Microfinance & Poor
By Moin Qazi
The microfinance sector is again facing troubles, this time in Assam with stress in rural households and a spate of loan defaults raising the spectre of a repayment crisis that hit Andhra Pradesh way back in 2010.
A law enacted by Assam on December 30, 2020, to regulate microfinance institutions (MFIs) threatens to pose severe operational challenges to the microlenders operating in the State. This could possibly harm the credit culture of borrowers in other neighbouring States as well, a section of industry feels.
The AP Microfinance Bill, which had imposed similar restrictions on operations of MFIs, especially with respect to collection of dues, had unleashed a crisis in the sector. This subsequently forced a significant number of MFIs to shut down or move out of the State
An internal study conducted by Microfinance Institutions Network (MFIN) last year, a self-regulatory body for the sector, showed that indebtedness of micro borrowers in Assam is more than double the national average while it is four times in a few districts where borrowers are facing or experiencing distress on account of indebtedness..
Born out of the simple notion that the poor can save and are bankable, microfinance is an approach to financial inclusion based on providing small denomination loans and other financial services to the working poor and others who lack the collateral, credit history, or other assets and are not served by conventional banking. It has generated considerable enthusiasm, not just in the development community but also at political levels. It has infused an entrepreneurial spirit in tiny business like clay-brick makers, seamstresses, and vegetable sellers.
Microfinance clients are drawn from Joint Liability Groups (JLGs) or Self Help Groups (SHGs). JLGs are purely credit groups comprising usually five members who cross-guarantee each other’s loans. Self Help Groups (SHGs) are savings and credit groups consisting of 10-20 members whose primary objective is promotion of savings. MFIs use the JLG route, whereas SHGs are financed by banks and the cooperative sector, cooperative banks, cooperative societies, et al.
In the last decade-and-a-half, microfinance institutions (MFIs) in India have struggled to gain legitimacy as credible institutions even though they have demonstrated the ability to deliver financial services to unbanked low income households sustainably. Serious doubts on their modus operandi, high interest rates, governance, client treatment and transparency continued to bedevil the sector.
The explosion of multiple lending and borrowing was a prime cause, and it was positively encouraged by MFI lenders. Poor households took on multiple loans from different sources, often only for the purpose of repaying one of the lenders, and this was actively fed by the combination of aggressive expansion in the number of clients and strict enforcement of payments. When it came to credit they were continually “bicycling”. This implied that microfinance customers spun the pedals by paying off one loan with the next. This was often because women feared losing this crucial lifeline and falling off the “credit bicycle”.
Poor households, in particular the rural poor, are exposed to unsteady flows of income. The reasons are many, including seasonal unemployment related to the agricultural labour cycle, sickness or death in the family or weather shocks among many others. Given the variability and vulnerability of their income, they value formal microfinance because it is more reliable, even if it is often less flexible than their other tools to manage their cash flow. Banks offer cheaper credit but are mired in thickets of red tape.
Microfinance needs a relook and has to undergo soul searching. When it comes to microfinance it is very important to think outside of the borrowing box. It will have to move beyond its traditional roots. Recent evidence suggests that relatively simple tweaks to microcredit products — including flexible repayment periods, grace periods, individual-liability contracts or the use of technology — may change their impact for both clients and institutions. Microfinance institutions should be consistent in applying best practices in evaluating repayment capacity, offering transparent terms and conditions and using credit bureau information to avoid overstretching clients with debts.
Poor households are not well served by simple loans in isolation. Microfinance provides a bandage where a major operation is needed, and at worst, it deepens the wounds while the bulk of microfinance portfolios may be commercially sustainable and attractive to conventional investors, reaching the still-excluded will continue to require innovation and experimentation. More than micro-loans, what the poor need are investments in health, education, and the development of sustainable farm and non-farm related productive activities.
To enable the poor to work their way out of poverty, they need to be enabled to move from one step to another of the financial ladder through graduated credit. Credit should be made available in staggered doses, with every new tranche disbursed after satisfactory repayment behaviour of the clients. This will also ensure that the vulnerable groups do not get into a debt trap; it will also make credit dispensation more efficient and qualitative.
Credit can be both an opportunity and a risk for low-income families. It is necessary to open doors, but it can also be a barrier. A person can dig oneself into a lot of debt, preventing the ability to move up financially. Loans can be malignant. Some people shouldn’t take on debt. Some businesses are too risky. And the temptation is always present to take these costly loans and scrimp on groceries. When they miss loan payments because a lingering illness keeps them away from their business, they get into the regular default cycle. That’s acute over-indebtedness.
Access to small loans for tiny businesses by itself won’t miraculously enable the poor to take them to a new level. It will not build a steady business because a lot of them face several barriers. A modest cash injection cannot generate a stable income, or create a profitable cycle of trade and income particularly when the daily struggle of most of these people has to do with making a living, feeding their families, educating their children and staving off ill health.
The notion that microfinance has the potential to spark sustained economic growth is misplaced. The direct evidence of microfinance’s impact is less than overwhelming. In several cases, these financial activities can damage the prospects of poor people. Microloans do create opportunities for people to utilise “lumps” of money for augmenting incomes and mitigating vulnerability, but that doesn’t necessarily mean investing in businesses could lead to sustained revenue growth. Not all microloans produce beneficial results, especially for those engaged in low-return activities in saturated markets that are poorly developed and which are prone to regular environmental and economic shocks.
Consumer protection in microfinance is not just about fair treatment and safeguarding of clients’ individual rights, but also about proper governance of microfinance institutions. The industry must be in a position to achieve its fundamental social mission of poverty reduction, while ensuring sustainability of operations. Microfinance institutions must deliver demand-driven, quality services to these clients, to low-income people and develop the industry in a healthy way.
The hard truism is that microfinance has been saddled with misplaced expectations, and we have lost a sense of its more modest, even though critical, potential. It is actually a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It will make the poor a little more resilient, but it is not the answer on its own. It has all to do with how we are using it and how we are defining the outcomes. — INFA