Microfinance: Missing component in Govt. response to economic revival from COVID-19 pandemic

The Government’s stated policy has been to provide relief and support not only to large businesses but also to Small and Medium Enterprises. As articulated by the President at a recent meeting with the bankers, the top priority is to “strengthen the production economy” – Pic by Shehan Gunasekara

By Dr. Nimal A. Fernando

Ever since the COVID-19 pandemic began to seriously impact the economy, the Government commenced an expanding program to provide relief to the affected businesses and individuals in numerous ways. The Government efforts have gathered momentum as the lifting of the restrictions on people’s movement and economic activities is enhanced. 

The Government’s stated policy has been to provide relief and support not only to large businesses but also to Small and Medium Enterprises. As articulated by the President at a recent meeting with the bankers, the top priority is to “strengthen the production economy”. 

Another salient aspect of the Government policy is to provide support to the informal sector enterprises including smallholder agriculture. There is a dire need for Government intervention and support to rebuild the badly affected economy. And that need is felt not only in the formal economy but also in the informal economy. 

And those in the informal economy do not have financial resources to rebuild their economic activities. Hence if they are not targeted in the Government assistance programs, they are likely to be pushed into deeper poverty.

Microfinance sector

A sizeable proportion of people in the informal economy relied on Microfinance Institutions (MFIs) –institutions providing savings and credit primarily for economically active low-income and poor men and women – for credit to carry out their microeconomic activities and small businesses. 

MFIs in Sri Lanka are a heterogeneous group. It includes small-scale NGO-MFIs, medium-size public and private companies as well as relatively large non-bank-financial institutions (NBFIs) providing microfinance services. 

Before the COVID-19 pandemic hit the economy, MFIs (excluding the NBFIs) were serving over 1.4 million low income men and women through credit services and the proportion of microfinance clients in the informal economy was over 70%. 

The outstanding loan portfolio of these MFIs (excluding NBFIs) was about Rs. 18.0 billion at the end of 2019, a small portfolio because the average loan sizes in the microfinance sub-sector is relatively low. The entire portfolio however was not enterprise and livelihood loans; admittedly it included loans given for medical emergencies and consumption purposes as well. 

Plight of the microfinance clients

What is the plight of the MFI clients now? 

A majority of the microcredit clients are in deep trouble: without access to working capital they find it difficult if not impossible to continue their production activities. 

With the hardships caused during the last two months, they are not in a position to repay their existing loans. Their main source of credit has been disrupted partly because MFIs that lent to them do not have adequate resources to provide more credit. Their choices are extremely limited. 

Options for the MFI clients  

Self-finance? Their ability to self-finance is limited; self-finance may be inadequate to take advantage of the investment opportunities that may be available. Alternative is to rely on informal sector money lenders who generally lend at exorbitant rates. This option if chosen is unlikely to be much help at the end. 

Their best option may still be to continue to access credit from the MFIs they were being served before the pandemic. And the MFIs know a lot more than others about the clients in their books.

Liquidity problem of MFIs

But MFIs face a serious funding constraint: their loan recoveries have gone down to near zero level in the last two months. No new lending operations due to business closures. So no opportunity for an inflow of collateral deposits. (Collateral deposits are directly linked to the amount of loans disbursed). And they are unable to borrow additional funds from commercial sources of credit such as banks and wholesale lenders to MFIs. 

Their liquidity crisis is more serious than that of their clients. Some MFIs will be forced to drastically scale down their operations while many others may be forced to simply shut their doors.

MFIs filled a gap in the market

The MFIs filled a gap in the financial markets by serving a segment of the population that the conventional banking sector chose to overlook. By doing that MFIs ease the credit constraint of these poor and low income people to some extent and made a contribution to the economy. 

A significant proportion of the clients were able to employ themselves because of their access to credit although the quality of some of the employment so generated may be low. The clients were able to maintain their families above or near poverty level. Many were able to reduce the severity of their poverty. With the family members of the clients, MFIs may have touched the lives of some 4.0 million to 6.0 million people, about 18-25% of the population of the country.

Considering this and the current plight of the MFIs and their clients, is it reasonable to overlook this segment of the economy and the community in the government policy responses to economic revival from the COVID-19 pandemic?

Tarnished image

The policy neglect of MFIs and their clients seems to be misguided. Misinformation, disinformation and exaggerated information about microcredit operations of the MFIs seem to have played a role in this. Many politicians in power seems to consider MFIs as exploitative institutions no different from the rapacious money lenders in the country. 

Microfinance has driven many low income families to despair, they believe. For many of them it is a sub-sector characterised by extremely high interest rates, aggressive marketing strategies, irresponsible lending, repressive collection practices and abusive operating systems. In fact some policymakers appears to hold the view that MFIs are a worse option than informal money lenders in the villages. 

A popular view among most segments in the society has been that irresponsible lending practices of MFIs caused an over-indebtedness among most of their clients. While it is true that some MFIs are responsible for irresponsible lending practices and resultant problems of over-indebtedness of the borrowers, it is unclear to what extent they can be used as solid evidence to write-off the entire industry from supportive policy responses. 

Credit is delivered to low income population by different type of organisations that exist along a continuum from informal lenders to formal financial institutions such as co-operatives, MFIs and banks. This holds true for all developing countries. The institutional diversity is a strength, not necessarily a weakness of the landscape. 

A more prudent approach to the problems of lack of access to credit among the low income population is to introduce measures to nurture healthy competition in the credit market. Cleaning up the microfinance industry, not writing it off, can have far reaching impact in this regard. The COVID-19 pandemic-induced crisis in the industry has created a window of opportunity for this. Policymakers need to make use of this opportunity.

National survey on indebtedness

However, crafting a sound policy on credit to low income population and the MFI sector requires reliable information and data, not anecdotal evidence and viewpoints propagated by various groups with vested interests including incumbents in the industry. 

It is high time for the Central Bank to plan a comprehensive national survey on indebtedness among low-income population in all sectors (urban, rural and estate), to be carried out soon after the country reaches the new normal. 

The data that would be generated by the proposed survey can be used systematically to formulate a smart policy package to address the access to credit problem among low income population in general while carving out a strategy to revive the microfinance industry to make it an integral and healthy component in the financial system.

Let’s shift the paradigm from policy-based evidence to evidence-based policy.

Urgently needed: Immediate assistance 

In the meantime, to enable MFIs to resume their operations and continue to serve at least their existing clients, the government needs to consider providing liquidity support, as has been done by our big brother India, through an appropriate mechanism. 

MFIs are certain to face a huge problem of recovering the ongoing loans in their books. They will be forced to reschedule some of these loans and perhaps write-off some others. In this context, MFIs will find it impossible to provide relief to their clients and resume their operations to assist in the economic revival of the informal sector.

(The writer is a development economist with over 40 years’ experience in the field. He is former Associate of the Kuala Lumpur-based global organisation, Alliance for Financial Inclusion and former Practice Leader for Microfinance at the Asian Development Bank. He can be reached at [email protected]).