Microfinance institutions are a menace

Every day we think about it and feel entrapped.” It’s not the future that Manda Gawande, 45, a housewife, and her four friends had desired when they borrowed money from a microfinance institution (MFI). “Every week goes by so fast that we think we’ve paid our installment only yesterday and the recovery boy’s back at our doorstep today.”

Anna. That’s the description they use in this run down Nagpur locality for the recovery boy.

Everything else must wait, but the group of five says they can’t miss the weekly meetings with the MFIs’ recovery agent, who, they say, knows they need small sums in their pressing times. “Installment,” she says, “is a fact of life.” Micro finance, says a woman borrower, “brings happiness in the beginning, tension in the end.”

Micro credit — small loans to the poor -—has spread like wildfire across the world with nearly half a billion consumers enrolled with the MFIs. India is no exception. There are about 70 million consumers of MFIs, and growing every year, country-wide data shows.

According to the Microfinance Information Exchange (MIX), the gross loan portfolio of 146 self-reporting MFIs in 2009 stood at $4.6 billion (approximately, Rs 20,700 crore), with an average per borrower loan of $144.5 (approximately Rs 6,500).

But what was pitted as an innovating financial practice to address poverty, is now being viewed as the next big investment opportunity, a concept that critics say is antithetical to its charitable roots.

New challenges and criticism stare the MFIs in the face. These include high interest rates, poor governance, lack of transparency, multiple lending, and vicious debt cycles. There is no knowledge of how the so-called micro-enterprises funded by MFIs are performing nation-wide, experts say.

Take Gawande ’s group, for instance. Representing a lower middle-income segment, it hasn’t borrowed money for any self-promoted business, but urgent domestic requirement. Yet the official pretext was the group’s hosiery business.

In her case, Gawande needed money for house repairs. The banks won’t lend. The MFI option was better than private usurer, who charges an interest of 5% per month. Problem is: Gawande bears the pressures: The loans, in her name, are tied to the group.

Since there’s no collateral, the MFIs resolve the problem of eligibility, requirement and enforcement of repayment by keeping the loan amount small, targeting groups instead of individuals, and making the attendance to the weekly meeting a compulsion.
“If one of us fails to pay our weekly installment,” Gawande explained, “others have to pay a fine from their pocket.” The moral obligation creates too much of a pressure, she says.

For four other members, reasons for borrowing money from the MFIs differ. But like tens of other MFI borrowers, they too had no business idea. “If we were entrepreneurs,” says one of them, “we would not have been in such dire needs in the first place.”

Gawande ’s other group members say two years since they borrowed money from different MFIs, including SKS micro-finance, they don’t think credit cycles will move out of their lives any time soon. Like others, they too are juggling multiple loans.
Gawande ’s personal debts vary from Rs 5,000 to Rs 15,000. “I borrowed from three places,” she says, “Rs10,000 each from Equitas and Janlaxmi and Rs12,000 from SKS.”

SKS collects the money weekly and over 50 installments; Jan Laxmi’s is a monthly repayment for a year, and Equitas’ repayment tenure is two years, every fortnight.

“We created microcredit to fight the loan sharks,” reasoned Professor Muhammed Yunus, the Grameen Bank founder and Nobel laureate, at a gathering of financial officials at United Nations earlier this year.  “We didn’t create microcredit to encourage new loan sharks.” The debate would not have hogged the limelight but for the farmer suicides in Andhra Pradesh linked to harassment by MFI recovery agents. The charitable MFIs suddenly looked like sahukars, though the MFI industry has been quick in rebuffing the Andhra suicides story, seeking a judicial probe.

A push for more transparency
Besotted by concerns and pressure for regulation, MFI sector is being pushed for more transparency. The debate so far has mostly centred on this question: How much interest and profit is acceptable?

The New York Times quoted Damian von Stauffenberg, founder of independent rating agency Microrate, as saying that while local conditions must be factored in, “any firm charging 20 to 30% above the market was unconscionable” and that “profit rates above 30% should be considered high.”

Yunus explicitly opposes the MFIs from going public with an IPO: First, Mexican firm Banco Compartamos went public in 2007. In October 2010, it was the Hyderabad-based SKS. “When you put an IPO, you are promising your investors that there is a lot of money to be made and this is a wrong message. Poor people should not be shown as an opportunity to make money out of.”
Yunus says anything beyond 15% above the cost of raising the money falls in red zone of loan sharking. By that measure, 75% of MFIs across the world would fall into his “red zone,” a lead researcher at MIX, Adrian Gonzalez, said in March 2010.

The transformation
The MFIs saw two major shifts this decade.

“When we look at the two decades of MFI presence in India, we find three distinct waves,” says MS Sriram, a Bangalore-based independent researcher.

The first wave, he says, was when the development sector discovered the methodology of reaching loans to the poor through a scalable model. The second wave was when these MFIs scaled up and sought methods to morph into commercial entities. In the third wave, the mainstream institutions themselves took to microfinance as a lucrative business, he says. Most high growth MFIs have adopted and improvised upon the Grameen methodology: identify the poor, organise them (so there’s homogeneity and moral liability of repayment in the absence of any collateral), and standardise products and systems, enforce discipline, and ensure that any breach is dealt with severely and sternly. It’s the third wave, where there’s huge money to be made from the poor.

As Sriram puts it, the MFI sector shifted from public purpose to private commercial interests; and from not-for-profit, donor-driven model to for-profit market model.

By early 2002, he says, most donor-driven MFIs were talking the language of transformation to keep up with their pace of growth; donors saw a market-based model to offer financial services to the poor.

It doesn’t alleviate poverty
The fundamental question though is: does micro finance alleviate poverty?

There are not too many large-scale studies on the sector, but a couple of efforts raise concern: One report, as quoted by the 2009 status report of MFIs in India by the Chennai-based Centre for Micro-Finance (CMF) released recently, suggests that the impact of microfinance on the poor has not been as positive as the sector would believe.

Another report goes to suggest that as an instrument of poverty alleviation, microfinance is not a clear choice.

Studies done by Professor R Ramakumar of the Tata Institute of Social Sciences and Pallavi Chavan show that NGO-led micro-credit programmes have been able to bring about a marginal improvement in their income, but the borrowers have not gained much by way of technological improvements, given the emphasis on ‘survival skills’.

The findings indicate that microfinance is a great tool for smoothening consumption and relieving seasonal liquidity crises that visit poor families; and that it obviates the need to resort to high-cost borrowing from informal sources.

Under certain simple assumptions, says Ramakumar, the borrower-initiated micro-enterprise should have a rate of return of at least 24-36% to break even.

It is well known that for a large- or medium-sized industry, a rate of return (before interest payment) of about 24% is considered to be respectable. For smaller industries or firms, the rate of return would be smaller, making the target of 24 to 36% highly unrealistic, given the low organic composition of capital in the enterprise. So, any rate of return below these rates of interest (24 to 36%) would imply a loss for the borrower, he explains. “The argument that loans under micro-credit programmes could raise incomes of the poor, thus, stands on very weak grounds,” his studies point out.

Take the case of Yousuf Turebkhan Pathan, 42, who runs a small electrical shop in Wardha’s Waifad village. As part of a five-member group he’s borrowed Rs 15,000 from Basix, payable over 18 months with an EMI of Rs1,000. That loan was barely sufficient for his shop’s expansion, and so he asked his mother to borrow from another MFI in the village for his enterprise. Now, the repayments eat most of his income.

Customers like Yufus and his mother Yasin Bi are ignorant and have no financial expertise to understand what interest rate they should actually pay on their small loans.

The contrast between the client who is supposed to benefit and the promoter who is actually benefited is stark, says Sriram. In such a business it is better to be moderate. “It would be in the long-term interest of these businessmen to consider this because the backlash in case of undue enrichment from the poor is going to be much larger and harsher,” he says. It’s time, he says, MFIs took a pause and introspected.