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MFI- changing scenario MFI- changing scenario Document Transcript

  • Making Micro – Finance interest rates affordable: A Way Forward?Topic- Making Micro – Finance interest ratesaffordable: A Way Forward? Page 1
  • Making Micro – Finance interest rates affordable: A Way Forward?Introduction........................................................................................................................3 The Microfinance Industry...............................................................................................3 MFI Models......................................................................................................................4 The Grameen system/model:............................................................................................5 The SHG model:..............................................................................................................5 The SHG-Bank-Linkage Model:......................................................................................5 The Andhra Pradesh Crisis...............................................................................................6Problems faced by the Microfinance Industry- .............................................................7 High Interest Rates- .........................................................................................................8 High level of Customer debts- ........................................................................................9 Use of Coercive force.....................................................................................................10 Clashes of interest with Politicians................................................................................10Solutions to the current problems faced by the microfinance.....................................11 Malegam Committee Report key recommendations and our comments on it...............11 Our recommendations on the way ahead.......................................................................13Concluding words............................................................................................................15References ........................................................................................................................16 Page 2
  • Making Micro – Finance interest rates affordable: A Way Forward?IntroductionAfter the liberalization of economic policies in 1991, India has grown at a phenomenalrate. In the last few years we have grown consistently at rates of above 8%. This has beenaccompanied by increase in per capita income, increased life expectancy and generalimprovement in the living standards of the people. But this growth has been mainlylimited to urban India. Rural India has been left behind.One of the various measures for upliftment of rural India is the extension of bankingfacilities to the poor. At present about 73% of the farmer-households have no access toformal sources of credit (Thorat 2007) 1. Access to banking facilities like loans, savings,insurance etc can help raise the living standards in the villages. Loans or Microloans asthey are called can help the rural people to start their own ventures. They can also help toprotect them from unfavorable conditions like droughts. These microloans have beenprovided by various bodies like the Micro Finance Institutions or by GovernmentAgencies through the self help groups.The Microfinance IndustryThe Microfinance Industry has been growing at a CAGR of 86% in the number ofborrowers and 96 % in portfolio outstanding between 2004 and 2009 (Lok Capital) 2.Between March 2008 to March 2009, the CAGR was 59% in the number of borrowers(22.6 million) and 52 % in portfolio outstanding ($2.3 billion) 2. Everything looked rosybefore the Andhra Pradesh (AP) crisis. • The NPA levels of the various MFIs remained at 0.2-3% even as most of the loans were unsecuritized, which is at par or even better than the NPA levels of banking industry 2. • The industry had remained virtually unaffected by the recession of 2008. Page 3
  • Making Micro – Finance interest rates affordable: A Way Forward? • The IPO of SKS Microfinance was subscribed nearly 11 times and they raised about $358 million. It drew investors like Narayana Murthy, venture capitalist Vinod Khosla and George Soros. • Credit was easily available to them. As of March 2009, banks and financing institutions had a total exposure to MFIs of $2.45 billion. This represents an almost 150% increase from the exposure in March 2008 2. • Indian MFIs faced a valuation that is 3.0x to 4.0x book value whereas MFIs across the world face an equity valuation of 1.5x to 3.0x book value 2.MFI ModelsIn terms of models, MFIs can be classified as lenders to groups or as lenders toindividuals. In India, MFIs usually adopt the group based lending models, which areof two types- the self-help group (SHG) model and the joint-liability group (JLG)model. Under the SHG model, an MFI lends to a group of 10-20 women. Under theSHG-bank linkage model, an NGO promotes a group and gets banks to extend loans tothe group. Under the JLG model, loans are extended to, and recovered from, eachmember of the group (unlike under the SHG model, where the loan is extended to thegroup as a whole). The most popular JLG models are the Grameen bank model and theASA model. Most of the leading MFIs in India follow a hybrid of the group models. MFIs Models SHG-Bank Grameen Model linkage model SHG MODEL Page 4
  • Making Micro – Finance interest rates affordable: A Way Forward?The Grameen system/model:Prospective clients are asked by the MFI to organise themselves into ‘Groups’ of fivemembers which are then organised into ‘Centres’ of around five to seven suchGroups. The members make frequent savings with the MFI, according to a fixedobligatory schedule, and they also take regular loans. They each have individualsavings and loan accounts with the MFI, and the main function of the Groups andCentres are to assist the financial intermediation process, through performing errandssuch as: Holding frequent meetings where savings and repayments are collected andhanded over to the MFI worker Organising contributions to one or a number of groupsavings funds Guaranteeing loans to their individual members.The SHG model:A typical SHG consists of twelve to thirty members. The group is not merely asavings and loan association, but serves as a “fellow-feeling” group that provides aplatform for an array of issues (such as watershed development, and family planning). AnSHG meets frequently (weekly), and in these meetings, members contributesavings/funds and take decisions on loans to members of the group. The SHG may at firstlend out of its own pool of funds and after gaining some familiarity with lending (andrecovering loans), it may borrow from an MFI for on-lending to the members. Briefly,the SHG-MFI system has financial linkages as follows. Each SHG in the systemraises funds from individual members and borrows from the MFI. Each SHG lends tomembers and saves with the MFI. The MFI raises funds from three sources: Capital, SHGsavings, and borrowings from outside. The MFI lends to SHGs, invests outside, andmaintains a cash balance. The MFI may have regulatory limitations on assets,liabilities, and interest rates.The SHG-Bank-Linkage Model:In India, the adaptation of the new microfinance approach by rural financialinstitutions assumed the form of the “Self-Help Group–Bank Linkage Program.” Underthe SHG-bank linkage program, NGOs and banks intermingle with the poor, Page 5
  • Making Micro – Finance interest rates affordable: A Way Forward?especially women, to form small homogenous groups. These small groups areencouraged to meet frequently and collect small saving amounts from their members andare taught simple accounting techniques to help them to maintain their accounts.Although individually these poor could never have enough savings to open a bankaccount, the joint savings enable them to open a formal bank account in the name ofthe group. This is the first step in establishing links with the formal banking system.Groups then, meet often and use the joint amount to pass on small loans to members formeeting their small surfacing needs. Also the SKS acceleration model and the ICICIpartnership model are very popular.The Andhra Pradesh CrisisBut then the crisis in AP occurred. It began with the revelations about the high interestrates (average rate of 36%) charged by the MFIs and about the coercive tactics used bythem to recover their money. Some cases of suicide came to light which further put theMFIs in more bad light. What was earlier the angel now appeared to be a devil. Questionsbegan to be asked about the high profitability of the MFIs. A disconnect was createdbetween their for upliftment motives and their for profit nature. The successful listing ofSKS microfinance further hastened this change in perception.Reacting to these upheavals the AP government implemented an act regulating theactivities of the MFIs in the state. • All MFIs had to register their activities at the district level. • The use of coercive force for loan recovery was made a punishable offence • The repayment was made monthly in place of weekly • MFIs were prohibited from charging interest in excess of the principal amount.Another point of contention was that the politicians viewed the MFIs as deterrents to theirpolicies of poor upliftment. They felt that the MFIs were doing what the government wassupposed to do. As such the MFIs were robbing the politicians of their opportunity to Page 6
  • Making Micro – Finance interest rates affordable: A Way Forward?gain some leverage from credit creation by the government sponsored Self Help Groupsor through other means. As such many politicians provoked the people not to repay theirloans. The number of NPAs increased drastically.All these things have had a crippling effect on the MFIs. The interest rates have beencurtailed. Banks have stopped lending to them. Repayment has suffered. The registrationprocess at the district level is cumbersome and takes a lot of time. As such the loandisbursal and repayment collection processes have been interrupted which has severelyimpacted the profitability of the MFIs. The basic outlook towards them has also becomehostile. The Microfinance Industry is at a crossroads and what happens now will decidethe future of the industry.Problems faced by the Microfinance Industry-Mentioned below are the different problems faced by the Microfinance Industry. We haveused a Fishbone diagram to understand the various cause- effect relationships occurringwithin the domain of this problem. The diagram does a decent job of representing thevarious problems and the relationships within these problems. We will try to furtherexplain these relationships in the preceding part to zoom in on the main causes for theproblems faced by the MFIs. As we can see in the diagram, numerous causes arementioned multiple times which only point to the few recurring problems. Page 7
  • Making Micro – Finance interest rates affordable: A Way Forward? Cause Effect Diagram to the Microfinance problem High Interest Rates High levels of Customer debts High targets to Small loans agents High Operational Credit driven Expenses Microfinance Multiple loans to Weekly Collection same person Regulation problem Rapid Growth High perceived risk Inability to deal with shocks like High Cost of funds droughts Absence of Insurance Present problems Change in perception from welfare Competition in MFI centric to in poor profit centric upliftment High levels of Customer Political Debt Mileage High Interest rates More Loans to people with visibility less chances due to IPO of repayment of SKS Clashes of interest Use of Coercive with Politicians forcesHigh Interest Rates-The MFIs have been charging a rate of 36% (SKS) 3 on an average. This rate can betermed as high when compared to other loans and low when compared to the moneylenders. The problems that have been caused because of it are- • These high rates have also led to the change in perception regarding the MFIs from being welfare centric to profit centric. • These high rates make it difficult for the people to repay their loans often resulting in NPAs. One can argue when compared to the money lender’s loans these loans are quite easy to repay, but if you look at these loans in isolation there is no doubt that a rate of 36% is causing repayment problems. A reduction in these rates will benefit both the people and the MFIs. We will look at steps on how to do that after studying all the problems • It can also lead to high level of customer debts, which will be studied under a separate heading. Page 8
  • Making Micro – Finance interest rates affordable: A Way Forward?Now lets look at the various factors which have resulted in such high interest rates. • The MFIs have a high operational expenses. This is caused because of the basic model of MFIs of giving a large number of small value loans and the resulting large backend work. • The weekly collection of repayment also causes high operational expenses. But this is a system which is required for the system to work effectively. In the absence of any proper savings mechanism, it makes sense to collect the repayments weekly due to the weekly nature of the wages in villages. • The cost of funds is normally about 12-16% 2. This is quite high even when compared with risky sectors like real estate (about 7%). This is because of the high perceived risk of the MFIs. • The MFIs in India are credit driven. This is because RBI regulations prevent them from accepting savings accounts. Therefore the MFIs are completely dependent on wholesale borrowing which is costly. Opening up the savings sector will provide more flexibility and help them become self sufficient. On top of that the cost of funds is significantly lower in the savings model.High level of Customer debts-The high levels of customer debt is another major problem facing the MFIs. The reasonsfor this are numerous but we will try to look at the factors which have relation with theMFIs. As per an article in the Economist-“[w]hereas 82% of households have borrowed from informal sources, mainly villagemoneylenders and relatives or neighbours, only 11% have an MFI loan. On average,borrowers also owe over four times as much to informal lenders, which charge far higherrates, than they do to MFIs. The […] survey finds that a mere 3% of households inAndhra Pradesh have more than one [MFI] loan; in contrast, 70% of people have atleast two informal loans. People with several MFI loans also tend to take them outsimultaneously, rather than staggering them, as they would if they intended to use one topay instalments on another.” (Economist 2010)4 Page 9
  • Making Micro – Finance interest rates affordable: A Way Forward?The MFIs are not the main reason for the high debts. But the impact of this factor is hugeand attention grabbing. Things like suicides have lead to a lot of bad publicity for theMFIs. Also it is easy to link the MFIs with suicides although they might not beresponsible for it. Mentioned below are the problems that can be caused because of highlevels of customer debts- • High levels of Debt can lead to suicides. • High levels of debts result in defaults in repayment.Some of the reasons for high debts associated with the MFIs are as below- • Multiple loans to same person has lead to rising debts. This is the result of pursuit of very fast growth and very high targets set to the field agents. • A major problem is the inability to deal with shocks like droughts. This is where insurance can come in. Insuring the work of the farmers can result in lesser debts and also lesser NPAs. • Not enough trainings and other services are provided which will help the poor to better utilize their Microloans. • Loans are given to people with very little chances of repayment.Use of Coercive forceThe use of coercive forces for the recovery of loans has also resulted in lots of badpublicity for the MFIs. Infact it was one of the reasons why the AP crisis occurred in theMicrofinance Industry. The main reason for this is that people are unable to pay. Thisagain may be due to high interest rates or due to high debt levels of people which havealready been studied in detail.Clashes of interest with PoliticiansAfter the IPO of SKS had put the MFIs into focus there have been clashes of interestbetween the MFIs and the politicians. The problems caused by this are mentioned below- Page 10
  • Making Micro – Finance interest rates affordable: A Way Forward? • The harsh regulatory measures by the AP government were the result of these clashes. • The politicians during the recent crisis have also used their clout to tell the people not to repay their loans. This has put the entire business model of the MFIs at risk.The reasons for the clashes are as below • The successful IPO of SKS Microfinance has put the Microfinance sector into focus. People have started targeting this. • The change in perception from welfare centric to profit centric and the resulting high profitability has further impaired its image making it a target for the politicians • The politicians also have used the MFIs to gain political mileage. By asking the people not to pay the loans and promising to cover the NPAs, they have taken a step towards destroying the entire model of the MFIs. • The politicians also view the MFIs as a competition to their own pro poor measures. They feel like the MFIs are robbing them of a chance to gain some political mileage.Solutions to the current problems faced by the microfinanceMalegam Committee Report key recommendations and our comments on itRecommendations which we agree on • The NBFC-MFI should not less than 90% of its total assets (except cash, bank balances and money market instruments) in the form of qualifying assets (ie- microloans). • A limit on annual family income of Rs.50000 and an individual ceiling on loans of Rs.25000 to a single borrower has been recommended. . • The interest rate has been capped at 24%. o We agree with this. It will not only challenge the MFIs to introduce further operational efficiencies into their system but it will also help to reduce the Page 11
  • Making Micro – Finance interest rates affordable: A Way Forward? bad name associated with the MFIs as a result of the high interest rates. A capped interest rate will give credibility to the rates charged by them. • RBI should be the regulator for the industry. It should regulate both the structural and functional elements to cover things like pricing, customer grievance and governance. o Again a very good recommendation. Individual states do not have the know how of RBI and their will be no consistency across the nation. RBI being the regulator is a very positive step indeed. • The individual state will not be the regulators for the industry. • 4 pillars have been suggested to improve the performance and regulate the sector- MFIs(internal audits). Industry association, RBI, andOmbudsman o It sure seems a good suggestion. But we will be able to say more about this point after we have got details about the exact functions recommended for these 4 pillarsRecommendation which we don’t agree with • Atleast 75% of the loans given by the MFIs should be for income-generating purposes. o Although the aim and purpose of this point is fair, but it will be very hard to implement. Therefore we recommend that it should not be implemented. In place of this rather the MFIs should be encouraged to provide income generation trainings and programes. • A restriction has been put on the other services which can be provided by the MFIs. This has to be in sync with the type of service and the maximum percentage of total income prescribed. o Rather than limiting the scope of the MFIs we should rather look to provide more flexibility to them by providing them with scope to broaden their operations. • Not more than 2 loans are to be given to a single person. This will help in enhancing the credit profile of the customers. Page 12
  • Making Micro – Finance interest rates affordable: A Way Forward? o Although recommendable, it will only result in the person taking loans from some other source. Therefore we should rather train the agents in such a way that they disburse loans sensibly. Also this will result in unnecessarily increasing the operational expense of the MFIs.Our recommendations on the way aheadCost of Funds- Currently it is at 12-16% due to increase in the risk weighted average tothis sector .Since there are more regulation put in by the RBI , the NPA in this sector willbe reduced which infact can reduce the risk associated with this sector. Therefore banksshould give credit to this sector at lower rate.Diversification- As diversity is the attractiveness any other financial Institution, Microfinance institutions should be allowed to enter into savings sector and insurance markets.This can serve as following purposes, • It will reduce the cost of funds. • Insurance will help in reducing impacts of shocks and thus reduce the number of NPAs. • It will increase the penetration of financial services provided to the poor. • It will help the MFIs to build better and stronger ties with the people.Correspondence Banking specially for repayments- The MFIs should look at themodel of correspondence banking where baking facilities are provided through localgrocery stores. This helps in reduction in the costs of setting up branches. This model hasalready been successful in Kenya and Mexico. These outlets can even be used to collectrepayments. Rather than the agent going to each JLG for repayment collection, the peopleshould be encouraged to make the repayment at the outlets near them. The agent will visitthe outlet every week to collect the payment and find whoever has not paid. This willimprove operational efficiencies and provide time to the agents so that they can selectloanees judiciously. Page 13
  • Making Micro – Finance interest rates affordable: A Way Forward?Agent trainings to aid them in prudent loan disbursal- Proper trainings should begiven to the agents so that they provide loans sensibly and with an eye on repaymentcapacity. In case of suspect loan repayment capacity, the agent should suggest insuranceor trainings to improve the chances of repayment.Interest rate cap- The benefits of this are as follows- • Credibility to the rates charged by the MFIs • Challenge the MFIs to come up with better techniques to reduce the operational inefficiencies and innovate to find ways to improve their profitability. • Improvement in the general outlook towards them.Trainings and programmes on income generation techniques- The MFIs shouldprovide trainings and programmes on income generation. The benefits of this are asbelow- • Improvement in loan repayments • Improvement in image of the MFIs. • Reduction in the hostility from the politicians • Building better relations with the people.Regulatory Body- Although we agree that at present RBI should be regulating the sector,with time RBI should create a separate body which can look after this sector in detail. Thebenefit of this will be that RBI does not have the bandwidth to look at the MFIs which arevery large in numbers specially in terms of operation and number of loans.Benefits to the smaller players- In order to promote Microfinance in India theGovernment can give more incentive to the small microfinance. This can be done by thesource side like provide the credit at lower rate from the banks. The benefit of this will bethat it will help spreading of microfinance to all parts of the country and encourage newplayers to come up. Page 14
  • Making Micro – Finance interest rates affordable: A Way Forward?Location based benefits to the MFIs- Government can classify places into differentclasses based on the credit necessity of the particular place and development and providecredit at lower rate to microfinance to these places. This will aid in the growth of MFIs inthat particular area,Concluding wordsIn the end we would just like to say that the Microfinance industry has a very importantpart to play in poverty alleviation. When compared with the alternative of money lendersMFIs are infinite times better. Inspite of the hiccups faced by the sector, we should lookahead to solve these problems and unleash the benefits of the MFIs on a nation widelevel. The present situation may be grim but with focused effort from various players thiscrisis can be conquered Page 15
  • Making Micro – Finance interest rates affordable: A Way Forward?References 1. Thorat, Usha. 2007. Financial Inclusion – The Indian Experience. Speech made at the HMT-DFID Financial Inclusion Conference 2007, 19 June 2007, Whitehall Place, London, UK. Available: www.rbi.org.in/scripts/speeches. 2. Lok Capital- http://www.microfinancegateway.org/gm/document-1.9.43423/05.pdf 3. SKS management Interview http://www.youtube.com/watch? v=HwvY8tNcuNw&feature=related http://www.youtube.com/watch? v=D3J9JhfWE4w 4. Economist (2010): Overcharging - Microlending is under attack, unfairly, 18th Nov. 2010 5. MRPA: http://www.microfinancegateway.org/gm/document-1.9.48954/MPRA_paper_271 42.pdf Page 16