The financial sector crisis in Andhra Pradesh seems to be playing out like a very bad dream that doesn’t end. It has been 33 days since the State Government of Andhra Pradesh passed a sweeping Ordinance governing all lending activities in the state by banks as well as non-bank finance companies (with only perhaps State Bank of India excluded from its ambit since it is not constituted as a company under the Companies Act but through its own Act) with stipulations that no collateral may be taken, repayments must be monthly, nobody must have more than one loan outstanding, all financial services business must be carried out in government offices and the permission of government agencies must be taken before any loans can be taken. Quite aside from the number of fundamental rights of its own citizens that the Ordinance infringes upon, it directly challenges the competence and the capacity of the Reserve Bank of India (RBI) to govern the financial system in the state since both sets of entities are directly regulated by it and given their systemic importance have been subjected to several rounds of supervisory audits over a number of years.
Not surprisingly, this political event has led to large scale defaults taking place inside the State and as on date, most banks and non-banks are in violation of the provisions of the Ordinance in one way or another, making their directors (including independent directors) liable for imprisonment. What is very surprising though is the complete absence of any public statement either from the Central Government or from the Reserve Bank of India. The last time something similar happened in Andhra Pradesh was in 2006 in Krishna district and both the RBI and the Central Government acted swiftly and brought an end to the crisis and did not allow it to spread beyond one district. This time around over a month has passed without any word from both these entities and there is a fear that, emboldened by this tacit encouragement, other State Governments will follow suit. Since this is a very real possibility, all banks and capital market participants have immediately stopped extending any funding to non-bank finance companies on a nationwide basis. In particular, focus has been on those RBI regulated non-bank finance companies whose businesses have enjoyed a priority sector tag on account of the criticality of their operations for the wellbeing of weaker sections of society.
This complete withdrawal of liquidity combined with the loss of capital that is sure to follow from all these defaults points to a likely collapse, on a nationwide basis, of financial services infrastructure that serves 2 crore low-income households with significant NPA implications for the banking system. Ironically, we may be one of the few countries in the world to have escaped the contagion effects of the 2008 global financial crisis on account of a robust economy but we will very likely be the first country in world where a crisis was created directly by the actions of a state government that ought to have acted in the role of a protector.
While there are many aspects of the situation that need to be addressed, we would like to comment on three key aspects that seem particularly salient to us:
1. The dangerous rhetoric that microfinance is unregulated and has hence, run amok.
In the past few weeks, we have heard several proposals for regulation of the microfinance sector. This impression has gained currency principally because Reserve Bank of India has chosen not to publicly reaffirm the fact that 80% of the microfinance sector is directly regulated by them. In fact all Non Bank Finance Companies (NBFCs) are regulated by the Reserve Bank of India, and the systemically important ones with an asset size over Rs. 100 crore are subject to stringent financial standards, monthly reporting requirements as well as a Fair Practices Code (See: RBI Circular No. DNBS (PD) CC No.185 / 03.10.042 / 2010-11 dated July 1, 2010) that specifically prohibits NBFCs from resorting to “undue harassment” for recovery of loans. The Fair Practices Code for NBFCs also makes it clear that the Board of each NBFC is free to “adopt an interest rate model taking into account relevant factors such as cost of funds, margin and risk premium and determine the rate of interest to be charged for loans and advances.
The RBI has made it mandatory for NBFCs to disclose explicitly in the application form for loan and other relevant documents, the rate of interest and the approach for gradations of risk and rationale for charging different rate of interest to different categories of borrowers. All of these regulations govern NBFCs that lend to rich as well as those that lend to the poor (popularly referred to as MFIs). If there is a need for more regulation on any aspect of MFI operations, including customer protection, by all means the RBI must take it forward but it is important to note that the sector is already very tightly regulated.
2. The root of the repayment crisis in AP is not large-scale wilful defaults by customers but orchestrated action by the state government to shut down collections.
In all this talk about ‘crisis’, let us not forget that collection rates were in the high nineties prior to the State Government of Andhra Pradesh stepping in with its Ordinance and directly causing this crisis. It must also be noted that outside of Andhra Pradesh, MFI collections continue to be high. Comparisons to the US sub-prime are ridiculous because in this case, the customer has forcibly been prevented from repaying the lender and actively exhorted to do. Government cited a few anecdotal, impossible-to-verify-or-attribute events as the basis of such a massive intervention.
3. The Ordinance itself over-steps the right of the legislature, impinges on the fundamental right of citizens.
The most glaring aspect of the Ordinance is that it completely takes away the rights of the poor to decide for themselves – since it seems to specifically target “low income households” for these restrictions – presumably leaving all of those of us that hold multiple credit cards and home loans untouched, at least for the time being.
For example, it prohibits all those that are registered with State Government managed Society for the Elimination of Rural Poverty (SERP), which includes more than 50% of all women in the State, from taking more than one loan at a time. Research shows that people usually take multiple loans because one loan is not able to meet all their requirements. Just to illustrate, a woman needs at least Rs. 8,000 to buy a buffalo whereas an average SHG loan is only Rs 4,000. If all the other formal lenders are now barred from serving her, she will necessarily have to turn to informal sources. The Ordinance will serve to further the outreach of traditional moneylenders in this manner and perhaps that is its true intent. The fact that women were the main beneficiaries of these programmes makes the situation even more poignant because they are the ones who will bear most of the burden of these failures and despite that, given their powerlessness within the community, their voices of protest are not being heard.
The Ordinance requires all borrowers to repay all their loans only on a monthly cycle and to continue to pay interest on the loan for a longer period of time. Do the authors of the Ordinance think that these women have monthly salaries? Most of them have daily or weekly income from labour or small trade. Weekly repayments that take place at her door-steps are usually easier for her, because they match the wage frequency of most of them. Monthly repayment requires women, who usually do not have access to a safe place to save, to put sums aside and wait to repay till the end of the month hoping that money does not get stolen in the interim and to pay an additional amount of interest on the loan not having earned anything on the savings.
110 Responses
We had warned that it would be a free fall:
Micro-Finance to Face Slow Painful Death. SKS Share to enter Free Fall. Sell, Sell, Sell! 7/11/10
Read more: http://devconsultgroup.blogspot.com/2010/11/micro-finance-to-face-slow-painful.html
SKS Micro-Finance drifting into a firm Bear Grip 14/11/10
Read more: http://devconsultgroup.blogspot.com/2010/11/sks-micro-finance-drifting-into-firm.html
Mr. Alexander: I hope you acted on your prediction and made money.
This is really insightful discussion. I believe the public policy and Ordinance are for the benefit of the society, playing game with some rules set won’t hamper the spirit of game itself. For example, multiple lending is the problem for both borrowers as well as lenders in such cases a regulation to lend loan with UID or PAN could be helpful in tracking multiple lending. Secondly, establishing the eligibility criteria for selection of targeted clientele and adopting practical measures to screen out those who do not meet those could also create a win-win situation.
I’m surprised by the fact that when government is so much bothered about high interest rates, then why they are not providing subsidiary to MFI to lend loans at lower interest rates? Or ask public sector banks or RBI to lend loans are lower interest rates.
We had warned that it would be a free fall:
Micro-Finance to Face Slow Painful Death. SKS Share to enter Free Fall. Sell, Sell, Sell! 7/11/10
Read more: http://devconsultgroup.blogspot.com/2010/11/micro-finance-to-face-slow-painful.html
SKS Micro-Finance drifting into a firm Bear Grip 14/11/10
Read more: http://devconsultgroup.blogspot.com/2010/11/sks-micro-finance-drifting-into-firm.html
Mr. Alexander: I hope you acted on your prediction and made money.
This is really insightful discussion. I believe the public policy and Ordinance are for the benefit of the society, playing game with some rules set won’t hamper the spirit of game itself. For example, multiple lending is the problem for both borrowers as well as lenders in such cases a regulation to lend loan with UID or PAN could be helpful in tracking multiple lending. Secondly, establishing the eligibility criteria for selection of targeted clientele and adopting practical measures to screen out those who do not meet those could also create a win-win situation.
I’m surprised by the fact that when government is so much bothered about high interest rates, then why they are not providing subsidiary to MFI to lend loans at lower interest rates? Or ask public sector banks or RBI to lend loans are lower interest rates.
Nachiket and Bindu: Excellent analysis. Why don’t you send a copy to AP government. Perhaps an own letter in newspapers might help a bit.
Sorry, I meant open letter*.
Thanks Sasi
Dear Ms.Bindu, please get ready with the next analysis on “How much loss is incurred by state exchequers on Subsidized Micro Finance”. Karnataka Government has mooted Micro Credit with a initial corpus of Rs.500 Crore to be given @4% rate of interest. Whether this is flat or on reducing balance basis and whether there would be entire transparency of the money going to the poor or to rich Political Parties is to be seen and probably the NGOs and Analysts would help you understand this aspect just in the same manner they are currently doing in trying to understand the perceived mis-deeds of the MFIs. This issue is already becoming a National Disaster.
Dear Ms. Bindu, continuing from the earlier post, I feel you should brace yourselves for a National Analysis as your fears have already come true. It seems every Government which is currently facing issues on Local front “Read SCAMS” would consider Microfinance as an option to make people forget their scams. It could happen soon in Maharastra (Adarsh Microfinance Company), In Karnataka it has already taken shape (Dharti Bante Microfinance Company), In Tamil Nadu (Doorvani Microfinance Company) and in the Country (National Double Growth Scheme (2G))
Nachiket and Bindu: Excellent analysis. Why don’t you send a copy to AP government. Perhaps an own letter in newspapers might help a bit.
Sorry, I meant open letter*.
Thanks Sasi
Dear Ms.Bindu, please get ready with the next analysis on “How much loss is incurred by state exchequers on Subsidized Micro Finance”. Karnataka Government has mooted Micro Credit with a initial corpus of Rs.500 Crore to be given @4% rate of interest. Whether this is flat or on reducing balance basis and whether there would be entire transparency of the money going to the poor or to rich Political Parties is to be seen and probably the NGOs and Analysts would help you understand this aspect just in the same manner they are currently doing in trying to understand the perceived mis-deeds of the MFIs. This issue is already becoming a National Disaster.
Dear Ms. Bindu, continuing from the earlier post, I feel you should brace yourselves for a National Analysis as your fears have already come true. It seems every Government which is currently facing issues on Local front “Read SCAMS” would consider Microfinance as an option to make people forget their scams. It could happen soon in Maharastra (Adarsh Microfinance Company), In Karnataka it has already taken shape (Dharti Bante Microfinance Company), In Tamil Nadu (Doorvani Microfinance Company) and in the Country (National Double Growth Scheme (2G))
Dear Bindu and Nachiket,
I have a few doubts as to what you have stated in the post above.
a) Are you implying that because the Fair Practices Code is in place there would be no violations of the Code? If I draw an analogy- do you mean to stay that since the Indian Penal Code is in place there would be no crime committed in India? Just the way you state that “the customer has forcibly been prevented from repaying the lender and actively exhorted to do” is it not possible firstly that the customer is not aware of and has not at all been made aware of possible recourse available to her and secondly that due to economic/ financial coercion “the customer has forcibly been prevented from” reporting such matters to the concerned authorities. Since you have mentioned that NBFCs are well regulated, it would be ironic to note that unlike Bank customers there is no Ombudsmen mechanism available to NBFC customers. I wonder if any of the NBFC MFIs (who incidentally have 80% share of the microfinance sector) have even ever mooted the concept of an Ombudsman!
b) I have been in the microfinance sector for several years and I can assure you that I can count on my fingertips the MFIs that implement the interest rate part of the Fair Practices Code to the t! Rarely have I come across MFIs that reveal to their customers the effective rate of borrowing instead of the flat rate. In my view it may be a good idea that bodies like MFIN and Sa-dhan make it compulsory for their members to clearly inform their customers about the effective rate of borrowing and no just the deceptively flat rate. Overall, I do not agree with your assertion that NBFC MFIs are already “very tightly regulated”. You seem to be benchmarking the little or non-existent regulation against non-NBFC MFIs. I believe all NBFC MFIs must aspire to be small scale banks and hence, a better benchmark would be banks and not trusts and societies.
c) Though I understand that all MFIs are facing rising defaults due to the Ordinance, it would not be fair to question the intent of the state government as the Ordinance applies ONLY to MFIs that are lending under the SERP or MEPMA. Hence, technically speaking, NBFC MFIs that use the JLG model should be crying foul and continue with regular collections. However, I do recognise that all MFIs, irrespective of their business model, have been impacted by the Ordinance.
d) On the point of Ordinance exceeding competence- firstly, assuming but not conceding the issue of competence, it is not the legislature but the state government that has exceeded it’s competence. The legislature will exceed it’s (again assuming but not conceding the issue of competence) competence only when passes the bill. While we are talking about the issue of competence, I do believe that the government/ legislature has not exceeded it’s competence because the Constitution of India clearly empowers the State legislatures to legislate on “money-lending and money-lenders”. Now, the question that arises is how do MFI NBFCs constitute “money-lenders”? Ans. (a) through their usurious rates of interest (which may be due to their high cost of funds, i.e., the fact that they are the middlemen between the real lender and the borrowers); or (b) in the instant case that they are lending under the SERP or MEPMA scheme (which is funded by the state government and hence, allows the state government/ legislature to regulate the lending under such schemes).
On the point that the Ordinance violates fundamental rights, the courts have on numerous occasions held that the Executive and the Legislature have the power to impose reasonable restrictions on fundamental rights. To give you an example every citizen has the right to life and liberty but that does not entitle an individual to take her life either through suicide or euthanasia. Similarly, the government being aware of the economic situation of MFI borrowers (who have borrowed from MFIs under the SERP/ MEPMA) has the right to restrict them from borrowing from other MFIs (who are lending under the SERP/ MEPMA). From my reading of the Ordinance, it does not restrict a borrower (who has borrowed from an MFI under the SERP/ MEPMA) to borrow from another MFI (under the JLG model) or a borrower (who has borrowed from an MFI under the JLG model) to borrow from another MFI (under the JLG model/ SERP/ MEPMA). It is very easy to be confused with the wording and hence the Ordinance needs to be read very carefully.
Hope my comments/ views have added to the discussion.
Thankyou Evangelist for your detailed response. Couple of responses:
1. Only insiders know that the NBFC-MFIs are regulated (however imperfect). One of our main objectives in writing this was to dispel the myth that these are completely unregulated companies. I would urge you to submit a framework, including the excellent suggestion on Ombudsmen, to the Malegam Committee of the RBI that will ultimately take a view on this matter.
2. The Ordinance prevents a borrower who has taken a loan from the SERP/MEPMA SHG program from taking a loan from any other institution. More than 50% of households as per a recent survey (http://microfinance.cgap.org/2010/11/11/who’s-the-culprit-accessing-finance-in-andhra-pradesh/) are members of an SHG. If they were so concerned about client well-being (and not just being anti-competitive), why didn’t they say no member that has already borrowed from an MFI will be given a loan from the SERP/MEPMA program either. The concern after all is multiple borrowing, not from whom? To use Samar of HT’s analogy (http://www.hindustantimes.com/India-s-micro-vision/H1-Article1-627687.aspx) , it is like BSNL being the regulator of telecom and them saying, no BSNL customer will be allowed to buy an Airtel SIM, but Airtel customers must feel free to go to BSNL and will in fact, be actively encouraged to do so.
Thanks for your response Bindu. I think the Malegam Committee is a good opportunity for all of us to contribute to the evolution of the sector. I believe that a lot can be learnt from the banking sector and implemented (and obviously modified) to suit the requirements of the MFI sector.
On your second point, I have two arguments to make. Firstly, I would like to distinguish between the two situations. In the example cited by you, it has to be borne in mind that BSNL though owned by the government is a commercial enterprise that is working for a profit motive, whereas, in the case of SERP/MEPMA, the state government is not indulging in a commercial venture but fulfilling it socialist obligations as enshrined in the Constitution. Therefore, it is my view that the state government is entitled to restrict the ability of SHGs to borrow from MFIs, so long as they are indebted to lenders.
Secondly, I am not sure if you are aware of this or not but all banks in this country that lend to home loan customers/ corporates/ SMEs including MFIs impose a similar condition on their borrowers, i.e., the borrower shall not avail any other credit facility from any other bank/ financial institution without the bank’s permission. So what we are crying foul about is actually prevalent across the banking system. The state government seems to have taken a leaf out of the banking industry’s books.
Dear Evangelist,
The ordinance, when literally interpreted, does not prevent a borrower registered with SERP/ MEPMA from borrowing from an MFI (which follows the JLG model) or from other SHGs that are not registered under SERP/MEPMA. SHG has been defined as “a group of women formed and registered with the SERP/ MEPMA”. MFIs, however, have been given a wider definition.
The clause pertaining to multiple borrowing exclusively refers to SHGs. Since in all other places in the ordinance, the word MFI is used instead of the more specific ‘SHG’, the ordinance overall impacts all MFIs (whether they follow the SHG/ JLG model).
Therefore, if we were to interpret the clause in the manner that has been suggested, then MFIs following the JLG model should have been allowed to continue operations without being affected. Since that is not happening, the interpretation is meaningless in the current context and will result in the client turning to informal sources like the moneylender.
Dear Jayshree,
Thanks for your response. I agree with your comments on MFIs in general being impacted by the Ordinance. In fact, it is a very badly drafted document. Whilst some of the procedures prescribed in the Ordinance are cumbersome, I do not think that MFIs should not face any problem in complying with the procedures. One aspect that certainly needs rectification is the registration bit. The registration ought to be at the state level and not district level.
On Section 10 of the Ordinance, it would helpful to have a look at the definition “Loan”. The definition of “Loan” categorically relates to SHG loans alone. Though in terms of technical interpretation I may be right but on the ground, the government personnel enforcing the Ordinance may not be aware of the nuances and are applying the Ordinance in a sweeping manner. However, the fact of the matter when such things are challenged in courts (as has already been done) such technical interpretations do not remain meaningless and will be relied upon by the state government. Hence, it may not be wise to ignore such interpretation.
Dear Bindu and Nachiket,
I have a few doubts as to what you have stated in the post above.
a) Are you implying that because the Fair Practices Code is in place there would be no violations of the Code? If I draw an analogy- do you mean to stay that since the Indian Penal Code is in place there would be no crime committed in India? Just the way you state that “the customer has forcibly been prevented from repaying the lender and actively exhorted to do” is it not possible firstly that the customer is not aware of and has not at all been made aware of possible recourse available to her and secondly that due to economic/ financial coercion “the customer has forcibly been prevented from” reporting such matters to the concerned authorities. Since you have mentioned that NBFCs are well regulated, it would be ironic to note that unlike Bank customers there is no Ombudsmen mechanism available to NBFC customers. I wonder if any of the NBFC MFIs (who incidentally have 80% share of the microfinance sector) have even ever mooted the concept of an Ombudsman!
b) I have been in the microfinance sector for several years and I can assure you that I can count on my fingertips the MFIs that implement the interest rate part of the Fair Practices Code to the t! Rarely have I come across MFIs that reveal to their customers the effective rate of borrowing instead of the flat rate. In my view it may be a good idea that bodies like MFIN and Sa-dhan make it compulsory for their members to clearly inform their customers about the effective rate of borrowing and no just the deceptively flat rate. Overall, I do not agree with your assertion that NBFC MFIs are already “very tightly regulated”. You seem to be benchmarking the little or non-existent regulation against non-NBFC MFIs. I believe all NBFC MFIs must aspire to be small scale banks and hence, a better benchmark would be banks and not trusts and societies.
c) Though I understand that all MFIs are facing rising defaults due to the Ordinance, it would not be fair to question the intent of the state government as the Ordinance applies ONLY to MFIs that are lending under the SERP or MEPMA. Hence, technically speaking, NBFC MFIs that use the JLG model should be crying foul and continue with regular collections. However, I do recognise that all MFIs, irrespective of their business model, have been impacted by the Ordinance.
d) On the point of Ordinance exceeding competence- firstly, assuming but not conceding the issue of competence, it is not the legislature but the state government that has exceeded it’s competence. The legislature will exceed it’s (again assuming but not conceding the issue of competence) competence only when passes the bill. While we are talking about the issue of competence, I do believe that the government/ legislature has not exceeded it’s competence because the Constitution of India clearly empowers the State legislatures to legislate on “money-lending and money-lenders”. Now, the question that arises is how do MFI NBFCs constitute “money-lenders”? Ans. (a) through their usurious rates of interest (which may be due to their high cost of funds, i.e., the fact that they are the middlemen between the real lender and the borrowers); or (b) in the instant case that they are lending under the SERP or MEPMA scheme (which is funded by the state government and hence, allows the state government/ legislature to regulate the lending under such schemes).
On the point that the Ordinance violates fundamental rights, the courts have on numerous occasions held that the Executive and the Legislature have the power to impose reasonable restrictions on fundamental rights. To give you an example every citizen has the right to life and liberty but that does not entitle an individual to take her life either through suicide or euthanasia. Similarly, the government being aware of the economic situation of MFI borrowers (who have borrowed from MFIs under the SERP/ MEPMA) has the right to restrict them from borrowing from other MFIs (who are lending under the SERP/ MEPMA). From my reading of the Ordinance, it does not restrict a borrower (who has borrowed from an MFI under the SERP/ MEPMA) to borrow from another MFI (under the JLG model) or a borrower (who has borrowed from an MFI under the JLG model) to borrow from another MFI (under the JLG model/ SERP/ MEPMA). It is very easy to be confused with the wording and hence the Ordinance needs to be read very carefully.
Hope my comments/ views have added to the discussion.
Thankyou Evangelist for your detailed response. Couple of responses:
1. Only insiders know that the NBFC-MFIs are regulated (however imperfect). One of our main objectives in writing this was to dispel the myth that these are completely unregulated companies. I would urge you to submit a framework, including the excellent suggestion on Ombudsmen, to the Malegam Committee of the RBI that will ultimately take a view on this matter.
2. The Ordinance prevents a borrower who has taken a loan from the SERP/MEPMA SHG program from taking a loan from any other institution. More than 50% of households as per a recent survey (http://microfinance.cgap.org/2010/11/11/who’s-the-culprit-accessing-finance-in-andhra-pradesh/) are members of an SHG. If they were so concerned about client well-being (and not just being anti-competitive), why didn’t they say no member that has already borrowed from an MFI will be given a loan from the SERP/MEPMA program either. The concern after all is multiple borrowing, not from whom? To use Samar of HT’s analogy (http://www.hindustantimes.com/India-s-micro-vision/H1-Article1-627687.aspx) , it is like BSNL being the regulator of telecom and them saying, no BSNL customer will be allowed to buy an Airtel SIM, but Airtel customers must feel free to go to BSNL and will in fact, be actively encouraged to do so.
Thanks for your response Bindu. I think the Malegam Committee is a good opportunity for all of us to contribute to the evolution of the sector. I believe that a lot can be learnt from the banking sector and implemented (and obviously modified) to suit the requirements of the MFI sector.
On your second point, I have two arguments to make. Firstly, I would like to distinguish between the two situations. In the example cited by you, it has to be borne in mind that BSNL though owned by the government is a commercial enterprise that is working for a profit motive, whereas, in the case of SERP/MEPMA, the state government is not indulging in a commercial venture but fulfilling it socialist obligations as enshrined in the Constitution. Therefore, it is my view that the state government is entitled to restrict the ability of SHGs to borrow from MFIs, so long as they are indebted to lenders.
Secondly, I am not sure if you are aware of this or not but all banks in this country that lend to home loan customers/ corporates/ SMEs including MFIs impose a similar condition on their borrowers, i.e., the borrower shall not avail any other credit facility from any other bank/ financial institution without the bank’s permission. So what we are crying foul about is actually prevalent across the banking system. The state government seems to have taken a leaf out of the banking industry’s books.
Dear Evangelist,
The ordinance, when literally interpreted, does not prevent a borrower registered with SERP/ MEPMA from borrowing from an MFI (which follows the JLG model) or from other SHGs that are not registered under SERP/MEPMA. SHG has been defined as “a group of women formed and registered with the SERP/ MEPMA”. MFIs, however, have been given a wider definition.
The clause pertaining to multiple borrowing exclusively refers to SHGs. Since in all other places in the ordinance, the word MFI is used instead of the more specific ‘SHG’, the ordinance overall impacts all MFIs (whether they follow the SHG/ JLG model).
Therefore, if we were to interpret the clause in the manner that has been suggested, then MFIs following the JLG model should have been allowed to continue operations without being affected. Since that is not happening, the interpretation is meaningless in the current context and will result in the client turning to informal sources like the moneylender.
Dear Jayshree,
Thanks for your response. I agree with your comments on MFIs in general being impacted by the Ordinance. In fact, it is a very badly drafted document. Whilst some of the procedures prescribed in the Ordinance are cumbersome, I do not think that MFIs should not face any problem in complying with the procedures. One aspect that certainly needs rectification is the registration bit. The registration ought to be at the state level and not district level.
On Section 10 of the Ordinance, it would helpful to have a look at the definition “Loan”. The definition of “Loan” categorically relates to SHG loans alone. Though in terms of technical interpretation I may be right but on the ground, the government personnel enforcing the Ordinance may not be aware of the nuances and are applying the Ordinance in a sweeping manner. However, the fact of the matter when such things are challenged in courts (as has already been done) such technical interpretations do not remain meaningless and will be relied upon by the state government. Hence, it may not be wise to ignore such interpretation.
This is a good analysis of issues involved. I am however not sure of the existing regulation of NBFC MFIs. The regulation is not very tight, focuses on institutions and prudential norms. The core of the current problem is customer protection, which regulation does not address. With MFI loans across the country at an insignificant 0.5% of bank credit, it is difficult to see RBI taking up fullscale regulation of MFIs – as there are no systemic threats arising from financial volumes. But the number of people served and their vulnerability pose important questions of customer protection. We need to look at a new legislation from a customer protection angle in MF sector.
Thank you sir. The broader point we wanted to make is that this is a regulated sector. Many people are not aware of this fact. Would we like regulation to be strengthened, particularly with respect to customer protection? Sure. But this is for the RBI to initate and strengthen over a periof of time keeping in mind its regulatory capacity and so on. It would be great if you could share a framework for this to the Malegam Committee.
This is a good analysis of issues involved. I am however not sure of the existing regulation of NBFC MFIs. The regulation is not very tight, focuses on institutions and prudential norms. The core of the current problem is customer protection, which regulation does not address. With MFI loans across the country at an insignificant 0.5% of bank credit, it is difficult to see RBI taking up fullscale regulation of MFIs – as there are no systemic threats arising from financial volumes. But the number of people served and their vulnerability pose important questions of customer protection. We need to look at a new legislation from a customer protection angle in MF sector.
Thank you sir. The broader point we wanted to make is that this is a regulated sector. Many people are not aware of this fact. Would we like regulation to be strengthened, particularly with respect to customer protection? Sure. But this is for the RBI to initate and strengthen over a periof of time keeping in mind its regulatory capacity and so on. It would be great if you could share a framework for this to the Malegam Committee.
Dear Nachiket & Bindu
Perfect arguements…just that it will be great if you look at the ills created by some of the players as well. I am shocked that MFIs promoted by corporates like L&T are operating at 40% IRR and I am sure that even you may not be aware and so are the bankers and possibly their own board, let alone their customers. Same with BASIX / BANDAN / SPANDANA / UJJIVAN / JANALAKSHMI / SAHAYATA and the list can go on. Can you please let us know if you as active partcipants in the sector are even aware of these pricing….the loan sizes ballooned and in even in places like Kallakuruchi in TN , large MFIs from AP started distributing loans to the extent of Rs.25000 in thr first year because every Rs.1 lent meant a valuation of Rs.2 – Rs.3 going by the market valuation of SKS then. It will be great if you publish a white paper on the realities of practices / pricing of MFIs. But all these can never be the reason for the unreasonable Ordinance of AP which does more damage to the customer than protecting them . A case of Politics over Good in the name of coomon name.
Thanks Microfinanceanalyst. On the issue of pricing, we have long held the position that there is room for massive reductions. We published this paper (http://ifmrtrust.co.in/downloads/IFMRTrustDiscussionNote-MFIPricingandValuation.pdf) last year analysing pricing and valuation impact. However, we also believe that the best way to effectively reduce this pricing without cutting off access to services is to let multiple models emerge, particularly those that challenge the incumbents on pricing. This is what happened in the Indian home loan market. Also more fundamentally, the AP Govt really needs to introspect: why is the client willing to volunatrily take loans at these exorbitant rates when the Govt program is providing (in theory) 3% money?
Thanks Bindu for the quick revert. Absolutely agree…my concern is not on Pricing but not disclosing it. Once the price is disclosed, markets will be at play to ensure that they come down- no need to interfere at all. When you disclose pricing as 24% …can it be 42%??? As a active participant, were you aware of this HUGE gap and possibly in the first place aware WHAT THE ACTUAL PRICING WAS? A response on this will be appreciated to understand the genesis of the crisis
On why they borrow if funding is available at 3%, that is another point…
1.Sufficient and timely money is not available at that pricing
2.Not available at a convenient point of transaction
If we are struck in the airport in the late hours, you may agree to pay Rs.700/- from Airport to say Numgambakkam(Chennai), Can the cabbie justify saying that the train ticket is available at Rs.8/- and if the customer wants he / she can use that mode and get away. Let us do any business with some conscience for it to be sustainable. In Arthashrashtra, there is a quote – “In Business make sure that the transactiong party also wins and then you always win”.
The issues with disclosing the correct effective price in this sector is:
a) who will move first (this is like a prisoners dilemma case, there is an incentive for the socially undesirable outcome to emerge in the long-run unless there are conscious penalties on all the parties)
b) clients might view it as an increase in the rates which could lead to reactions ranging from non-repayment to rejection of the MFI (push clients towards competitors who might be charging a higher effective rate)
Perhaps a better way might be, as Bindu suggests, to encourage competing models that evolve cost-effective methods of delivering lower cost accessible finance/ improve delivery of lower cost finance. Any other way may be more costly and need more efforts than it reduces costs / has beneficial effects.
Dear Ms.Shobha, Being transparent is an intent which is needed in every business (not really practical), more so in financial services and even more so when concerning the profile of the customer MFIs are dealing with. Transparency only on paper would not entirely serve the purpose considering the literacy and understanding levels of the customer. However, putting on paper clears all the mess atleast on paper. The better governed MFIs try to educate the customer through their screening exercise continuously. I am part of an Organization which started operations in April 2010. We have made it a point to clearly give all the charges collectable from the customer first during our group training programs, then after enrollment on the Pass Books and then again in the weekly Collection Demand Sheets. The interest principle on weekly reducing balance basis is clearly given on all these documents. Apart from this the information is both in vernacular as well as english. Each product is clearly identifiable by using different coloured pass books and a convenient method is used to educate the customer about the product they choose to take. Apart from this Credit life insurance policy both for the customer as well as the spouse is provided and the cost is mentioned on all communications to the customer. Grievance cell nos. and clear instructions not to entertain anyone else other than staff members are communicated. No Center meetings are conducted beyond 1 P.M. and no meetings on Saturdays and Sundays. These are also mentioned to the customer during the training program. These are taken into consideration not only to safeguard the customer but the worklife balance of our own staff. No agent driven business and no center leader references are considered for funding to crush the incidence of self-centered intermediaries. Loan Utilization checks and impact studies are part of the program while continuous audit to monitor the center manager’s activities are conducted. This helps in safegouading the customer as well as control. The issue of non-payment is essentially on account of wrong motivation by interested parties and not a consequence of higher/lower interest rates. It is clearly a case of need deciding what rate you pay. While this is true for the privileged customers it holds same for the under privileged too.
However, the point on encouraging competing models to lower cost is well taken and it is the need of the hour. Destructive creativity is probably the need of the hour.
On the point of Clients moving out on account of increased rate. This is not a true hypothesis since a Rs.10/- decrease in weekly installment would be about 7% decrease on effective rate. The needy poor do not really feel that Rs.10/- higher is going to change their lives that drastically. Hence it makes a lot of better sense to be transparent as much as possible.
Thanks Mr. Venkateswaran. Your organisation is certainly setting high standards in transparency. I hope these become the norm in the industry.
The best way to understand and compare price is to look at Yield to Maturity (YTM) of the loan – include interest rate + processing fees + cost of idle security deposit + tenure of the loan and so on. We look at this number and ask our partner institutions to disclose this number to clients mandatorily. It has been a common concern in the banking industry as a whole that interest rates and fees are quoted separately. Some argue that this is easier to understand for the client.
Dear Shobha
There are clear examples emerging – look at all new MFIs which have been promoted by professionals in the last 24 months and go to their website and just as you complete this go to websites of older MFIs (who have basked in high profits for all these years ) with the weird logic of Rs.10 /- extra does not matter. It matters when you give this Rs.10/- per EWI at the end as Rs.500/- which is no small amount.
Can you believe BASIX / BANDHAN even today claim that they are operating at 19% – 24% where in reality they are at 40%.Look at the fiasco when AP govy made it mandatory to declare interest rate all inclusive(else punishable with imprisonment) and then comes BASIX declaring in CNBC that they are opearting at 27% and within the next day reporting that they are operating at 32%-34%.
Declare to the customers what they understand but also all inclusive rate and also declare to bankers and in website what you actually charge so that you cap the greed. Rs.1 per EWI also means Rs.20Lacs of extra cash when you have 5 Lac customers and Rs.10 means Rs.200 Lacs !!!
Dear Bindu, I have read your analysis. Have you ever studied the dimension of why poor people borrow? Is there a study on how the money given to the people is used? To my knowledge there is no study. As students of finance (including me) we focus only the cash flows. What is needed is to study how he or she uses the money. It is not for business alone. They do not distinguish between the business and their house hold requirements. If money is to be paid, personal belonging are sold to pay for them, if business requires money they get money from ill liquid assets in our language ( for example even a silk sari is an asset). There is need for more sociological , anthropological and cultural aspects of borrowing money is needed than to just think this as another business opportunity. The big MFI are just frauds with no social commitment. I know i am making a sweeping statement. Is there any evidence that this kind of lending has make poor better, at least over the past five years?
Thanks Prof. Prabhakar. I would highly recommend reading “Portfolios of the Poor” by Prof. Jonathan Morduch (I would be happy to send you a copy if you send me your address). It follows households over several years and gives a detailed account of how household finances are being managed. The key insight is that given irregular cashflows that low-income households face, there is a very important role that small value convenient loans play in managing temporary income-expense mismatches. Without this, they would be forced to sell assets and cut back on critical consumption like education.
On the question of impact, there are atleast a few high-quality academic studies. The most recent one (http://ifmr.ac.in/cmf/publications/wp/2009/31_Banerjee_Miracle_of_Microfinance.pdf ) was conducted by MIT economists and studied the impact of Spandana’s programme in Hyderabad. They find important effects on new businesses created in slums and increase in business income and decrease in wasteful expenditure. Nothing earth shattering, but positive and significant nevertheless.
Dear Bindu,
Thank you very much for your kind letter. Kindly send me to my address,
Dr.K.Prabhakar,No,9,sivan koil north mada street,Villivakkam,Chennai-600049. I know my remarks are provocative. Sorry for the same. My construct is we are studying poverty, and inclusion in their static forms. What is required is study of business models that are used and influencing sociological behavior and giving rise to different social expectations in the ever changing technological environment. The model is syntropic model and used in Social Forecasting. I will be happy to send you the methodological aspects for your kind perusal. The increase in status for a poor person is likely to increase his needs and this is likely to give rise to different social relationships and behavior. This kind of study will really help the dynamics of lending and its impact on business model. I take this opportunity to suggest http://www.businessmodelgeneration.com, it is authored by 470 authors from 45 countries.
There is excellent study on models for social initiatives.If you are charging market rates of interest, where is the question of social lending? In fact many MFI are charing more than the market rates ~ is it possible to provide some answer.
It is 59.9% by L & T and L & T is yet to deny the same.
Dear Nachiket & Bindu
Perfect arguements…just that it will be great if you look at the ills created by some of the players as well. I am shocked that MFIs promoted by corporates like L&T are operating at 40% IRR and I am sure that even you may not be aware and so are the bankers and possibly their own board, let alone their customers. Same with BASIX / BANDAN / SPANDANA / UJJIVAN / JANALAKSHMI / SAHAYATA and the list can go on. Can you please let us know if you as active partcipants in the sector are even aware of these pricing….the loan sizes ballooned and in even in places like Kallakuruchi in TN , large MFIs from AP started distributing loans to the extent of Rs.25000 in thr first year because every Rs.1 lent meant a valuation of Rs.2 – Rs.3 going by the market valuation of SKS then. It will be great if you publish a white paper on the realities of practices / pricing of MFIs. But all these can never be the reason for the unreasonable Ordinance of AP which does more damage to the customer than protecting them . A case of Politics over Good in the name of coomon name.
Thanks Microfinanceanalyst. On the issue of pricing, we have long held the position that there is room for massive reductions. We published this paper (http://ifmrtrust.co.in/downloads/IFMRTrustDiscussionNote-MFIPricingandValuation.pdf) last year analysing pricing and valuation impact. However, we also believe that the best way to effectively reduce this pricing without cutting off access to services is to let multiple models emerge, particularly those that challenge the incumbents on pricing. This is what happened in the Indian home loan market. Also more fundamentally, the AP Govt really needs to introspect: why is the client willing to volunatrily take loans at these exorbitant rates when the Govt program is providing (in theory) 3% money?
Thanks Bindu for the quick revert. Absolutely agree…my concern is not on Pricing but not disclosing it. Once the price is disclosed, markets will be at play to ensure that they come down- no need to interfere at all. When you disclose pricing as 24% …can it be 42%??? As a active participant, were you aware of this HUGE gap and possibly in the first place aware WHAT THE ACTUAL PRICING WAS? A response on this will be appreciated to understand the genesis of the crisis
On why they borrow if funding is available at 3%, that is another point…
1.Sufficient and timely money is not available at that pricing
2.Not available at a convenient point of transaction
If we are struck in the airport in the late hours, you may agree to pay Rs.700/- from Airport to say Numgambakkam(Chennai), Can the cabbie justify saying that the train ticket is available at Rs.8/- and if the customer wants he / she can use that mode and get away. Let us do any business with some conscience for it to be sustainable. In Arthashrashtra, there is a quote – “In Business make sure that the transactiong party also wins and then you always win”.
The issues with disclosing the correct effective price in this sector is:
a) who will move first (this is like a prisoners dilemma case, there is an incentive for the socially undesirable outcome to emerge in the long-run unless there are conscious penalties on all the parties)
b) clients might view it as an increase in the rates which could lead to reactions ranging from non-repayment to rejection of the MFI (push clients towards competitors who might be charging a higher effective rate)
Perhaps a better way might be, as Bindu suggests, to encourage competing models that evolve cost-effective methods of delivering lower cost accessible finance/ improve delivery of lower cost finance. Any other way may be more costly and need more efforts than it reduces costs / has beneficial effects.
Dear Ms.Shobha, Being transparent is an intent which is needed in every business (not really practical), more so in financial services and even more so when concerning the profile of the customer MFIs are dealing with. Transparency only on paper would not entirely serve the purpose considering the literacy and understanding levels of the customer. However, putting on paper clears all the mess atleast on paper. The better governed MFIs try to educate the customer through their screening exercise continuously. I am part of an Organization which started operations in April 2010. We have made it a point to clearly give all the charges collectable from the customer first during our group training programs, then after enrollment on the Pass Books and then again in the weekly Collection Demand Sheets. The interest principle on weekly reducing balance basis is clearly given on all these documents. Apart from this the information is both in vernacular as well as english. Each product is clearly identifiable by using different coloured pass books and a convenient method is used to educate the customer about the product they choose to take. Apart from this Credit life insurance policy both for the customer as well as the spouse is provided and the cost is mentioned on all communications to the customer. Grievance cell nos. and clear instructions not to entertain anyone else other than staff members are communicated. No Center meetings are conducted beyond 1 P.M. and no meetings on Saturdays and Sundays. These are also mentioned to the customer during the training program. These are taken into consideration not only to safeguard the customer but the worklife balance of our own staff. No agent driven business and no center leader references are considered for funding to crush the incidence of self-centered intermediaries. Loan Utilization checks and impact studies are part of the program while continuous audit to monitor the center manager’s activities are conducted. This helps in safegouading the customer as well as control. The issue of non-payment is essentially on account of wrong motivation by interested parties and not a consequence of higher/lower interest rates. It is clearly a case of need deciding what rate you pay. While this is true for the privileged customers it holds same for the under privileged too.
However, the point on encouraging competing models to lower cost is well taken and it is the need of the hour. Destructive creativity is probably the need of the hour.
On the point of Clients moving out on account of increased rate. This is not a true hypothesis since a Rs.10/- decrease in weekly installment would be about 7% decrease on effective rate. The needy poor do not really feel that Rs.10/- higher is going to change their lives that drastically. Hence it makes a lot of better sense to be transparent as much as possible.
Thanks Mr. Venkateswaran. Your organisation is certainly setting high standards in transparency. I hope these become the norm in the industry.
The best way to understand and compare price is to look at Yield to Maturity (YTM) of the loan – include interest rate + processing fees + cost of idle security deposit + tenure of the loan and so on. We look at this number and ask our partner institutions to disclose this number to clients mandatorily. It has been a common concern in the banking industry as a whole that interest rates and fees are quoted separately. Some argue that this is easier to understand for the client.
Dear Shobha
There are clear examples emerging – look at all new MFIs which have been promoted by professionals in the last 24 months and go to their website and just as you complete this go to websites of older MFIs (who have basked in high profits for all these years ) with the weird logic of Rs.10 /- extra does not matter. It matters when you give this Rs.10/- per EWI at the end as Rs.500/- which is no small amount.
Can you believe BASIX / BANDHAN even today claim that they are operating at 19% – 24% where in reality they are at 40%.Look at the fiasco when AP govy made it mandatory to declare interest rate all inclusive(else punishable with imprisonment) and then comes BASIX declaring in CNBC that they are opearting at 27% and within the next day reporting that they are operating at 32%-34%.
Declare to the customers what they understand but also all inclusive rate and also declare to bankers and in website what you actually charge so that you cap the greed. Rs.1 per EWI also means Rs.20Lacs of extra cash when you have 5 Lac customers and Rs.10 means Rs.200 Lacs !!!
Dear Bindu, I have read your analysis. Have you ever studied the dimension of why poor people borrow? Is there a study on how the money given to the people is used? To my knowledge there is no study. As students of finance (including me) we focus only the cash flows. What is needed is to study how he or she uses the money. It is not for business alone. They do not distinguish between the business and their house hold requirements. If money is to be paid, personal belonging are sold to pay for them, if business requires money they get money from ill liquid assets in our language ( for example even a silk sari is an asset). There is need for more sociological , anthropological and cultural aspects of borrowing money is needed than to just think this as another business opportunity. The big MFI are just frauds with no social commitment. I know i am making a sweeping statement. Is there any evidence that this kind of lending has make poor better, at least over the past five years?
Thanks Prof. Prabhakar. I would highly recommend reading “Portfolios of the Poor” by Prof. Jonathan Morduch (I would be happy to send you a copy if you send me your address). It follows households over several years and gives a detailed account of how household finances are being managed. The key insight is that given irregular cashflows that low-income households face, there is a very important role that small value convenient loans play in managing temporary income-expense mismatches. Without this, they would be forced to sell assets and cut back on critical consumption like education.
On the question of impact, there are atleast a few high-quality academic studies. The most recent one (http://ifmr.ac.in/cmf/publications/wp/2009/31_Banerjee_Miracle_of_Microfinance.pdf ) was conducted by MIT economists and studied the impact of Spandana’s programme in Hyderabad. They find important effects on new businesses created in slums and increase in business income and decrease in wasteful expenditure. Nothing earth shattering, but positive and significant nevertheless.
Dear Bindu,
Thank you very much for your kind letter. Kindly send me to my address,
Dr.K.Prabhakar,No,9,sivan koil north mada street,Villivakkam,Chennai-600049. I know my remarks are provocative. Sorry for the same. My construct is we are studying poverty, and inclusion in their static forms. What is required is study of business models that are used and influencing sociological behavior and giving rise to different social expectations in the ever changing technological environment. The model is syntropic model and used in Social Forecasting. I will be happy to send you the methodological aspects for your kind perusal. The increase in status for a poor person is likely to increase his needs and this is likely to give rise to different social relationships and behavior. This kind of study will really help the dynamics of lending and its impact on business model. I take this opportunity to suggest http://www.businessmodelgeneration.com, it is authored by 470 authors from 45 countries.
There is excellent study on models for social initiatives.If you are charging market rates of interest, where is the question of social lending? In fact many MFI are charing more than the market rates ~ is it possible to provide some answer.
It is 59.9% by L & T and L & T is yet to deny the same.
The poor take money because their requirements are genarally very urgent and at that moment they dont look into the cost of borrowing but the availability of the credit which the MFIs have been providing at the doorstep that too in many cases by dissociating the existing CBO/SHGs/SGSY- SHGS, otherwise why would the MFIs prefer the women borrowers. Infact these organisations offered ready to serve clientele which the MFI very ably encashed at the net returns ranging from 8 to 15%. Banks you are aware function at less than 2% of such returns.Except that the money has been made available at the doorstep in adequate measures rather more than the requirement at times by the MFIs( NBFCs)no other efforts have been made by them towads the women empowerment, development and enterprenerial capabilities among them etc. which is an integral part of the women promotional and development endeavour. Poor need much more than credit alone which was not a botheration of the funding agencies. Poo need escort and handholding sevices for a longer period which go beyond making the credit available. The SHG linkage programme had been very effective in not only naking the credit available to the poor but also helped in empowering them both economically and socially.This movement was systemically marred by both the MFIs and SGSY-SHG movements. Its high time a brain storming procees on the issue is is initiated and a poor friendly and helping programme is devised to help the poor both financialy and socially to ensure a better standard of living and living with dignity- Sangra
The poor take money because their requirements are genarally very urgent and at that moment they dont look into the cost of borrowing but the availability of the credit which the MFIs have been providing at the doorstep that too in many cases by dissociating the existing CBO/SHGs/SGSY- SHGS, otherwise why would the MFIs prefer the women borrowers. Infact these organisations offered ready to serve clientele which the MFI very ably encashed at the net returns ranging from 8 to 15%. Banks you are aware function at less than 2% of such returns.Except that the money has been made available at the doorstep in adequate measures rather more than the requirement at times by the MFIs( NBFCs)no other efforts have been made by them towads the women empowerment, development and enterprenerial capabilities among them etc. which is an integral part of the women promotional and development endeavour. Poor need much more than credit alone which was not a botheration of the funding agencies. Poo need escort and handholding sevices for a longer period which go beyond making the credit available. The SHG linkage programme had been very effective in not only naking the credit available to the poor but also helped in empowering them both economically and socially.This movement was systemically marred by both the MFIs and SGSY-SHG movements. Its high time a brain storming procees on the issue is is initiated and a poor friendly and helping programme is devised to help the poor both financialy and socially to ensure a better standard of living and living with dignity- Sangra
Excellent Perspective by two of the real practioners of financial inclusion. However, one important point which I wish to make here is this crisis was written all over the wall but very few saw it. It is all the making of the MFIs especially the NBFCs or those who converted themselves to NBFCs due to valuation compulsions. It is something like Kashmir which feels it is neither with Pak or with India and wants to do everything on its own. Age old practices, very less transparency and a no-care attitude for regulatory requirements. Every MFI felt that the Psychology of group which helped them to maintain near zero delinquency would continue to hold good at every point in time and hence did not believe in scientific risk management practices. Now the very same Psychology is playing against them. The customer has got an incentive not to pay from the Government and the very same incentive which the MFIs gave them by repeat loans in much quicker time, is working against the MFIs now. Let us assume for once the situation would completely reverse and things would come to normal times, How many MFIs would be able to identify who had defaulted and in which MFI? They do not share information between their own branches, how are they going to share information to other MFIs? There is no data de-duping between own branches, deduping between companies would be a distant dream. Such populist measures would continue to happen and in different forms by different stage artists and the one who will suffer is the end customer and the industry unless they become more regulated and transparent while ensuring better understanding of their customers.
MFIs are working as a washerman (Dhobi) they exactly which cloth is yours and the customers are also served in the same sense. So there is no problem of data sharing and perhaps you don’t know that many MFIs are having very good practices of data sharing and storage. Scientific approach doesn’t mean only the booked rules, this is to make the process easier and accessible to masses. There may be some bad practices, so have more tight regulation, but sector is very much helpful to those who are not bankable by our structured Banks.
Dear Sublesh Singh, I am currently the Director in a start up MFI and was drawn to this industry since it served my personnel need to do some good while doing my professional duty as a Finance professional. I was at the other end of the spectrum handling very large infrastructure development clients. For me it was a drastic change from Macro to Micro and I found it very enriching as well as gave a lot of peace to my mind that I was also doing some good, until this. While I am not trying to crib, I am only trying to put a perspective which even if seen in hindsight would do a lot of good. Scientific risk management practices do not stop bad loans, but they give you some early signs which if seen through would allow you to take some preventive action. By scientific I mean, small technology support. For eg:- There was a lady who had taken two loans from different places (abt 60 KM) from two branches of a leading MFI, her husband died and insurance as per policy was processed by one of the branches, the lady asked why the other branch who has also lent is not processing the insurance claim twice? Ideally this should be done since, the insurance is for the credit life and hence whatever the cover is for,it should be processed. The insurance company does not agree to this since there were two addresses and both loans happened at more or less the same period. The due diligence of the MFI was questioned and they were right in doing so. If there was a de-duping mechanism within the MFI then this would have helped. I do believe there are many MFIs who are doing good both on their operations as well as risk management practices. However, one bad apple is what spoils the basket and now we are all bad apples.
Dear Ramakrishanan, Two things that come to my mind.
1. There is no study on business models that are adopted by the people who take loans. One of my student who has done work with flower vendors found that they prefer the Kandu vaddi person( popularly known in Tamilnadu) rather than from MFIs. 95% of them say that it is waste of time to go to SHGs as they prefer talking and attending meetings rather than focussing on business.
2. We in the name of serving the bottom of the pyramid charge interests as high as 40%~ is it right? what is serving the bottom of the pyramid? is it another way to get money from poor who is already exploited?
I found there is no study on the business models any where in MFI agenda. Without knowing how the person creates value how can you lend? For example the life of flowers is just 48 hours and the vendor has only 8 hours of shelf life of the product in the market. Is there any study on the informational needs of these people? To my knowledge there are no studies.
This is the case even with most celebrated inventions. The Prajapathi(mitticool) invention is more celebrated than sold.
Why there is no research? why this apathy to know what is happening and designing things that address only peripheral issues? Do we have any sociologists and anthropologist go into these questions? The answer to my knowledge is no.
I am not able to understand your stand. You have stated that industry need to be more regulated and in a reply to me you said you want the free market forces to operate. Kindly clarify.
Dear Prof Prabhakar, regret the delay in replying to this, I was away for some time (sort of brooding about the happenings in the Sector). Yes my stand is clear as far as regulation is concerned. Regulation for risk management practices, Regulation controlling multiple lending and Regulation for sharing data esp., w.r.t defaulters. Further, my stand as far as free market forces to operate is again clear and this is not restricting only to Interest Rates. Capital Raising cannot be regulated if the end goal is to alleviate poverty. This domain cannot be controlled by Subsidy and Donations, There has to be free flow of capital with a reasonable expectation of return on investment coupled with capital adequacy norms (again an area for regulation), for this industry to succeed. There has been many an advocate for self-regulation, but that is an area of debate. Hope my stance is clarified.
Excellent Perspective by two of the real practioners of financial inclusion. However, one important point which I wish to make here is this crisis was written all over the wall but very few saw it. It is all the making of the MFIs especially the NBFCs or those who converted themselves to NBFCs due to valuation compulsions. It is something like Kashmir which feels it is neither with Pak or with India and wants to do everything on its own. Age old practices, very less transparency and a no-care attitude for regulatory requirements. Every MFI felt that the Psychology of group which helped them to maintain near zero delinquency would continue to hold good at every point in time and hence did not believe in scientific risk management practices. Now the very same Psychology is playing against them. The customer has got an incentive not to pay from the Government and the very same incentive which the MFIs gave them by repeat loans in much quicker time, is working against the MFIs now. Let us assume for once the situation would completely reverse and things would come to normal times, How many MFIs would be able to identify who had defaulted and in which MFI? They do not share information between their own branches, how are they going to share information to other MFIs? There is no data de-duping between own branches, deduping between companies would be a distant dream. Such populist measures would continue to happen and in different forms by different stage artists and the one who will suffer is the end customer and the industry unless they become more regulated and transparent while ensuring better understanding of their customers.
MFIs are working as a washerman (Dhobi) they exactly which cloth is yours and the customers are also served in the same sense. So there is no problem of data sharing and perhaps you don’t know that many MFIs are having very good practices of data sharing and storage. Scientific approach doesn’t mean only the booked rules, this is to make the process easier and accessible to masses. There may be some bad practices, so have more tight regulation, but sector is very much helpful to those who are not bankable by our structured Banks.
Dear Sublesh Singh, I am currently the Director in a start up MFI and was drawn to this industry since it served my personnel need to do some good while doing my professional duty as a Finance professional. I was at the other end of the spectrum handling very large infrastructure development clients. For me it was a drastic change from Macro to Micro and I found it very enriching as well as gave a lot of peace to my mind that I was also doing some good, until this. While I am not trying to crib, I am only trying to put a perspective which even if seen in hindsight would do a lot of good. Scientific risk management practices do not stop bad loans, but they give you some early signs which if seen through would allow you to take some preventive action. By scientific I mean, small technology support. For eg:- There was a lady who had taken two loans from different places (abt 60 KM) from two branches of a leading MFI, her husband died and insurance as per policy was processed by one of the branches, the lady asked why the other branch who has also lent is not processing the insurance claim twice? Ideally this should be done since, the insurance is for the credit life and hence whatever the cover is for,it should be processed. The insurance company does not agree to this since there were two addresses and both loans happened at more or less the same period. The due diligence of the MFI was questioned and they were right in doing so. If there was a de-duping mechanism within the MFI then this would have helped. I do believe there are many MFIs who are doing good both on their operations as well as risk management practices. However, one bad apple is what spoils the basket and now we are all bad apples.
Dear Ramakrishanan, Two things that come to my mind.
1. There is no study on business models that are adopted by the people who take loans. One of my student who has done work with flower vendors found that they prefer the Kandu vaddi person( popularly known in Tamilnadu) rather than from MFIs. 95% of them say that it is waste of time to go to SHGs as they prefer talking and attending meetings rather than focussing on business.
2. We in the name of serving the bottom of the pyramid charge interests as high as 40%~ is it right? what is serving the bottom of the pyramid? is it another way to get money from poor who is already exploited?
I found there is no study on the business models any where in MFI agenda. Without knowing how the person creates value how can you lend? For example the life of flowers is just 48 hours and the vendor has only 8 hours of shelf life of the product in the market. Is there any study on the informational needs of these people? To my knowledge there are no studies.
This is the case even with most celebrated inventions. The Prajapathi(mitticool) invention is more celebrated than sold.
Why there is no research? why this apathy to know what is happening and designing things that address only peripheral issues? Do we have any sociologists and anthropologist go into these questions? The answer to my knowledge is no.
I am not able to understand your stand. You have stated that industry need to be more regulated and in a reply to me you said you want the free market forces to operate. Kindly clarify.
Dear Prof Prabhakar, regret the delay in replying to this, I was away for some time (sort of brooding about the happenings in the Sector). Yes my stand is clear as far as regulation is concerned. Regulation for risk management practices, Regulation controlling multiple lending and Regulation for sharing data esp., w.r.t defaulters. Further, my stand as far as free market forces to operate is again clear and this is not restricting only to Interest Rates. Capital Raising cannot be regulated if the end goal is to alleviate poverty. This domain cannot be controlled by Subsidy and Donations, There has to be free flow of capital with a reasonable expectation of return on investment coupled with capital adequacy norms (again an area for regulation), for this industry to succeed. There has been many an advocate for self-regulation, but that is an area of debate. Hope my stance is clarified.
The Economist’s article on the Andhra Pradesh crisis, cites a recent study by CMF and says…
“A survey of a representative sample of nearly 2,000 rural households in AP released on November 16th by the Centre for Microfinance (CMF), an Indian research institute, makes it possible to assess such claims. It suggests that fears of an epidemic of over-indebtedness due to excessive lending by MFIs are exaggerated.”
Here’s a link to the article
http://www.economist.com/node/17522350?story_id=17522350
The recent State Of the Sector Report(Page 4) states otherwise – Average Poor Household(MFI Target Customers) in AP has an average of 9 MFI+SHG Loans and on an average 3 MFI Loans & 6 SHG Loans (either thro’ different family members or thro’ multiple loans in the same name) and based on MFI published statistics it is atleast Rs.25,000 of outstanding MFI Loan/household. It will be better if the place where the research has been done is outlined as this seems to be in some unique geography of AP and hence may be misleading
Dear Microfinanceanalyst,
The State of the Sector Report is a collation of data from different sources and hence has some data inconsistencies. For instance, on page 38, it mentions that only 11% of the households in AP had borrowed from MFIs and 53% from SHGs; and it goes on to say that the median number of loans per household was four (as opposed to an average 9 MFI+SHG loans!). Thus, using numbers from a chronicle (as the report is described by the author himself), to support an argument is inappropriate.
The CMF study in AP was conducted across 1920 households that were randomly selected for the survey. It was a three stage random sampling design in which first, 8 districts were selected; then 64 villages; and finally 1920 households.
Dear Microfinance analyst,
The number that you cite (9.63 Loans/Per Poor Household) from the State of the Sector Report is equivalent to the total number of microfinance loans divided by the number of poor households in the state. However, as Mr. Srinivasan acknowledges in that same section of the report, we have little evidence that microfinance institutions serve only poor households. Mr. Srinivasan writes, “Available evidence, both anecdotal and study based, indicates that – customers whether of SHGs or MFIs – are typically not-poor and are well above the poverty line income (State of the Sector Report, p. 5).” Therefore, the number of microfinance loans per poor (BPL) household cannot be taken as a measure of an average household’s outstanding microfinance debt nor can it be taken as a indicator of overleveraging.
The CMF study used a rigorous sampling methodology which allowed researchers to estimate the percentage of rural households with microfinance debt. We find that the majority of the debt held by rural households is from informal sources not MFIs or SHGs. While the breakdown of total household debt could possibly be different for urban areas, our findings suggest that rural households do not hold extraordinarily high levels of microfinance debt, at least relative to other sources.
The other implication of the 9.63 Microfinance Loans per Poor Household number is that households engage in multiple-borrowing. We find that while multiple borrowing is common among rural households (84% of households borrow from multiple sources), the majority of these households borrow from multiple informal sources, not from multiple MFIs or SHGs as many had claimed. In fact, we find that only 3% of rural households have multiple MFI loans outstanding.
Dear Shardul
Not sure of sampling & statistical implications. If there is any proof needed, ask any MFI operaing in India on the average number of MFI loans any customer household is servicing and the number of households with multiple loans is atleast 80%. Recognising that this can not be brushed aside and that it is a reality a committee has been set up by the MFI industry body.
Thanks
sorry …read “ask any MFI operaing in India ‘ as operting in AP
This is a much needed good media, healing whatever damage has already been done. However, there is a bit of damage which has been done by the players themselves and multiple lending is an issue which is serious and not overstated.
The Economist’s article on the Andhra Pradesh crisis, cites a recent study by CMF and says…
“A survey of a representative sample of nearly 2,000 rural households in AP released on November 16th by the Centre for Microfinance (CMF), an Indian research institute, makes it possible to assess such claims. It suggests that fears of an epidemic of over-indebtedness due to excessive lending by MFIs are exaggerated.”
Here’s a link to the article
http://www.economist.com/node/17522350?story_id=17522350
The recent State Of the Sector Report(Page 4) states otherwise – Average Poor Household(MFI Target Customers) in AP has an average of 9 MFI+SHG Loans and on an average 3 MFI Loans & 6 SHG Loans (either thro’ different family members or thro’ multiple loans in the same name) and based on MFI published statistics it is atleast Rs.25,000 of outstanding MFI Loan/household. It will be better if the place where the research has been done is outlined as this seems to be in some unique geography of AP and hence may be misleading
Dear Microfinanceanalyst,
The State of the Sector Report is a collation of data from different sources and hence has some data inconsistencies. For instance, on page 38, it mentions that only 11% of the households in AP had borrowed from MFIs and 53% from SHGs; and it goes on to say that the median number of loans per household was four (as opposed to an average 9 MFI+SHG loans!). Thus, using numbers from a chronicle (as the report is described by the author himself), to support an argument is inappropriate.
The CMF study in AP was conducted across 1920 households that were randomly selected for the survey. It was a three stage random sampling design in which first, 8 districts were selected; then 64 villages; and finally 1920 households.
Dear Microfinance analyst,
The number that you cite (9.63 Loans/Per Poor Household) from the State of the Sector Report is equivalent to the total number of microfinance loans divided by the number of poor households in the state. However, as Mr. Srinivasan acknowledges in that same section of the report, we have little evidence that microfinance institutions serve only poor households. Mr. Srinivasan writes, “Available evidence, both anecdotal and study based, indicates that – customers whether of SHGs or MFIs – are typically not-poor and are well above the poverty line income (State of the Sector Report, p. 5).” Therefore, the number of microfinance loans per poor (BPL) household cannot be taken as a measure of an average household’s outstanding microfinance debt nor can it be taken as a indicator of overleveraging.
The CMF study used a rigorous sampling methodology which allowed researchers to estimate the percentage of rural households with microfinance debt. We find that the majority of the debt held by rural households is from informal sources not MFIs or SHGs. While the breakdown of total household debt could possibly be different for urban areas, our findings suggest that rural households do not hold extraordinarily high levels of microfinance debt, at least relative to other sources.
The other implication of the 9.63 Microfinance Loans per Poor Household number is that households engage in multiple-borrowing. We find that while multiple borrowing is common among rural households (84% of households borrow from multiple sources), the majority of these households borrow from multiple informal sources, not from multiple MFIs or SHGs as many had claimed. In fact, we find that only 3% of rural households have multiple MFI loans outstanding.
Dear Shardul
Not sure of sampling & statistical implications. If there is any proof needed, ask any MFI operaing in India on the average number of MFI loans any customer household is servicing and the number of households with multiple loans is atleast 80%. Recognising that this can not be brushed aside and that it is a reality a committee has been set up by the MFI industry body.
Thanks
sorry …read “ask any MFI operaing in India ‘ as operting in AP
This is a much needed good media, healing whatever damage has already been done. However, there is a bit of damage which has been done by the players themselves and multiple lending is an issue which is serious and not overstated.
On behalf of Integrated Congress of Women Entrepreneurs it is submitted that the crises of mFIs can be easily solved if and only if the financial assistance is provided through either by DRDA, District Industries Centers, KVIC, KVIB or SIDBI of state financial institutions.A sdeparate consortium constituting of MFIs, DRDA. DIC.KVIC is formed at District level and the Microfinance is provided to viable projects to raise the socio-economic status of beneficiaries, then we can bring golden sparrows in rural areas.
Dr.Mrs Sushma Joiya
National President
Integrated Congress of Women Entrepreneurs.
On behalf of Integrated Congress of Women Entrepreneurs it is submitted that the crises of mFIs can be easily solved if and only if the financial assistance is provided through either by DRDA, District Industries Centers, KVIC, KVIB or SIDBI of state financial institutions.A sdeparate consortium constituting of MFIs, DRDA. DIC.KVIC is formed at District level and the Microfinance is provided to viable projects to raise the socio-economic status of beneficiaries, then we can bring golden sparrows in rural areas.
Dr.Mrs Sushma Joiya
National President
Integrated Congress of Women Entrepreneurs.
Dear Bindu,
Some questions. You said that the market is regulated.( http://www.indianexpress.com/news/microfinance/698154/).In this press report Akual says now only RBI has asked him to reduce the intrest burden to 24%. Which statement is correct. Why there is no mention in your article about 35 deaths?( http://ibnlive.in.com/news/new-woe-for-andhra-farmers-as-suicide-toll-rises/133511-3.html). Your posting only talks about the un constitutionality and the free market mechanism. It never talked about the L &T 59.09% interest rates. If goverment of AP has not taken action do you think MFI’s would have done what they are doing now?
Dear Prof. Prabhakar, I believe that giving cognizance to what is not proven is nothing but foolish. The last month has been a bombardment by the media without actually going deep into the claims. I can only comment what I interpret and beyond that it is useless not only for me but also to the others. Here about L&T Microfinance charging 59.53% is something I can’t believe only by what is claimed in the news item. Pls also note, in the same news item, it also mentions that L&T has a portfolio of Rs.185 Crores among 5903 borrowers. We all know for sure that micro-loans are small and even if we give allowance for probable multiple lending among the same borrowers by L&T finance, the average loan size is Rs.3.13 lakhs and that too in one district? There is something more to this statistics and hence a reputed organization like L&T finance has probably left it unanswered. About the deaths, it’s only one person who can for sure give the real reason behind the death and that’s the person who died. RBI regulates the function of the NBFCs but rates are market related, although it is not right to charge exhorbitant rates whatever be the situation. In every regulated financial services organization the pricing is dependent upon the Cost of Funds, Cost of Operations, Risk premium based on customer evaluation and finally the mark up for return on equity. This will depend upon the scale of operations of each entity. Since the ticket size of the microloans is too small, the cost of operations is high, but that does not mean it can ever remain high. With increase in productivity, better technology, it is possible to reduce the rates substantially for the large organizations. But , as you should be much aware, this can happen only with competition and not regulation of interest rates in a free economy.
i agreed views of Ramakrishnan Venkateswaran,all becomes news no one knows this business and its impact. due to compettion and multiple finance the most importanc factor of MFI “peer presure” will goes out. self regulation among MFI is need and mutual sharing of datas and cooperation is most wanted
Dear Ramakrishnan, Thanks for your reply and your assertion that what is not proven need not be taken in to account. Do you mean to say that the reports of suicides are false. Or you agree with partial statement that they re happening but all are not because of MFIs. Do you mean to say that the 140 lives are expendable, to have market adjustment? For you it may be free market mechanism, for the poor it is life and death. It is interest burden and loan sharks in the name of addressing poverty that are affecting the poor. Do you think civil society to keep silent so that fellow human beings are exploited? What reputed company is L & T. It is yet to reply me after 15 emails i have sent them. There are three questions1. What is the interest rates that are charged by these reputed MFIs?2. What are their loan collection procedures? In the same blog see the another report given by Vijayalakshmi and Balaji. The loan collector will detain a person who has not paid his or her due in a center against her will even if he or she has no money. Do you justify these as humane practices to serve the poor? Do you think unregulated and free economy will provide justice to poor? It has never happened and not likely to happen and American Banking crisis is an example for the same. Please answer one question, why opacity or non transparency in their operations? Please advise reputed companies to clarify.
Dear Bindu,
Some questions. You said that the market is regulated.( http://www.indianexpress.com/news/microfinance/698154/).In this press report Akual says now only RBI has asked him to reduce the intrest burden to 24%. Which statement is correct. Why there is no mention in your article about 35 deaths?( http://ibnlive.in.com/news/new-woe-for-andhra-farmers-as-suicide-toll-rises/133511-3.html). Your posting only talks about the un constitutionality and the free market mechanism. It never talked about the L &T 59.09% interest rates. If goverment of AP has not taken action do you think MFI’s would have done what they are doing now?
Dear Prof. Prabhakar, I believe that giving cognizance to what is not proven is nothing but foolish. The last month has been a bombardment by the media without actually going deep into the claims. I can only comment what I interpret and beyond that it is useless not only for me but also to the others. Here about L&T Microfinance charging 59.53% is something I can’t believe only by what is claimed in the news item. Pls also note, in the same news item, it also mentions that L&T has a portfolio of Rs.185 Crores among 5903 borrowers. We all know for sure that micro-loans are small and even if we give allowance for probable multiple lending among the same borrowers by L&T finance, the average loan size is Rs.3.13 lakhs and that too in one district? There is something more to this statistics and hence a reputed organization like L&T finance has probably left it unanswered. About the deaths, it’s only one person who can for sure give the real reason behind the death and that’s the person who died. RBI regulates the function of the NBFCs but rates are market related, although it is not right to charge exhorbitant rates whatever be the situation. In every regulated financial services organization the pricing is dependent upon the Cost of Funds, Cost of Operations, Risk premium based on customer evaluation and finally the mark up for return on equity. This will depend upon the scale of operations of each entity. Since the ticket size of the microloans is too small, the cost of operations is high, but that does not mean it can ever remain high. With increase in productivity, better technology, it is possible to reduce the rates substantially for the large organizations. But , as you should be much aware, this can happen only with competition and not regulation of interest rates in a free economy.
i agreed views of Ramakrishnan Venkateswaran,all becomes news no one knows this business and its impact. due to compettion and multiple finance the most importanc factor of MFI “peer presure” will goes out. self regulation among MFI is need and mutual sharing of datas and cooperation is most wanted
Dear Ramakrishnan, Thanks for your reply and your assertion that what is not proven need not be taken in to account. Do you mean to say that the reports of suicides are false. Or you agree with partial statement that they re happening but all are not because of MFIs. Do you mean to say that the 140 lives are expendable, to have market adjustment? For you it may be free market mechanism, for the poor it is life and death. It is interest burden and loan sharks in the name of addressing poverty that are affecting the poor. Do you think civil society to keep silent so that fellow human beings are exploited? What reputed company is L & T. It is yet to reply me after 15 emails i have sent them. There are three questions1. What is the interest rates that are charged by these reputed MFIs?2. What are their loan collection procedures? In the same blog see the another report given by Vijayalakshmi and Balaji. The loan collector will detain a person who has not paid his or her due in a center against her will even if he or she has no money. Do you justify these as humane practices to serve the poor? Do you think unregulated and free economy will provide justice to poor? It has never happened and not likely to happen and American Banking crisis is an example for the same. Please answer one question, why opacity or non transparency in their operations? Please advise reputed companies to clarify.
Dear Nachiket and Bindu,
One of the challenges of crises is that they are complex phenomena often with multiple contributing factors. One of the dangers I see is that all of us fall back on our preheld beliefs as explanations. MFIs will blame politics. Others with blame excessive lending. Whereas some sincerely believe in the wrongdoings of MFIs. Surely all of the views are right in some ways and yet the conclusions to be drawn quite different.
My own biases arise out of work we did last year looking at the crises in four different markets from 2009: Morocco, Bosnia, Nicaragua and Pakistan. In the latter two of these politics played a role. Our hypothesis was that in markets where growth continues unabated but where high levels of lending are already concentrated create a tinder box where a variety of sparks might cause a credit crisis. Politics is a common spark, but in a few cases it was just growing debt burdens or the role of middle-men (women actually) in the credit processes.
I find your diagnosis of the Ordinance to be fair. But I wonder if by focusing so much on the Ordinance itself we miss out on other lessons arising out of this experience. If, for example, we are to expect crises to emerge in low income credit markets from time to time (regardless of state intervention) what would be done about it? Are these experiences to be muddled through in an attempt to come out the other side in a stronger position. This is how the microfinance market in Bolivia seems to have matured following a major credit crisis in 2000. Or should the credit crisis be something to be assiduously avoided so as not to cause a backward step. In Bolivia again the regulators and the MFIs acted responsibly and took wise corrective measures.
One wonders if the present crisis in India is an opportunity to move through into a new a better future. Or if it is a major setback that will be difficult to overcome. Aside from some criticisms of the Ordinance and some calls for stronger underwriting/credit processes, I wonder what else you think should be done, if anything at all to foresee, mitigate, prevent or recover from such crises?
Greg
Dear Greg, I would like to mention that all 4 things mentioned in your post above i.e., foresee, mitigate, prevent or recover from such crises is possible only with regaining the “Trust”. MFIs should now work to regain the trust of their customers, regulators, the policy makers and above all their stake holders be it in debt or equity form and necessarily in this order. Unless the MFIs re-invent their models to compel their customers to continuously trust them, there is no possibility of making the other players trust them. By this I mean, the MFIs need to ensure that their customers are not hoodwinked by some politician or Bureaucrat and that is possible only if there is a compelling need for the customer not to be hoodwinked. The MFIs on their part should create livelihood linkages and such other mechanisms for continuous connect, which force the customer to focus on their immediate need i.e., continuity of livelihood at most points in time. This will not only help the MFIs regain trust but also act as a cash flow understanding mechanism so as to foresee issues essentially related to cash flow. This in itself may still not solve our issue of foreseeing such political interventions, that is when the MFIs should take their act to a higher platform by actually taking stakes in the livelihood linkages so created by them. This will surely ensure that trust regained is kept for longer period. How will the other players fall in line is also linked to the trust so created among the customers and when the regulators and policy makers are taken into confidence the stake holders i.e., the Banker and Investor will fall in place and take a longer bet on the industry. Every business is built around trust, which today is highly shaken against the MFIs.
I strongly feel that the diagnosis of the ordinance is the most important issue. There is no denying the fact that there have been some excesses by the MFIs but to crucify them is simply not acceptable.
The very government and the banks including RBI did nothing for fifty years after independence except for shouting that they exist and work for the poor.Since 1998 MFIs have brought in significant changes to the lives of the people. At least one can say that the poor got corruption free services. Yet MFIs find themselves in such predicament because they are an easy target.
Only one request to the regulators/bankers/politicians: Go and ask the poor women in a village or in an urban slum: if she does not get the next loan what will happen?
You will get the answer. Parents will not be able to pay the school fee for their kids, they will not be able to pay for their medical exlenses, the poor trader will fall short of the working capital, the farmer will fall short of money to pay for the agri inputs, single women with no guardian will be expolited to the maximum. I don’t want to be emotional but these are the realities and it is high time that the MFIs should come up with an aggressive stand and need not be defensive. They may have committed mistakes but they you have not committed sin.
So they cannot be punished like this.
Sandeep
Sandeep, I couldn’t agree with you more! Either the microfinance commentators and regulators just don’t see the reality that you describe or are choosing to ignore it blatantly.
Greg, thanks for your thoughtful comments. I think no one would argue that the MFI industry is perfect. Several hard-nosed practitioners themselves will tell you that the classic JLG loan is but a stepping stone, the MFI will have to evolve with time to offer broader and cheaper services. Like all other industries, as this evolution happens, there will be hits and misses. The ones that over-stretch and are lax about under-writing will very likely fail and must be allowed to fail (after all, there are no deposits to protect here). But the reality that we are confronting now is that an entire industry of institutions working to provide financial services to the poor is facing extinction due to political whim.
Dear Nachiket and Bindu,
One of the challenges of crises is that they are complex phenomena often with multiple contributing factors. One of the dangers I see is that all of us fall back on our preheld beliefs as explanations. MFIs will blame politics. Others with blame excessive lending. Whereas some sincerely believe in the wrongdoings of MFIs. Surely all of the views are right in some ways and yet the conclusions to be drawn quite different.
My own biases arise out of work we did last year looking at the crises in four different markets from 2009: Morocco, Bosnia, Nicaragua and Pakistan. In the latter two of these politics played a role. Our hypothesis was that in markets where growth continues unabated but where high levels of lending are already concentrated create a tinder box where a variety of sparks might cause a credit crisis. Politics is a common spark, but in a few cases it was just growing debt burdens or the role of middle-men (women actually) in the credit processes.
I find your diagnosis of the Ordinance to be fair. But I wonder if by focusing so much on the Ordinance itself we miss out on other lessons arising out of this experience. If, for example, we are to expect crises to emerge in low income credit markets from time to time (regardless of state intervention) what would be done about it? Are these experiences to be muddled through in an attempt to come out the other side in a stronger position. This is how the microfinance market in Bolivia seems to have matured following a major credit crisis in 2000. Or should the credit crisis be something to be assiduously avoided so as not to cause a backward step. In Bolivia again the regulators and the MFIs acted responsibly and took wise corrective measures.
One wonders if the present crisis in India is an opportunity to move through into a new a better future. Or if it is a major setback that will be difficult to overcome. Aside from some criticisms of the Ordinance and some calls for stronger underwriting/credit processes, I wonder what else you think should be done, if anything at all to foresee, mitigate, prevent or recover from such crises?
Greg
Dear Greg, I would like to mention that all 4 things mentioned in your post above i.e., foresee, mitigate, prevent or recover from such crises is possible only with regaining the “Trust”. MFIs should now work to regain the trust of their customers, regulators, the policy makers and above all their stake holders be it in debt or equity form and necessarily in this order. Unless the MFIs re-invent their models to compel their customers to continuously trust them, there is no possibility of making the other players trust them. By this I mean, the MFIs need to ensure that their customers are not hoodwinked by some politician or Bureaucrat and that is possible only if there is a compelling need for the customer not to be hoodwinked. The MFIs on their part should create livelihood linkages and such other mechanisms for continuous connect, which force the customer to focus on their immediate need i.e., continuity of livelihood at most points in time. This will not only help the MFIs regain trust but also act as a cash flow understanding mechanism so as to foresee issues essentially related to cash flow. This in itself may still not solve our issue of foreseeing such political interventions, that is when the MFIs should take their act to a higher platform by actually taking stakes in the livelihood linkages so created by them. This will surely ensure that trust regained is kept for longer period. How will the other players fall in line is also linked to the trust so created among the customers and when the regulators and policy makers are taken into confidence the stake holders i.e., the Banker and Investor will fall in place and take a longer bet on the industry. Every business is built around trust, which today is highly shaken against the MFIs.
I strongly feel that the diagnosis of the ordinance is the most important issue. There is no denying the fact that there have been some excesses by the MFIs but to crucify them is simply not acceptable.
The very government and the banks including RBI did nothing for fifty years after independence except for shouting that they exist and work for the poor.Since 1998 MFIs have brought in significant changes to the lives of the people. At least one can say that the poor got corruption free services. Yet MFIs find themselves in such predicament because they are an easy target.
Only one request to the regulators/bankers/politicians: Go and ask the poor women in a village or in an urban slum: if she does not get the next loan what will happen?
You will get the answer. Parents will not be able to pay the school fee for their kids, they will not be able to pay for their medical exlenses, the poor trader will fall short of the working capital, the farmer will fall short of money to pay for the agri inputs, single women with no guardian will be expolited to the maximum. I don’t want to be emotional but these are the realities and it is high time that the MFIs should come up with an aggressive stand and need not be defensive. They may have committed mistakes but they you have not committed sin.
So they cannot be punished like this.
Sandeep
Sandeep, I couldn’t agree with you more! Either the microfinance commentators and regulators just don’t see the reality that you describe or are choosing to ignore it blatantly.
Greg, thanks for your thoughtful comments. I think no one would argue that the MFI industry is perfect. Several hard-nosed practitioners themselves will tell you that the classic JLG loan is but a stepping stone, the MFI will have to evolve with time to offer broader and cheaper services. Like all other industries, as this evolution happens, there will be hits and misses. The ones that over-stretch and are lax about under-writing will very likely fail and must be allowed to fail (after all, there are no deposits to protect here). But the reality that we are confronting now is that an entire industry of institutions working to provide financial services to the poor is facing extinction due to political whim.