Putting cap on microlending rates will prevent poor from accessing credit

Banco Compartamos, the Mexican microfinance lender, has warned Andhra Pradesh policy wonks to resist from putting cap on microlending rates as such a step would force more people to go to the money lenders and prevent poor in the villages from accessing credit.

The world’s first listed microfinance company — Compartamos (which means let’s share in Spanish) has over 50% share of Mexico’s microfinance sector — suggests that India should build stronger credit bureaus that keep a check on the number of microfinance institutions.

“I think what they are trying to do will have the opposite effect; globally it has had the opposite effect as people go back to the money lenders — who are unregulated and charge significant interest rates,” said Carlos Danel, Compartamos founder and executive vice-president, in a telephonic interview with DNA.

According to Danel, lawmakers could hamper the growth of the industry in India and hurt the poor more if a cap on interest rates on loans is placed, citing the example of another Latin American country, Colombia, where government-placed interest rate ceilings have stalled growth of microfinance institutions — to reach only 7% of the population.

This is because, according to Compartamos, a ceiling on interest rate forces many companies to push up average loan size, thereby making them out of the reach of the poor. In Colombia, the average loan balance per borrower is $1,117 as against $300 in Mexico, and in comparison the average loan balance per borrower in India is $144.

Mexico  — which does not have any interest rate ceilings have — has seen microfinance institutions reach out to 14% of the people as against 3% in India, according to Deutsche Bank.

“I can easily see the source of the problem…you (India) should give a thought to having good credit bureaus than putting a cap on interest rates,” said Danel.

Earlier this month, the Congress-led government in Andhra Pradesh — citing a wave of suicides blamed on harassment by microfinance collectors — brought out  ‘Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Bill’ in the Assembly. Although the state legislature is yet to hold discussions on the bill, analysts believe that support from all political parties should help the bill to be passed.

The bill seeks to put a cap on microlending rates, place restrictions on recovery practices and limit collections on debts to once a month from once a week earlier.

According to Vijay Mahajan, president of Microfinance Institutions Network, which represents 44 for-profit microlending companies, business activity has already come to a grinding halt; collection rates have dropped to 20% from 95% after the state government passed the ordinance in October.

Stephen Rasmussen, a former World Bank microfinance expert now with independent policy and research centre, the Consultative Group to Assist the Poor, warned that setting interest rate caps too low could have a negative effect as it would drive business model of many companies unviable.

“India has had history of government-mandated financial inclusion measures. Now, if the previous efforts have not yielded desired results, the government should see that capping of interest rates does not curtail the growth of microfinance industry,” Rasmussen said.

On SKS Microfinance Ltd, the embattled microfinance company, Danel said that the Hyderabad-based company should have pursued its growth more structurally after it got listed.

“I have met Vikram a couple of times. My officials have visited their facility [India] and they have been highly impressed. But 99% of our problems are related to management,” Danel said.

“When you grow at the speed of SKS, there are plenty of challenges especially in management. We are a labour intensive industry and we need to manage well the people we hire, training them,” explained Danel.

Earlier this week, SKS stock plunged to lifetime low of `559 at the Bombay Stock Exchange.

Compartamos started as a non-governmental organisation in 1990, started by a Catholic social action group called Gente Nueva. It later became a for-profit company in 2000, before getting listed on the country’s stock market in 2007.

Like India, Mexico too is severely underbanked; just over 25% of the working people have a bank account, compared to about 55%
in India.

This is one reason why many people with no access to credit from formal banking system turn to loan sharks and pawn shops for credit.

Compartamos’ initial success was to understand that the poorer segments of Mexico’s 108 million population, which traditional banks have avoided as too risky, are potentially good business. Compartamos’ non-performing loans totalled 1.97% of its total portfolio for the third quarter ended September 30 2010.

“Our average effective interest rate is 58%,” said Danel, adding that the experience of Compartamos in its earlier days made it realise that daily collections would only drive up its expenses. Hence, a collection agent — who sanctions a loan and is also mandated to collect — visits each group every week, riding on public buses. Further.

Compartamos’ own borrowing cost is lower than other Mexican microfinance players, thanks to its strong credit rating.

SKS Microfinance’s effective interest rate is of 24%.

“I think one of the biggest things which SKS could not do was to expand beyond the loan systems. Now poor people need more than just loans. Compartamos has a history of dealing efficiently with its clients because the regulatory system in Mexico allowed it to expand beyond just loans.”