Microfinance has shot into the limelight of late, for entirely wrong reasons. In a country where only about 40% of the population has access to banks, micro finance institutions (MFIs), over the last decade and a half, have provided a lifeline to about 30 million households that are otherwise outside the banking system. Commercial banks, as they are structured today, are unable to service the requirements of micro credit to those who have no collateral.
MFIs have brought banking to the doorstep of the borrower, whereas commercial banks typically expect the borrower to come to their doorstep. Because of the activities of some MFIs, there is an attempt to strangle the entire sector. Onerous conditions are sought to be placed on their functioning. An impression is being created that rates of interest at which they lend should be capped as MFIs are earning profits of a high magnitude.
A letter from the government to the public sector banks to discourage those MFIs that lend at beyond say 22-24%, threatened to choke funding. While many banks understood the numbers to be interest rate caps, the government clarified that the numbers were illustrative and not mandatory. The government?s example did not take into account the intrinsic differences amongst MFIs in terms of their age, their size and their area of operation. A new MFI, even if professionally and competently managed, will be unable to lend at 24%. This is so as they borrow from banks and other financing institutions at 15-16%. Operational costs of such MFIs are about 10%. Allowing 2% for non-performing loans, around 2% for return on assets, means that the minimum that they need to charge to stay alive is 29-30%. The government?s concern is obviously motivated by the perception that MFIs are making money hand over fist at the cost of poor loanees. While some may be, the majority are not.
The fact of the matter is that according to the State Sector Report 2009, out of about 230 MFIs that reported information, about one-third are making losses. Only about half of the smaller MFIs are profitable. If at all, the government is agitated about MFIs making supernormal profits, the right approach would be to control the spread (margin over cost of funds) rather than the rate at which an MFI lends. Incidentally, some companies in the financial sector (stock exchanges) have gross margins of 75% because of a lack of competition. But we haven?t heard anyone from government complaining!
A global comparison shows that on average, return on assets of Indian MFIs was 0.7%?considerably less than Brazil?s 6.4%, Mexico?s 3% and Indonesia?s 3.1%. So while some larger, older MFIs in India are perhaps enjoying substantial profits, most of the others are not. Formulating public policies on the basis of a few outliers is fraught with a number of unintended consequences.
The most extreme consequence will be that MFIs will vacate the credit space that will gratefully be reoccupied by the local moneylenders with all their associated ills. Another possibility is that MFIs will perforce have to borrow at a higher rate of interest from unconventional sources and therefore their lending rates would go up rather than come down. A third consequence will be that only the very large MFIs will survive.
Such attempts revive the age-old conundrum: Is the price of credit more important than its availability? Should competition not be allowed to take care of pricing?
Take the case of a constable in Hyderabad who lends Rs 100 every morning to a push cart vegetable seller and is paid Rs 110 every evening by the vegetable seller. The annual simple rate of interest in this case works out to a whopping 3,650%. On the face of it, such an interest can raise the hackles of everybody. However, if the vegetable seller is able to earn Rs 250 with the amount borrowed, then parting with Rs 10 by way of interest does not bother him at all. On the contrary, in the absence of the loan from the constable, he would not have been able to earn anything at all. Should the government step in and stop this practice without finding an alternative source from which the vegetable seller can raise funds?
The Ordinance governing the activities of MFIs in Andhra Pradesh should be viewed in this context. While the Ordinance has no doubt been promulgated for the public good, whether it will do more harm than good is debatable. Amongst other requirements, MFIs are prohibited by the Ordinance from disbursing or recovering loans at the doorstep of the borrowers. They cannot collect loan repayments on a weekly basis. The loan recovery can only be at the local gram panchayat office, not more frequently than once a month.
These conditions strike at the basic model of MFIs. Unlike banks who wait for the customers, MFIs go to the customers and provide banking services in the vicinity. By forcing them to move away, much of the raison d?etre for the existence of MFIs will be defeated. While no one would recommend strong-arm methods of recovery, forcing recoveries to be made only after a minimum of a month attacks the very revenue model of these institutions?a model that has contributed to a less than 2% non-performing loans.
Andhra Pradesh has been at the forefront of micro finance. Out of the approximately Rs 30,000 cr of bank outstandings to MFIs in the country, nearly one-third are in Andhra. Reports indicate that the average borrowings per household from MFIs in the state was eight times the national average. Clearly, multiple lending and ever-greening of loans was rampant. So, some checks and controls were obviously necessary. But whether the Ordinance will help to control the activities of MFIs or eliminate them altogether should be a matter of public concern. Let?s hope the Ordinance is not a case of throwing out the baby with the bathwater along with the bathtub.
The author is chairman, MCX stock exchange
