At a time when we in Sri Lanka are considering the passage of new legislation to regulate Microfinance (MF), it would be an appropriate time to consider recent events in Andhra Pradesh in India.
It should be noted that a conservative estimate is that MF institutions in Sri Lanka are estimated to have over 300,000 clients and serve 1.5 million people, i.e. approximately 7.5% of the population.
There has been an unprecedented crackdown on micro lenders in Andhra, based on an ill-judged decision that a spate of suicides by poor farmers in the State was caused by harassment of borrowers by recovery agents of micro lenders operating in the State.
In typical South Asian political fashion, the State politicians, instead of dealing directly with the problem, enacted an emergency order to suspend all debt collections forthwith!
Reddy Subramaniam, Andhra Pradesh’s Principal Secretary, stated that “the State Government is not against the microfinance industry, what the State Government has objected to is the way microfinance is being practiced to achieve hyper profits.”
As a result commercial bank credit to micro lenders immediately ceased. Borrowers soon stopped making repayments, anticipating loan waivers based on political patronage, putting the whole MF system in jeopardy. MF is huge in India, with an estimated 30 million borrowers and a loan portfolio of $6.5 billion.
Indian Government’s reaction
The Government of India’s reaction was immediate; Pranab Mukherjee, the Minister of Finance wrote to the Chief Minister of Andhra Pradesh recommending ‘corrections’ to the emergency order, which caused the crisis.
He stated that there were no plans to introduce a separate regulator for the MF industry, as he believed the Reserve Bank of India was sufficiently vigilant. This is interesting since Bangladesh has recently created a separate regulator while Sri Lanka is in the throes of drafting legislation for the purpose. The Andhra Pradesh MFIs sought judicial redress and obtained a court order allowing them to resume collecting repayments.
At inception, MF was exclusively a not-for-profit venture, supported by donor funds. However, very high repayment rates, together with the fact that for-profit banks and financial houses were not working with the poor and marginalised, left a wide gap in the market. This fuelled a humongous demand for micro lending which resulted in the need to access capital far in excess of what donors could provide at subsidised rates. This resulted in resort to commercial capital, to meet the hugely expanding demand.
The special, positive and unique factors characterising microfinance, joint and several group liability, the close contact the MF institution had with the community and the intimate knowledge they had of individual borrowing families led to a boom in the pull factor, which in turn led to increasing reliance on commercial capital. Recently SKS Microfinance based in Hyderabad raised $ 350 million in an Initial Public Offering.
Due to the successes in poverty alleviation attributed to MF in poverty alleviation and empowerment, governments also got involved; for example in India the MF sector has been designated as a priority sector by the Reserve Bank of India to which commercial banks must devote 40% of their lending.
Another example is the State setting up its own MFIs such Sri Lanka’s Samurdhi and Gemidiriya, to compete with non-governmental and commercial MF actors. The classic problem, endemic to South Asia, is that all borrowers from State-connected agencies live in eternal hope of loan waivers, based on past experience!
Leasing companies and finance companies have also set up MF schemes, which critics say are mostly small individual loans being made against collateral and far different from the traditional MF practice of joint and several liability and collateral free lending, etc.
The attraction has been high repayment rates. The poor and the marginalised, unlike other segments in society, repay – since they need to keep borrowing to climb out of poverty. MF was conceived as a methodology to save the poor from loan sharks and usurious money lenders, by donor-funded charities.
The advent of for-profit MFIs , as against the traditional not-for-profit institutions which were predominant, has resulted in allegations that MF is being practiced to gain what Andhra’s politicians have called ‘hyper profits’.
This coincides neatly with the so-called ‘socialist’ ideology, now fast disappearing even from locations such as Cuba, North Korea and Venezuela, that ‘profit’ is a bad word! MF was never cheap, the issue was always equitable access to credit, not interest rates per se. Even non-profit MFIs charged interest rates of 30% or more to cover costs of mobilisation of funds and outreach to marginalised groups, including women.
Opportunity to attack
For a long time, Indian politicians, bureaucrats and other elite supporters of the hierarchical caste-driven status quo, who hark back nostalgically to the days of India’s closed economy and the much-ridiculed 4% Hindu rate of growth – where the poor and marginalised Dalits and Tribals were destined to remain at the bottom of the Indian economic pyramid, where they had been for near 3,000 years – were waiting for an opportunity to attack and destroy the empowerment of the poor and marginalised brought about by MF, which was a threat to their continued domination of Indian society.
The suicides caused in Andhra due to over-borrowing by farmers mainly from commercial banks, money lenders and government programmes, gave them an opportunity to strike at the MFIs; the high-profile, much-publicised and successful securitisation IPO of SKS Microfinance and the claim of ‘hyper profits’ gave them both the ammunition and the trigger.
The need for more and more funds to meet the increasing demand for MF and the potential for profitability due to high repayment rates, resulted in many Indian MFI’s turning into for-profit companies and raising more than $500 million in private equity from foreign venture capitalists, specialised MF funds and high net worth investors.
The Reserve Bank of India’s priority ending requirement led to a flood of funds into the sector, estimated at around $ 6 billion in credit. All safeguards put in place by the not-for-profit MFIs, such as know your borrower and his/her family capacity to repay, source of income, viability of the venture to be undertaken with borrowed money, etc., were sometimes overlooked in the rush to disburse and recover.
Over borrowing, where a poor and marginalised family would borrow from government agencies, (as indicated above, there is a feeling in South Asia, based on past experience, that government loans will inevitably be waived) MFIs, commercial banks, money lenders, cooperatives and a number of other micro lenders led to very high over-borrowing and indebtedness, resulting in inability to repay all the loans. The lack of a unique identification number for every Indian made it impossible for lenders to check the level of borrowing and indebtedness of micro borrowers.
Sri Lankan advantage
Here, we in Sri Lanka have an advantage; every Sri Lankan has a unique identity number in the National Identity Card (NIC) and building a database of micro borrowers is not too difficult; the technology and infrastructure is in place. It only requires implementation.
In fact, this can be done by the MFIs themselves and there may be a role for the Lanka Microfinance Practitioners Association here.
In India the Micro-Finance Institutions Network has adopted a Code of Conduct requiring transparent interest rates, a limit of three companies lending to a client and the prohibition of ‘abusive, violent or unethical’ collection methods. The network is also pooling members’ client records to better assess borrowers.
With Sri Lanka’s unique NIC number, to build a database of micro borrowers to track over-borrowing is relatively simple. In India, the Unique Identity Authority of India, headed by Nandan Nilekani, formerly of software giant Infosys, is just putting the ‘Adhara’ system, of giving every Indian a unique identity number, into place. Sri Lanka is very far ahead in this aspect. But we have not used the available infrastructure, as in so many other areas, to build an online accessible database of borrowers!
Building a database
Sri Lanka is proposing new legislation on a Regulatory Authority for MF; the authority’s first task should be to be building a database of micro borrowers, accessible to micro lenders to avoid the Indian tragedy of over-borrowing and the resultant suicides and other distress and the resultant characteristic reaction by populist politicians, looking for a scapegoat, which causes a crisis in the whole microfinance industry across the board, as in Andhra Pradesh.
It recently transpired at a discussion organised by the LMFPA and GTZ Promis that reportedly, the National Development Trust Fund, the successor to the Janasaviya Trust Fund, had an online database of the NIC numbers of all its credit partner organisations’ clients. If this is available, operational and updated, it would be a huge advantage towards building a database of MF borrowers.
On this aspect of over-borrowing, another factor which will assist Sri Lanka MFIs would be, to research and prepare a profile of indebtedness of a given community. This profile would be based on criteria such as the number of MFIs, commercial banks, leasing companies, finance companies, cooperative rural banks, thrift and credit cooperatives, money lenders and Samurdhi Banku Sangams operating in the locality. All these institutions have to register under some existing law and the information is in the public domain.
Sustainability of the economic base of the locality: Is it primary industry-based, such as agriculture or fishery, which would be susceptible to seasonal or sudden shocks, or migrant remittances, which are more sustainable, or plantation or manufacturing, garment and other factories, etc?
Also, how many families are on Government welfare programs, such as Samurdhi? How many families are on Internally Displaced Peoples allowances? This would allow an MFI to assess the level of risk and the potential for multiple debt liability being a hazard, on the basis of the debt profile of the community, before deciding whether to operate in that community.
Politically immature and kneejerk reactions, such as legal restrictions on debt collection, as in Andhra Pradesh, are anti-poor, shotgun responses, which will have negative influences on the long-term effectiveness of the microfinance industry, which has a proven and well-established track record of pulling millions of poor and marginalised people out of poverty in the context of an open and free market economy.
(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.)