter se guarantee provided by other members. Loans were also provided to purchase a basic tool ticket, which was an attraction for contractors to employ them.
For those who wanted to start an enterprise, with the assistance of the International Labour Organization (ILO), the Small Scale Enterprise Development Division (SSED) of the Ministry of Youth Affairs and Employment was set up to provide business training based on the highly successful model of ‘Start Your Business’ based on a program conducted by Sweden’s Chamber of Commerce for their members and promoted worldwide by the ILO.
Seeing the success of these initiatives the Central Bank of Sri Lanka also started the Isuru program funded by the Japanese Government, small groups taking small loans for economic activity through collateral free inter se guarantees.
Janasaviya program
The next big initiative was the poverty alleviation project of the Janasaviya Trust Fund, a multipronged integrated approach to poverty alleviation through, community infrastructure projects selected by the community, implemented by community participation with a cost contribution, a nutrition intervention, a micro credit facility and a community mobilisation fund.
This was implemented through partner organisations in the community. Over 100 community organisations which had no previous experience in micro credit were inducted into the field through this initiative. This was probably the largest expansion of micro credit ever, in Lanka.
At this same time, the Janasaviya Program of the Government was launched, which was designed to give a poor family a monthly grant, for a fixed period, to held them to graduate out of poverty. This program reflected the argument that microcredit is no panacea to an extremely poor family, which are thereby being put under a debt burden, out of which they cannot escape, and that initially a micro grant will help them more. This same concept was carried through into the Samurdhi program and its successor Divi Neguma, but there was no time limit for the micro grant, it was open ended.
Bandhan
A study by Esther Duflo, an economist at the Massachusetts Institute of Technology, presented at Harvard University, seemed to strengthen the argument for one-off micro grants rather than micro credit. Duflo evaluated a project implemented in the India state of West Bengal by an Indian micro finance institution called Bandhan, yes, the very same one, which has now received a banking license from the RBI.
Bandhan implemented a program designed by BRAC of Bangladesh; working with families living in extreme penury, Bandhan gave each of them a small productive asset – a cow, a couple of goats or some chickens. It also provided a small stipend to reduce the temptation to eat or sell the asset immediately, as well as weekly training sessions to teach them how to tend to animals and manage their households.
Bandhan hoped that there would be a small increase income from selling the products of farm animals provided, and that people would become more adept at managing their own finances. In fact Duflo’s research showed the results were much more dramatic. Well after the financial help and the handholding had stopped, the families of those who had been randomly chosen for the Bandhan program were eating 15% more, earning 20% more each month and skipping fewer meals than people in a comparative group. They were also saving more.
The effects were so large and persistent that they could not be attributed only to the direct effects of the grants; people could not have sold enough milk, eggs or meat to explain the income gains. So what was the real reason? Duflo’s research showed that the recipients worked 28% more hours; mostly on activities not directly related to the assets they were given. The researchers found that the beneficiaries’ mental health improved dramatically, the program had cut the rate of depression sharply.
Duflo argues that the program provided these extremely poor people with the mental space to think about more than just scraping by or surviving day-to-day. In addition to finding more work on existing activities, like casual agricultural labour, they also started exploring new lines of work. Duflo reasoned that the absence of hope had helped to keep these people in penury; the Bandhan intervention injected a dose of optimism into their desperate lives. Where the grants component is not one-off, but paid every month, there being no exit mechanism, a dependency syndrome is created and the breakout of poverty rarely achieved.
Lessons for Lanka
Sri Lankan policymakers need to study, learn and internalise urgent lessons from the Indian experience, in regard to the bonanza in total financial inclusion achievable through the proper and effective regulation of micro finance.
Micro entrepreneurs are the initiators who later blossom into small and medium businesses. The cutting-edge skills picked up in nurturing a micro enterprise, through the risky initial phase, is the kindergarten, the boot camp, of small business development. The survivors, who pull through are the ones who have to be cherry-picked and supported, with all the facilities being trumpeted for small and medium businesses.
Unless this fundamental economic truth is understood and the foundation for business development laid through a positive micro lending environment, the whole push at the SME level, notwithstanding all the recent high level song and dance, is doomed to be a non starter.
Sri Lanka has the infrastructure, through a State and non State micro finance institutional structure, but the law, the regulatory regime, has to fall into place, as in India. If the next phase of financial inclusion is to be achieved and the natural business skills and ingenuity of the poor, marginalised and excluded is to be given an opportunity for a full flowering. Then only will the economic bonanza be achieved.
(The writer is a lawyer, who has over 30 years of experience as a CEO in both State and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)
