Responsible microfinance

In the context of the crisis faced by the MFIs in Andhra Pradesh, a new concept of ‘Responsible Microfinance’ has emerged from among the pundits who work on the sector.

This is supposed to mean: ‘Financial activities by institutions that make just about enough returns to stay in business and charge rates of interest on loans to the poor that are only marginally higher than what the commercial banks charge their prime customers.’

Benign neglect

Microfinance was meant to solve the problem of financial exclusion, which it has done to a great degree, in countries which has allowed micro lenders to operate, not only in a supportive regulatory environment, but also in countries like Sri Lanka where the regulatory environment can be described at best, up to now, to be one of mere ‘benign neglect’.

While nothing positive was done for the sector, nothing was done which would have a negative effect on the sector in a major way, except the occasional politically-driven loan waivers for micro borrowers from State banks and Government controlled cooperatives, which ruined a carefully-developed loan culture, which had been developed over the years by MFIs with their clients.

Recently in Sri Lanka there has been a draft regulatory legal framework for the MFI industry published and there has been much discussion by stakeholders, who have in general welcomed the legal recognition given to the sector by the draft law, but also made public some serious misgivings they have on certain provisions and been engaged with the framers on changes which need to be made.

On this there has been no finality, although there has been a statement from a representative of a commercial bank that works in the sector that the legislation will be taken up by Parliament in the first quarter of 2011.

Importance of the sector

The importance the sector is given today in Sri Lanka by investors can be measured from the fact that a foreign investor raised the matter very early in the seminar on the 2011 Budget organised by the Daily FT to celebrate its first anniversary, before a packed house, on 23 November, on the issue of access to credit to small farmers.

The response of the Secretary to the Treasury, as reported in the news papers, was to the effect that ‘while accepting that the microfinance sector might need some assistance, there was no great need of changing the regulations pertaining to collateral for micro borrowers.’

The non commercial bank and finance company MFIs in Sri Lanka are estimated to have approximately 300,000 clients covering 1.5 million persons, that is around 7.5% of the population mainly among the poor and marginalised. In India, the number is estimated to be 30 million.

The sector is of vital importance as an alleviator of poverty and assisting the poor and marginalised, especially women, to climb out of poverty. The rumour that the main provider of whole sale subsidised credit to these MFIs, the successor to the Janasaviya Trust Fund (JTF), the National Development Trust Fund (NDTF), is to be closed down and its activities and funds handed over to the Sri Lankan Savings Bank, which has been circulating for some time, has been of destabilising effect on the sector.

This has not happened yet, although the rhetoric has been there, and this on top of the cap placed by the NDTF on lending interest rates by partner MFIs has caused confusion and doubts in the sector.

Clarity is required quickly and decisively to stabilise the sector and its sustainability as a vital alleviator of poverty in Sri Lanka today. Microfinance has a long history in Sri Lanka, going back to the Seetu scheme, the Death Aid Societies and the savings and credit cooperative movement.

The way forward

In India, the success of the Grameen Bank, BRAC and other MFIs in Bangladesh convinced policy makers that microfinance was the way forward for the liberation of India’s poor and marginalised from the curse of financial exclusion which was trapping them in poverty.

The MFIs have around 30 million clients in each country. Consequently MFIs mushroomed all over India and poor households accessed loans they had never been able to get from anyone except the local money lender and pawn broker at usurious rates, at much lesser rates of interest.

But the interest rates were higher than what the mainstream commercial banks and financial institutions charged their clients, since the cost of money, the risk, the close monitoring and supervision required all had to be recovered from what was charged as interest on the loan.

Interest rates of 20-30% may seem high when compared to commercial bank lending to rates to their prime customers, but not as high as the money lenders’ exploitative rates. Microfinance institutions working with committed NGOs were able to reach a large group of hitherto-excluded households and promote their integration into India’s mainstream economy.

When the MFIs were facing problems of accessing adequate capital, the Reserve Bank of India compelled the formal financial sector to provide 20% of their lending to the sector, deeming the microfinance sector a ‘a priority sector’. Funds flowed freely to the microfinance sector. Markets develop where profits can be made.

Currently there is US$ 6 billion outstanding in loans to MFIs from the formal financial sector. Searching for profitable lending to marginalised communities, who have no other access to finance except from the usurious informal financial sector, is what the money lenders and pawn brokers did and that is what the MFIs do.

No one can run at a loss. The issue is, what is the margin of profit? For the money lender, it is usurious and exploitative; for the MFI it should be ‘responsible,’ to cover the MFI’s costs of generating capital, of operations, recovery and a provision for risk from bad loans.

Anti-poverty tool

Microfinance has been described as an anti-poverty tool that has to at least break-even; it has to recover costs of operations at least. The position has been well articulated by Vikram Akula, founder of India’s largest microfinance company SKS Finance. He has called for enlightened regulation for the sector to weed out rogue actors without pushing other actors who practice responsible microfinance to collapse.

Akula said: “Do not destroy an entire industry because of the actions of a few rouge players,” speaking at the India Economic Summit organised by the World Economic Forum, a few weeks ago in New Delhi. “There is a right way to do microfinance, and a majority do practice ethical lending and have been doing so for decades.” Like any other sector “occasionally you get rogue players and errant practices”.

SKS has faced the wrath of politicians in Andhra due to the politicians losing the control over the poor and the marginalised by their patronage networks being undermined by the financial empowerment of the poor through access to micro loans.

Bullied to a halt

Of the 57 suicides in Andhra for which the politicians blame SKS and MFIs, only 17 were actually SKS borrowers and none of them were in default. Arrests of field workers and legislative curbs of weekly debt collections compelled the 6,000 field workers of SKS to remain idle.

Local politicians have bullied the MF business to a virtual halt in Andhra.

Sam Daley Harris, Director of the Microcredit Summit Campaign has chimed in: “Microfinance in India, or at least in Andhra Pradesh, is in the midst of a near death experience.”

C. Ranga Rajan, a former head of the RBI and currently Chairman of the Prime Minister Economic Advisory Council in India, has publicly rebuked the MF sector, saying that they should “rectify their mistakes and change their business model”.

The crisis has resulted in MF Institutions Network, a group of 44 for-profit MFIs in India asking their formal financial sector lenders for US$ 222 million in emergency funds as a ‘business continuity loan,’ as repayments have plummeted.

In Andhra Pradesh alone, there is US$ 2.7 billion in outstanding loans to MFIs from 6.7 million borrowers. Akula attributes the main reason for this being the ban on weekly collection of repayments by MFIs imposed by the Andhra legislature in a blatantly populist move.

The poor cannot collect and keep their money safe for four weeks, and if they have cash there are other needs on which they are tempted or compelled to spend the money. Therefore, they default in loan repayments. Pranab Mukherjee, India’s Minister of Finance, has said that he would formulate new rules to govern the MF industry once he receives a report from the Reserve Bank of India.

Private investors

The fact is that moving from non profit to commercial or a for-profit model has allowed the MF industry to grow and serve more people. By attracting private investors’ capital to the field, MFIs can achieve scale and have a much greater impact.

But this growth in India has come with some problems. The involvement of private investors means that managers of MFIs need to learn how to balance social goals and serving the poor with financial goals through attracting private investors.

The MFI sector is diverse, in the beginning there were only the pawn brokers and the money lenders to compete with. But today there are a plethora of institutions; some NGO, some commercial, some State-owned.

In India, the mostly-illiterate marginalised poor are probably overwhelmed by the money, choices and options on offer. In Sri Lanka, having a more educated and literate population, the possibility in exploitation by rogue actors in the MF sectors, including money lenders and pawn brokers who have reinvented themselves as MFIs, is less. That is why over-borrowing is not yet an issue in this country.

Promoting responsible microfinance

How can ‘Responsible Microfinance’ be promoted? The Centre for Financial Inclusion has developed some guidelines:

Avoidance of over-indebtedness: Providers should take reasonable steps to ensure that credit will be extended only if borrowers have demonstrated an adequate ability to repay loans.

Transparent and responsible pricing: The pricing terms and conditions of financial products will be transparent and will be adequately disclosed in a form understandable to borrowers. Responsible pricing means that prices, terms and conditions are set in way that is both affordable to clients and sustainable for financial institutions.

Appropriate collection practices: Debt collection practices will not be abusive or coercive.

Ethical staff behaviour: Staff of MFIs will comply with high ethical standards in their interaction with clients and ensure that adequate safeguards are in place to detect and correct corruption or mistreatment of clients.

Mechanisms for redress of grievances: MFIs will have in place timely and responsive mechanisms for complaints and problem resolution for their clients.

Privacy of client data: Privacy of individual client data will be respected and the law in this respect will be adhered to; such data will not be used for other purposes without the express permission of the client.

Considering the India experience with over borrowing and its consequences on the MF industry, we in Sri Lanka, who are on the threshold of introducing a new regulatory regime for the sector, would do well to include provisions for ‘Responsible Microfinance’ as a part of the regulatory package.

Over borrowing

Mary Ellen Iskendarian of Women’s World Banking, an International MFI collective, says that the pressing problem in India is over-indebtedness or over borrowing. Big Indian MFIs are now sharing information, pledging not to lend to a person who has already borrowed from three other MFIs and to keep total lending to a limit.

One point of over borrowing is that since MF loans are usually small, micro borrowers may have to access several MFIs to collect enough capital for an investment.

The Centre for Microfinance in India released a survey recently of 2,000 households in Andhra, which showed that 82% of the households had borrowed from informal sources and only 11% have borrowed from MFIs.

Only 3% who borrow from MFIs have more than one MFI loan, in contrast to 70% of borrowers from informal sources (money lenders, pawn brokers and relatives). On average the micro borrowers owe four times as much to informal lenders than to MFIs.

Today Indian is moving, or rather being driven, by the events in Andhra towards ‘Responsible Microfinance’.

The Economist Intelligence Unit has ranked Peru as one of the countries which has the best business environment for MF, partly because the regulator there has successfully set and enforced rules on capital buffers leading to a more stable environment for the industry.

Computerised database

Every one of us in Sri Lanka has a unique number, the National Identity Card. Building a computerised database of MF borrowers based on this, with online real time access, so that MF lenders can check on the credit status of an applicant, similar to the commercial banks’ Credit Information Bureau (CRIB), is not too complicated.

The information base and the technology are available; the Information & Communication Technology Authority (ICTA), which operates under the Presidential Secretariat, of which the Secretary to the President is the Chairman, has the capacity.

In fact it was reported that the National Development Trust Fund, the successor to the Janasaviya Trust Fund, a wholesaler of credit to MFIs, since 1989, already has a data base of its partners and borrowers available.

Building on this to create a base of data to cover all MFIs and to avoid over borrowing is not rocket science and is fairly uncomplicated. It should be done soon, if Sri Lanka is to avoid replicating the crisis in India. In fact an association of MFIs in India is also trying to set up a credit bureau.

(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.)