M. Qazi: India - Microfinance: The Need to Revive India’s Defining Sector

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Mar 2018
India, March, 07 2018 - 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 about their modus operandi, high-interest rates, governance, client treatment, and transparency continued to bedevil the sector.

There has been a sudden burst of sunshine on the microfinance sky. With the clouds of demonetisation clearing away, microfinance institutions are basking under the canopy of clear, radiant skies. There have been a lot of cheerful developments in the sector. Equity investments have increased with many non-banking MFIs (microfinance institutions) raising significant money from domestic and foreign investors. Among the major investments in the sector was Janalakshmi Financial Services, raising ?1,030 crore from a clutch of investors such as Morgan Stanley, TPG Capital, and Treeline. Another MFI — Satin Creditcare — has raised ?205 crore from existing promoters, overseas investors, and IndusInd Bank. City-based Village Financial Services is also looking to raise funds.

Underlying intentions and purposes
Microfinance — an approach to financial inclusion based on providing small loans and other financial services to poor people, and primarily women — has generated considerable enthusiasm, not just in the development community but also at political levels. 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 about their modus operandi, high-interest rates, governance, client treatment, and transparency continued to bedevil the sector.

There is little doubt that the founders of these organisations were genuinely seeking to help poor and low-income people improve their economic and social prospects. Over time, however, organisational goals (growing bigger, winning international awards, having higher levels of profitability, and closer links with mainstream finance) led them to abandon their original mission. The social focus was displaced by financial focus.

Crumbling of the sector
The sector’s biggest shock came seven years ago in India’s southern state of Andhra Pradesh: After a spate of suicides by highly indebted borrowers there, local authorities banned any collection of private microloans. Around $1.2bn in debts was eventually written off, leaving the foundation of the sector shaken.

The aftermath of demonetisation not only put a brake on growth but it put the sector through a rocky patch and the industry has been experiencing a chill since then. In states like Maharashtra and Uttar Pradesh, the industry is gasping on account of a vitiated credit culture driven by populist politics.

A political tint
Experiences over the world have consistently shown that whenever microfinance suffers a crisis, particularly on the client front, the politicians stoke it, sometimes leading to large conflagrations. In India, It has much to do with its socialist history and popular politics. The poor is a constituency which politicians see as a very sensitive turf. Anything which leads to greater empowerment of the poor makes them insecure. Demonetisation was a big jolt for the poor whose financial lives were severely rattled leaving MFIs lurching with poor recoveries. To add to the woes of the collecting agents, politicians poured the explosive political gasoline inciting borrowers with loan boycott exhortations.

The politicians are under an illusion that they scored a political victory over the microfinance industry in Andhra/Telangana in the 2010 crisis. However, they are wrong. The worst sufferers of the crisis have been the low-income households. With the veritable exit of microfinance institutions (MFIs) from the region, availability of microfinance has dramatically reduced and money-lenders are thriving again and are having a wonderful time.

Fixing one point on the economic continuum won’t make much difference unless all parts of the continuum are improved at the same time. What the politicians need to do is to focus on the crippling economy which can barely breathe in an environment of suffocation created by the severe currency crunch. What the rural population actually needs, and what can help MFIs, is more of economic oxygen.

Why has it become inevitable?
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 the other tools to manage their cash flow. Banks offer cheaper credit but are mired in thickets of red tape.

We must laud the positive side of microfinance, even while some of its practitioners have strayed away from the core mission. Financial institutions, like all other institutions, operate within the same culture and are therefore susceptible to the overall influences that are at play in the transformation of that culture. Microfinance provides loans to needy individuals, who are illiterate, have no credit history, and live in villages with no roads or infrastructure. Additionally, the majority have never had a bank account and indeed would not be considered suitable borrowers by mainstream banks. Banks will never cater to them. However, microfinance companies, including commercial ones, will. They have no assets, no collateral, so the banks’ doors are shut to them.

There is no doubt that indigent clients themselves value microfinance, as evidenced by their strong demand for such services, their willingness to pay the full cost of those services, and high loan repayment rates that are primarily motivated by a desire to have access to future loans.

Expanding the scope and reach
Indeed, it is no wonder that some 200 million people around the world borrow from microfinance institutions—200 million people who were, in all likelihood, not eligible for any formal credit before microfinance started. To provide a more balanced perspective on the microfinance industry compared to other kinds of financial-services providers, MFIs need to do more to measure and explain their social and economic value.

Microfinance has matured and sobered over time; it is undergoing changes, and several microfinance organisations have now transformed into small banks. These institutions are leading the development of new kinds of products and services that, while based on the fundamental roots of the microfinance tree, branch out into many new directions to serve low-income individuals and communities. Beyond more conventional products in savings, credit, payments and insurance, their offerings also address needs in areas like housing, energy, agriculture, and small enterprise.

Today, the frontiers of microfinance go well beyond microcredit, to include savings, insurance, money transfers, and other products that the poor need just as much as the rich to manage their financial lives. These financial services are essential tools that help individuals manage their businesses, cope with unpredictable cash flows and variable incomes, and afford lump-sum expenses, like school fees and health emergencies.

Integrating technology
The growing use of mobile phones, digital services, and mobile money accounts is beginning to fill that vacuum. Mobile operators are teaming up with banks, financial tech (fin-tech) companies, and data analytics specialists to use the data they have on customers to gauge their credit risk. They then offer microfinance products to some who would otherwise lack any proof of their capacity to repay a loan. For the microfinance industry, such systems represent a significant opportunity, as they enable borrowers to apply for, receive, and repay loans on their mobile phones, using a network of local agents to deposit and withdraw cash.

Time to revive microfinance
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 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.

Microfinance is a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It has all to do with how we are using it and how we are defining the outcomes. It needs to shape more responsible capitalism. It is certainly not a natural choice by any means but a right choice for wise investors and society alike. Similarly, politicians should be wary of the adverse consequences of their narrow populism. We have the means of taming wrong tendencies—laws for punishing them, norms for shaming them, and cure for healing them. Let us not in our imperfect understanding or prejudice throw the baby out with the bathwater.



Source : Qrius
 

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