Bangladesh , August, 24 2006 -
MICRO-credit or micro-finance, whatever we call it, is playing an important role in our country. The sources of micro-credit in our country, can be divided into two main categories. The first one is the commercial bank (private and nationalised) and the second is the NGOs -- Non-government organisations. Without analysis of the details, if we compare the overall performance of these two categories it seems that NGOs are doing better. However, we should analyse more details to find out the actual performance scenario.
To find out the actual picture of the micro-credit operation of the NGOs, the following points which need to be discussed critically, are its effective rate of interest, recovery rate, tax implication, foreign donor agency or source of finance and, finally, the government's steps in this regard.
Before entering into the details, this scribe would like to make it clear that he is not attacking somebody or organisation or their interest. However, it should be made clear what some of the NGOs are publicly claiming and what they are actually doing. It is also worth mentioning here that not all NGOs are doing the same. Lack of appropriate governmental rules and regulations is also important here. Now let us consider the points mentioned earlier one after another.
To understand the effective rate of interest we have to consider a typical micro-credit loan. Let us consider a village member needs Tk. 5000 as loan for some very small investment. He goes to a commercial bank. The problem with the commercial bank is that they cannot lend without appropriate collateral. So he is forced to move to the NGOs' credit facilities.
If one analyses the situation above critically what one will see that the particular villager is not moving willingly to the NGOs, rather he has no alternative but to go to any of the NGOs for the micro-credit. The situation is exactly the same when a small child start weeping for a particular toy in the shop and the shop-keeper asks for an extra premium over the normal price for that, because he knows that this customer has no choice but to buy it. The situation in this loan case is more unethical and inhuman, as this is the case where basic human need is involved. In the child's case it is a just a toy. Whatever explanation an NGO may try to offer to rationalise the high rate of interest that it does indirectly realise, the simple truth that comes up is as follows:
Now let us return to the example that A needs Tk. 5000. He goes to NGO B and asks for the same. B gives him Tk. 5000 at the flat interest rate of 15 per cent, which is slightly less than that of the commercial banks. So A is happy to have Tk 5000 as loan at a lower interest rate without any collateral. Now see what he is actually paying and at what rate of interest when the payback period comes.
As per terms of mandatory saving, NGO B takes away 5 per cent of the amount lent i.e. 5000, which is Tk 250. The borrower A receives only 4750 (5000 less 250) in the actual term. During the payback period, A returns total along with interest at 15 per cent flat, i.e. principal Tk 5000 plus interest at the rate of 15 per cent, which together comes to Tk 575. He pays the amount at the rate of Tk 250 each week for 23 weeks. If we calculate the effective rate of interest we see that A actually receives as loan Tk. 4750. He actually returns Tk. 250 for 23 weeks which comes to Tk. 5750. Thus the total interest in 23 weeks is Tk. 1000. The effective rate of interest is (1000/4750) x (52/23), which is 47.59 per cent per year.
If the borrower A can utilise Tk. 4750 for the full 23 weeks, in that case the simple interest rate will be 47.59 per cent.
However, in our typical example, A repays Tk 250 in the following week and another Tk 250 in each of the subsequent weeks. So the interest should be calculated on the outstanding balance amount. This should the principle to calculate the effective interest rate.
So whatever the NGOs say that the interest rate is 15 per cent flat, but they are ignoring the time period, i.e. 23 weeks of time instead of 52 weeks of the year and the need is to calculate interest on the balance amount after every weekly payment instead of the whole amount of Tk. 5000. When they say their interest rate is 15 per cent flat, it seems attractive. But the actual rate is much more higher than what they are publicly claiming.
In the village environment, it is not so easy to get a business which can give 15 per cent plus return from an investment of only Tk. 5000. In this situation, the 15 per cent flat rate of interest is not only high, it is very high. So the borrower has to earn at least 48 per cent of his or her investment as profit just to repay. But the real situation in this typical example is much worse, as the borrower cannot utilise the full amount of Tk. 5000 for the 23 weeks, which gradually reduces due to weekly repayment.
This micro-credit is like the "Mohazoni Karbar" done in the most organised way. This scribe really does not see any difference between NGOs' micro-credit and Mohazon's lending.
The recovery rate of the NGOs is very high compared to that of the commercial bank. If we analyse their claimed success we can see that the commercial bank has slightly lower recovery rate mainly because of high officials' involvement with the borrower. In most of the cases the defaulters have the ability to repay but they are unwilling to do so.
In case of NGOs, the borrowers are the poor people. They are forced to repay on time. Moreover, the mechanism they (NGOs) have developed -- weekly meeting and weekly recovery and formation of groups -- is effective in this regard. The poor borrower cannot escape from this. If we enquire we will find there are a number of cases that the borrowers have sold his or her other assets or land to repay the loans. So the success that is claimed by the NGOs is not the full picture. Behind the success story, there is a dark picture. In the long run the overall economy will suffer, as it is silently increasing the gap between the rich and poor.
Someone may ask: how the micro-finances are increasing the gap between the poor and rich. If we critically analyse, we can see and explain that. However, that is a different issue and one may not go into that direction.
If we consider the tax implication, we can see that the commercial bank is paying full tax on their profit whereas the NGOs do not have any obligation to pay tax. Although the operational activities and principle are same for these two sectors, one is paying tax and another is not. One can argue that NGOs are not working for profit and they do not distribute the earning. Their strong argument is that they reinvest their earning in other sector or among other poor borrowers. But the fact here is that NGOs are lending their earning to other poor people, which is fine, but they are doing so at the same high interest rate. It is not like a charity.
So we can see there is a clear discrepancy between what is said and what is done. In the modern investment feasibility study concept, tax is considered as a cost. So NGOs are getting competitive advantages. To overcome this imbalance, tax needs to be imposed on NGOs' micro-finance scheme. However if there is enough evidence that they have invested the earning, they may get the tax relief. Otherwise, they should pay tax based on the amount which is not yet invested or lent.
Foreign donor agencies also like the NGOs' micro-finance. Foreign large capital investing companies also like to invest their funds in the NGOs. The calculation is simple here. If they invest at 15 per cent interest rate into an NGO and 15 per cent in the commercial bank, the NGO will give more return as no tax is payable on its income.
This micro-credit has been rewarded by many developed countries, but they themselves cannot implement this kind of scheme. There could be many reasons for that. One reason could be that they do not need this kind of scheme -- the another and the most likely one is that it is not feasible in their countries. Borrowers in those countries can easily calculate the effective rate of interest and they will not borrow at such a high rate.
The government has a lot of things to do in this regard. If required, they can impose new regulations. Following are some suggestions that government can think about: the government can introduce a requirement for yearly compliance certification from an external body like auditor for those NGOs which are involved in micro-credit. The new tax rule for the NGOs may require that they have to pay tax on the profit distributed to the trustees or the amount which is not invested in another project. When foreign funds come to any NGOs, they have to notify the government with details of terms and conditions. Failing to do so may be regarded as non-compliance of the local law. A separate commission can be formed to oversee the NGOs activities and micro-finance operation.
However, a detailed analysis is necessary to overcome challenges created by the situation. The NGOs are also doing good things, rather they are actually doing very good jobs for the development of the country. Through micro-finance they have created huge employment opportunities having very good positive impact on the economy.
However, in micro-credit they are not doing exactly what they are saying. Even if they say their interest rate is 15 per cent flat which is not the case, the straight forward yearly rate is 47.59 per cent which is very high compared to 15 per cent flat rate. If we consider the tax implication, then the earning will be more than 100 per cent.
External auditor and also the internal auditor can play a vital role in this regard. Auditors can check the documents and verify the actual situation. It is the combined responsibility of the auditors, the government and sensible citizens to check what the NGOs are saying and what they actually are doing.
The writer is an ACCA affiliate and financial and management consultant