The way forward with microfinance

Indian Micro Finance Institutions (MFIs) primarily cater to a certain demographic — the bottom of the pyramid. In the aftermath of the demonetization move and push for a cashless economy, they need to reinvent themselves. 

There are three different kinds of MFIs: The large, few in number, are for-profit or Non-Banking Financial Companies (NBFCs). Then, there are trusts and Non-governmental Organisations (NGOs), which are small but numerous. The RBI has given conditional licences to eight large NBFC-MFIs to convert themselves into small finance banks. This is the third category.

All three currently disburse loans, and collect repayments, which are mostly in cash. In semi-urban and rural areas, almost 95 per cent such transactions are cash transactions. They cannot continue in this way. 

Big or small, they draw money from banks, which is then transported to the cluster of community centres via the MFI branches. At such centres regular meetings are held to distribute money to Lower Income Groups. Of course, the exact procedure varies, but then they pay loan installments to generate fresh money to give out more loans. The residual money, in interests or otherwise, are sent back to bank branches.

Post demonetization, when the Rs 500 and Rs 1,000 notes were replaced with the new Rs 500 and Rs 2,000 notes, people started hoarding Rs 100 notes, and the circulation was affected. No one was giving out change.

MFIs began to face massive problems and the circle of borrowing-lending came to a screeching halt. Borrowers could not repay the money and business went down by almost 80 per cent in some cases. My understanding is that it is gradually getting better. The second week of November was a nightmare, the week after slightly better, and so on.

The government pushing for a cashless economy means that the MFIs cannot survive in their current form. 

Many NBFC-MFIs are also business correspondents of banks. They accept deposits and give loans on behalf of banks for which earn draw fees. Naturally, the MFIs that are also serving as business correspondents can get people draw cash directly from the banks. 

By and large, banks in India are lazy. They pander to large corporations and salaried individuals who have collateral to offer them. Naturally, they do not see business in the hinterland. So, the MFIs will stay as long as banks remain lazy but they need to be more tech-savvy and have to form alliances with banks and fintech companies to create a new architecture for lending and collection of loan repayments.

Farmers are only a small part of the borrowers of Rs 64,000 crores MFI industry in India. They will also be hit hard as in cashless banking system, with doorstep banking concept will die. Farm labourers may have to forego a day’s wage and pay for transport to reach bank branches to draw money. The density of bank branches in rural areas is low.

Micro ATMs could be one solution to the doorstep banking issue. The RuPay card also can be a solution if used effectively, despite increasing costs for banks when small amounts are withdrawn daily. 

While it is too early to say the last word on this drive, for rural areas, financial literacy is the key to make is successful. There are over 250 million Jan Dhan accounts, and we need to motivate people to see the upsides in using them. 

We’re a developing country and our profile is very different from other cashless economies such as Denmark and Sweden. Financial inclusion isn’t as deep as it should be yet, but the future isn’t bleak. The RBI needs to take steps to connect and push financial literacy. Former RBI Governor D Subbarao had initiated outreach programmes in rural pockets. We need to deepen them. The rural India is not fully prepared yet to embrace a cashless economy. We need to put in extra efforts to bridge the gap.

The author is Consulting Editor, Mint and wrote by invitation in his capacity as Adviser-Strategy, BandhanBank. As told to Dipshikha Ghosh.