Restrictions by Central Bank on microfinance loans: Can the socioeconomic issue be cured?

Over 82% of Sri Lanka’s population, including 92% of the poor, live in rural areas of the country. Hence, they are easy targets for these irresponsible lenders or lending institutes – Pic by Shehan Gunasekara

On 3 December, the Monetary Board of the Central Bank of Sri Lanka has issued a new direction curtailing the maximum rate of interest on microfinance loans of Licensed Finance Companies. This is a welcome move as far as the borrowers of the microfinance industry are concerned. 

This direction is introduced as a result of many concerns over the industry in the recent past. If I am not mistaken, Central Bank Governor Dr. Indrajit Coomarasamy personally joined one of the fact-finding missions to investigate the plight of the helpless customers in the north sometime back. This shows the depth of this issue taking place in the country over a period of time.

The direction was issued with the objective of protecting the customers being charged with exorbitant interest rates on microfinance loans granted by the Licensed Finance Companies (LFCs). It is not clear whether the Specialised Leasing Companies (SLCs) are exempted from this direction. The CBSL has introduced an interest rate limitation of 35% per annum inclusive of all other charges on microfinance loans through the new direction to LFCs. This is a timely move and should be commended CBSL for doing so. 

However, can these Acts and Directions alone protect the less informed market segments in the society who are not conversant in the financial literacy and who have no idea has to how credit works for the betterment of their lives? Earlier, Microfinance Act No. 6 of 2016 too was introduced to the industry with the view of safeguarding the interest of the customers and also with the intention of disciplining the product after a decade of trials.

Micro financiers destroying villages

Recently (25 November), in an article of a regional newspaper Mada-Rata (published along with one of the sister newspapers of Daily FT, Lankadeepa), regional reporter of Nuwara Eliya Sampath Jayalal quoted a speech delivered by the Additional Divisional Secretary of Nuwara Eliya Mallika Amarasekara on the consequences of irresponsible micro-financing amongst the women of Nuwara Eliya District. She has disclosed the reality of this saga from top to bottom saying micro financiers were destroying their villages like a worm specialty. 

The wording itself shows the gravity of the issue. They (micro financiers) are slowly destroying the harmony of families and ethics of the society. When loans are offered, women just take loans without a purpose, not knowing how the money can be spent productively. They feel the monies are given free. The monies are not used for money generating purposes. Instead, they are being used for consumption such as buying new clothes, hiring a vehicle to go to a wedding ceremony or paying utility bills, etc. 

In most cases the husband, the breadwinner of the family, doesn’t know about the wife’s financial commitments. This scenario leads to many family disputes. Some women have taken loans from four to five institutes to pay on daily basis on all five days of the week. When these loan commitments cannot be met, these women resort to many unethical behaviours which finally end up in separation, divorce or committing suicide, etc. She further said the interest rates offered by these microfinance institutes were around 60% per annum though they say that the interest rates are around 25% to 30%.

We heard a heartbroken story from Jaffna a couple of years ago. A father killed himself as he could not pay his loan instalments. After his death, the loan sharks were behind the mother. She too killed herself subsequently but only after killing her three children by poisoning them. Unimaginable plight. Who is responsible for these agonies? 

 We heard a heartbroken story from Jaffna a couple of years ago. A father killed himself as he could not pay his loan instalments. After his death, the loan sharks were behind the mother. She too killed herself subsequently but only after killing her three children by poisoning them. Unimaginable plight. Who is responsible for these agonies? 

Easy targets for irresponsible lenders

An article written on 8 November by Nisha Arunatilake, the Director of Research at the Institute of Policy Studies of Sri Lanka and published by one of the sister newspapers of Daily FT, Daily Mirror, stated that more than 82% of Sri Lanka’s population, including 92% of the poor, are living in rural areas of the country. Hence, they are easy targets for these irresponsible lenders or lending institutes. 

Many voluntary organisations formed by influential women have come forward to educate and to assist these helpless women. Even the Central Bank of Sri Lanka (CBSL) is conducting awareness programs in many parts of the country. However, the impact of their hard work is still not visible. Maybe these lenders are smarter than them or these organisations may be still halfway into their mission. 

In the absence of a properly-laid-down mechanism to improve the social standing of these women by the Government, these discriminations cannot be fully evaded. Developing the rural economy is necessary to help them to survive. Better jobs and business opportunities are the best means of increasing earnings and overcoming this issue as a country can’t afford to lose this productive and equally lucrative product.

 

Government has failed to discipline microfinance

It is evident that the microfinance market is highly popular among the people of the country. However, the Government has failed to discipline the product for the betterment of the county’s economy. Hence, a different approach will put the product on the correct track. 

The LFCs too without dodging the CBSL decisions should cooperate with them to set up a better platform for micro-financing. It is voiced by some LFCs that the given interest rate cap is insufficient for them to survive as unlike in leasing, in micro-financing a huge cost has to be incurred to administrate the product. 

For instance, to manage a portfolio of Rs. 2.5 b, it is said that around 300 employees are needed. The write-offs of loans are further deteriorating the yield at the end of the financial year. Under such circumstances it is said the sustainability of the industry is questionable under the new restrictions. 

To overcome this situation, a broader concept which is unique to Sri Lanka can be designed by the CBSL without working in isolation but with the consultation of licensed finance companies, microfinance operatives, peer groups, law enforcement authorities and media and also with customers who have been benefited and victimised, a better product can be re-launched into the market. 

We are not alone

As far as this issue is concerned, we are not alone. Our neighbouring country India too has been affected by this situation badly. Bollywood superstar Amitabh Bachchan has cleared more than $ 560,000 worth of debt owed by farmers, amid a wider agricultural crisis that has forced many rural workers into extreme poverty. 

Government data indicates that 11,772 farmers across India committed suicide in 2013, the most recent available data, equal to 44 deaths every day. Indian micro-borrowers mainly farmers have battled against a variety of hardships in recent years, brought about by a combination of monsoon-damaged crops, rising fuel costs and lack of state support.

The impact of the Andhra Pradesh microcredit crisis was so strong that it contributed significantly towards the global dip in microcredit outreach in 2011. The Andhra Pradesh microcredit crisis was largely started by reports in popular media that suicides were being aggravated by microcredit lenders charging high-interest rates and harassing borrowers. This has resulted in political instigation of non-reimbursements of rentals in some Indian states which almost killed the sector.

In Bangladesh, Dr. Qazi Kholikuzzaman Ahmad, Chairman of PKSF, a body that monitors microfinance, describes microcredit as a “death trap” for the poor. He explains how poor people often take up the loans without thinking of the consequences, and that 60% of borrowers take loans from several sources. For many recipients, it is a lifeline, and very often it is the only way for them to establish a business. 

Some argue that people can quickly sink into a cycle of debt, with many lenders charging exorbitant rates of interest. Villagers complain of harassment from the debt collectors and there have been allegations of physical assaults. Because field officers decide repayment rates in most cases, they sometimes use coercive and even violent tactics to collect instalments on the microcredit loans.

 

Character of the lending institutions

Coming back to Sri Lanka, let us evaluate, the character of the lending institutions in Sri Lanka which contributes to this dilemma. As per the research data, a large number of microfinance companies are not registered under the Central Bank. Hence, the applicability of the new direction is questionable on them. All these directions are applicable to the registered financial institutes with the CBSL. If laid-down procedures are not adopted, they can be penalised for not doing so. However, there is no visible procedure in place to penalise unauthorised market segment in the industry. 

Then the question arises why CBSL can’t take some remedial action against such companies. It is evident in some instances even the registered companies which don’t fulfil CBSL obligations go scot-free giving various excuses. Hence, it appears CBSL ignores the unauthorised market segment as they have more regulatory work to be dealt with in registered finance companies. 

CBSL is a regulator and not a raiding unit. Their role is different. The public perception is that they should do the supervisory role as well as the policeman’s role in the market. This perception cannot be blamed fully as the public cannot see any other alternative entity to handle the policeman’s role. The Sri Lanka Police (SLP) is responsible for bringing these unauthorised operatives to a punishable stage in courts in order to curb this mania. However, we don’t see such operations happening in the market other than a few isolated incidents here and there once in a while. This may be due to the fact that these unauthorised agents are being backed by powerful politicians, their henchman or by infamous underworld figures.

However, it is made to understand that the Police Department moves into action only if there is a complaint lodged against such operatives and not otherwise. As far as there is no complaint against them, they (SPL) is not mandated to inquire into such operations. Though this statement is subject to correction, in reality too we don’t see much action is taken against so-called micro financial organisations operating in the market without proper authentication, by SPL. 

This is a serious lapse in the administration mechanism of the country as far as this socioeconomic issue is concerned. The SPL’s stance is that anyone can operate their own lending business as far as the money engaged for such purpose is legal. They are not interested in the rate of interest which creates this social dilemma. 

 

For over a decade CBSL has tried to regularise the microfinance sector in the country and finally on 15 July 2016, Microfinance Act No. 6 of 2016 was introduced. Similarly, now CBSL has enacted a direction to curtail the interest rates charged from the borrowers by LFCs. The initiatives taken by the Central Bank is appreciated to discipline the microfinance industry of the country. However, the bottom of the iceberg which is under the water is very much larger than the tip. Hence, many corrective and fearless measures should be taken to stabilise the industry

Looking for loopholes

CBSL has done a smart move by wording the direction by saying 35% per annum inclusive of all other charges on microfinance loans. If not for this wording, even the CBSL registered companies will find a way out through fee base income to get exorbitant returns again. It is evident, in some instances the earlier introduced Loan to Value (LTV) direction is not fully followed by some companies and banks. They have found ways to evade the contents of the direction which cannot be challenged. Similarly, companies might find loopholes to get away with this direction too.

The informal lenders claim that they use their own funds. However, somewhere during their business process, they tap formal industry to bridge their funding gaps. It is doubtful whether the CBSL has adequate resources to map these practices taking place in the financial market. 

The less informed market segments (the borrowers) are not interested in finding out whether their lender is registered with CBSL or not. As far as they get their monies without a hassle, less documentation and on time, they are happy. Under such circumstance, when things go bad, the blame comes on the formal NBFI. This is one of the main reasons for the country’s NBFI to have a negative perception in the minds of people. The NBFI is mostly carrying the sins committed by unauthorised lenders and lending organisations which are not governed by the regulations of the CBSL.    

One or two registered companies are also responsible for this social dilemma. Strict action should be taken on such companies to have a better perception of the NBFI. Otherwise, the NBFI is treated as a set of shylocks or “poli mudalalis”. Possibilities are there in the market to place a dummy board of directors by once failed companies to re-launch their operations. CBSL will have to be watchful of such events taking place in the industry. However, again it is doubtful whether the CBSL is geared to find such events happening in the market and to take appropriate action. Hence, it is highly recommended to form an alternative dedicated body to curb such events along with unauthorised lending operations taking place in the market. It is somewhat similar to FCID instead of CID to handle crimes involved in financial irregularities. 

 

Conclusion 

For over a decade CBSL has tried to regularise the microfinance sector in the country and finally on 15 July 2016, Microfinance Act No. 6 of 2016 was introduced. Similarly, now CBSL has enacted a direction to curtail the interest rates charged from the borrowers by LFCs. The initiatives taken by the Central Bank is appreciated to discipline the microfinance industry of the country. However, the bottom of the iceberg which is under the water is very much larger than the tip. Hence, many corrective and fearless measures should be taken to stabilise the industry.

Gordon Sondland, the US Ambassador to the EU, in a recent interview conducted in Brussels by TV channel FRANCE 24, spoke on EU sanctions on USA-manufactured cars, about which his President Donald Trump has two concerns. It is whether the users are refusing to buy the US made cars or the relevant governments are blocking the sales of cars in the region. If the answer is the first one then the manufacturers are at fault. If the answer is the second one then they (USA) will have to retaliate.

Correspondingly, people of this country are not rejecting the microfinance industry. It has improved the living standards and wellbeing of many. However, some have been victimised by the irresponsible behaviour of a few players in the industry and unauthorised players who have entered the industry by force. All the Government will have to do is prepare a level playing field for the industry to flourish by eradicating dissimilarities which are located in the submerged part of the iceberg. Introduction of more sanctions on the visible tip of the iceberg will curtail the growth of the industry. 

(The writer is the founder of Infornets, an organisation which is formed with the intention of sharing credit related information and financial knowledge to less-informed people, locally and globally. He counts 35 years of experience in the Non-Banking Financial Industry of Sri Lanka. He is a former CEO/General Manager of a non-bank financial institution. He holds a Master’s Degree in Business Administration from the UK. He is a Member of Institute of Management of Sri Lanka and an Associate member of Sri Lanka Association of Advancement of Science. He can be reached via [email protected] or www.infornets.com.)