India contemplates legislation on microfinance

Consequent to the attacks on the microfinance industry in the Indian poverty-ridden state of Andhra Pradesh, brought about, according to some analysts, by the hostility to the microfinance industry shown by some state level politicians, who were threatened by the empowerment the financing schemes provided to the poor and marginalised and thereby eroding the politicians power of patronage, the Reserve Bank of India (RBI), Indian’s Central Bank, appointed a committee chaired by Y.H. Malegam to take stock of the situation of microfinance in Andhra Pradesh and make recommendations.

The crisis was created by some suicides by heavily indebted farmers in Andhra Pradesh due to them being unable to meet their debt obligations. The state legislature enacted an ordinance banning the weekly collection of instalment repayments by microfinance institutions and limiting them to monthly collections.

The local politicians also started a campaign against the microfinance institutions labelling them as exploiters of the poor and usurious money lenders in disguise and encouraged borrowers to default. Repayment collections plummeted, borrowers who had been conditioned by the discipline of weekly repayments, were unable to hold the money for a whole month, until the agent of the microfinance institution came calling, the poor have so many diverse claims on any small resource they may have at hand at any given time.

Crisis mode

In crisis mode, the commercial banks which had lent money to microfinance institutions, on an RBI directive, stopped further disbursements and called back pre-existing advances. Microfinance institutions stopped lending and began laying off staff. Some microfinance institution leaders asked for crisis funding assistance from the Government of India or the commercial banking sector.

The problem was further compounded by the antipathy to the for profit microfinance industry which has expanded by geometrical proportions in recent years in India.

Microfinance had originally started as a not for profit operation, supported by grants from donor and INGO funds. As costs of disbursement were high and monitoring and supervision were expensive, interest rates were higher than the average commercial bank lending rate.

The poor, unlike middle and upper class borrowers, repaid their loans; they did not default, they could not afford to, as they had no other recourse to money, other than the usurious village money lender. The issue, being access to and availability of, credit, rather than the rate of interest, per se. Repayment rates were over 80% on average for microfinance institutions.

Microfinance bandwagon

In time, encouraged by the not for profits’ success, for profit microfinance institutions also emerged. This success enticed other financial institutions into the sector. Like in Sri Lanka, state banks, commercial banks, finance companies and leasing companies all jumped onto the bandwagon of microfinance. It is alleged that some money lenders also rebranded themselves as microfinance institutions!

To compound the problem, the Reserve Bank of India declared that the commercial banks should provide refinance to microfinance institutions as it was declared a priority sector. Microfinance outreach and disbursements increased rapidly and the demand for loans and for additional funds to lend also went up.

Due to the high average recovery of loans, the issue of securitisation and listing on stock exchanges also became an option for raising funds for microfinance institutions. Microfinance institutions such as SKS Fund in India listed and raised substantial amounts of funds from investors.

Traditional microfinance practitioners such as Prof. Yunus of Bangladesh’s Grameen Bank, who famously declared that “micro credit would put poverty into the museum,” were opposed to these for profit microfinance institutions and also against them raising funds on the stock exchanges.

Microfinance in India was in crisis. The judiciary struck down the Andhra State Legislature’s ordinance banning weekly collections of interest. Pranab Mukherjee, India’s Minister of Finance, also spoke out against the Andhra Pradesh law. He stated that the Reserve Bank of India had been asked to look at the problem and report.

Bangladeshi crisis

Amidst this bad and negative publicity for the microfinance sector in India, in neighbouring Bangladesh, the home of the Grameen Bank and its founder Nobel Laureate Mohammed Yunus, another crisis erupted.

Firstly a Norwegian news paper reported that some NORAD aid funds, meant for the Grameen Bank, had been diverted to another for profit Grameen affiliate without the donor’s consent and in violation of the terms of the grant, and that after the issue was raised by NORAD with Grameen, the funds had been retransferred to Grameen Bank, for which it was originally intended. NORAD said the issue was satisfactorily settled as far as they were concerned.

Prof. Yunus was not popular among Bangladesh’s politicians, for two reasons. Firstly, microfinance, which he had started in Bangladesh, empowered the poor and marginalised and constrained the power of patronage of the politicians, as in Andhra Pradesh, India.

The second factor was during the time the Bangladesh Army took over ruling the country, due to the corruption and chaos inflicted on that nation by the two Begums, who led the two main rival political parties, the widows of two Presidents who had been assassinated in Bangladesh turbulent political history.

Prof. Yunus made the fundamental error of trying to start a political party to take on the two Begums, probably at the instigation of the Army generals. He soon realised his folly and gave up the high risk venture. But the Begums did not forget nor forgive, and as soon as the Norwegian story broke, they publicly attacked the microfinance sector, in general, calling them all sorts of rude epithets, obliquely attacking Yunus’ credibility, in particular.

A Commission of inquiry into Grameen in particular and the microfinance sector in general was also announced. The news flashed around the world and the credibility of the microfinance sector was eroded worldwide.

MIT study

At about the same time the Massachusetts Institute of Technology (MIT) announced the results of a research study of micro lenders in the slums of Hyderabad, capital of Andhra Pradesh, that was able to establish that poor women who had accessed micro loans had not been able to improve their lives in the context of three important poverty indicators – women’s empowerment, expenditure on health and education.

The study was viewed as important because it was the first major randomised, controlled and peer reviewed study on the impact on micro loans on poverty in the three decade history of microfinance in India. The study surveyed 7,000 households in 104 slums, half of whom had accessed micro loans and half who had not.

Randomised and controlled trials are seen as the most accurate method of impact testing, because they eliminate the problem of selection bias in determining the sample to be interviewed.

Prathap Kasina, a Research Manager for MIT, declared: “It is incredible that billions of dollars are going into programmes for which such studies have not been conducted. People assumed that micro credit was the silver bullet and started working with it, without any obvious proof.”

Microfinance under pressure

Microfinance was under pressure, Alok Prasad the CEO of India’s microfinance association MFIN, was constrained to admit to the BBC’s Newsnight programme that he does not know what proportion of India’s 30 million micro borrowers have benefited from loans: “We are talking about an industry that has grown very rapidly in the last five years, an industry of about 30 to 35 million clients, assessing how many have actually benefited calls for a great deal of research on the ground over a certain period, I must confess, that’s not something which has really happened.”

Asked about Yunus’ statement that micro credit could put poverty in the museum, Prasad conceded: “There may have been a bit of hyperbole there.”

The international community has reacted with alarm at this assault on microfinance in general and Prof. Yunus in particular, in Bangladesh. The organisers of the international Microcredit Summit issued a statement that the situation in Andhra Pradesh required more scientific analysis before final conclusions should be made and advised caution in using the unfortunate situation there to denigrate the whole sector worldwide.

They quoted statistics from CGAP, a World Bank affiliate which does research on microfinance, that more US$ 21 billion has been internationally invested in microfinance. This excludes funds generated within a nation state, 69% of those internationally committed funds were committed by public donors and investors.

In Paris at the head office of ADIE, a French Grameen spin off, a group has taken the initiative to form ‘Friends of Grameen’ to support the independence of the Grameen Bank and its founder Prof. Yunus, as they had been the target of an ongoing pressure campaign of rumours and misleading information. The Chairperson of Friends of Grameen is Mary Robinson, former President of Ireland and former UN High Commissioner for Human Rights.

The other members reads like a who’s who of the international community – Jagdish Sharan Verma, former Chief Justice of India and former Chair of the National Human Rights Commission; James D. Wolfensohn, former President of the World Bank; William Drayton, founder and Chairman of Ashoka Innovators for the Public; Dr. Kamal Hossain, senior Lawyer from Bangladesh; and Maria Nowak, President of ADIE.

Nowak says: “Our organisation will get to work quickly, as the world looks at Bangladesh as a pioneer and role model in the field of microcredit. The priority of Friends of Grameen will be to continue to advocate that Grameen Bank should remain an absolutely autonomous entity, owned by borrowers, and should continue to benefit from the guidance of its founder with friendly political and legal support of the government, as a significant stakeholder.”

Empowering poor women

It is well and good for first world researchers to set up indicators and evaluate programmes in under developed societies, with all due respect to MIT and its study, any experienced worker in the microfinance field in a developing country knows that the empowerment created among poor women by the control of financial resources which they never had before the micro loan scheme came into being is an intangible which cannot be captured by any indicator.

And certainly in Sri Lanka there is incontrovertible proof that any surplus a mother has in her hand at any given time is inevitably invested in child nutrition, education of her children and the improvement of housing stock. Even a short visit to the Janashakthi Banku Sangam of the Women’s Development Federation at Hambantota, or even a visit to any other Sri Lankan MFI, for that matter, will convince the worst sceptic of this fact.

Reports are that the reserve bank of India’s Malegam Committee may recommend an interest rate cap, which will be fixed at a reasonable rate, and bringing microfinance institutions under the regulation of the RBI. Microfinance institutions will be required to disclose the calculations of their cost of operations including the difference between what they spend on mobilising money and their income from lending that money.

The committee’s recommendations are expected to be based on the Basel committee report that issues supervisory guidance for the application of the Basel Core Principles for Effective Banking Supervision to microfinance activities.

Irony

The irony of all this is that subsequent research in Andhra Pradesh has proved that the farmers who committed suicide were unfortunate people who had taken multiple loans from money lenders in addition to the financing some of them had borrowed from microfinance institutions.

Ignorance combined with the fact that only small amounts of money were available from microfinance institutions had led the farmers to over-borrowing from money lenders, which led to them being unable to repay on time.

India has no way of monitoring over borrowing, there being no national identity scheme, unlike in Sri Lanka. Only now is the Adhaar scheme to give every Indian a unique identity number and a smart photo identity card with data on computer servers retrievable 24/7 online being introduced by the Unique Identity Authority of India.

In Sri Lanka a draft law on microfinance and setting up a supervisory regime is on the Central Bank web site. The Lanka Microfinance Practitioners Association has had discussion with Central Bank and Treasury officials and requested certain amendments. The bazaar talk is that the bill will be presented to Parliament after the local government authority elections. But now that those elections have been staggered, it may take more time.

Sri Lanka’s microfinance history

Sri Lanka has a very long history of microfinance. Even before the business sector was branded as microfinance, we had Death Aid Societies (Marana Adhara Samithi) similar to the Burial Societies found in South Africa, Tanzania and Ethiopia, and Cheetu schemes, Rotating Savings and Credit Societies (a group of people who voluntarily pool a specified amount of money weekly and once a month, one participant gets the whole amount, in sequence) operating in our villages, which were essentially savings and credit schemes and all about responsible and accountable money management. There is even a Cheetu Ordinance No. 3 of 1935, which provides for the regulation and control of cheetus.

Death Aid Societies came about due to the poor and marginalised becoming impoverished due to the high cost of funeral arrangement and related religious and social obligations and activities, and a tradition of setting up self help organisations to collect subscriptions from members and assisting financially and in other ways in the event of a death of a relative of a member. Some Death Aid Societies today have evolved into very successful microfinance institutions.

The first thrift and credit cooperative society was initiated in 1905 at Menikhinna near Kandy. It is on this rich and successful tradition that institutions like, the cooperative rural banks, Sarvodaya SEEDS, the National Youth Savings and Credit Cooperative (NYSCO), Sanasa and the other microfinance institutions supported by the Janasaviya Trust Fund (JTF) – (now known as National Development Trust or NDTF and amalgamated, it is reported, with the Sri Lanka Savings Bank), like the Arthacharya Foundation, the Janashakthi Banku Sangamaya of the Women’s Development Federation of Hambantota, Sewa Lanka Finance, Sareeram and hundreds of others  and the recent Samurdhi Banku Sangamaya have developed.

Farmer suicides in Sri Lanka

Farmer suicides in Sri Lanka in the past have been due to crop failure and inability to repay loans taken for agricultural activities. Not due to over-borrowing. Our social indicators, including literacy rates plus the long tradition in microfinance and the social stigma on being a serial debtor, in our society, the Buddhist and Hindu ethic of living within your means, the Islamic stricture against usury, the Christian principle of ‘never a lender or borrower be’ have been a deterrent to taking the risk of borrowing more than ones assets will reasonably permit. There is no evidence of systemic over-borrowing among micro borrowers in Sri Lanka.

But with the recent floods in the rice bowl in the North Central and Eastern Provinces, which have caused widespread destruction, unless some countermeasures are taken, farmers may be driven to desperate steps due to inability to meet debt obligations for cultivation loans. Every Sri Lankan has a unique identity number, as an antidote to the danger of over borrowing a data base of microfinance borrowers can easily be built up and referred to before disbursement.

At a time when legislation to regulate microfinance in Sri Lanka is being contemplated, it will be advisable to take such pre-emptive steps before the worldwide attack on microfinance brought about by the unfortunate events in the rest of South Asia reaches our shores, which is inevitable in this globalised, wired and connected up world we live in.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government 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.)