From Dream to Harsh Reality?

​The Story of Microfinance in Development

​Most of us have read the recent news reports on SKS Microfinance in the papers. While these pertain to one company and some recent occurrences, the problems have become quite common. They have far-reaching effect on the sector and the people who rely on microfinance to set up or develop their enterprise. This article looks at microfinance and its evolving nature in the context of a country like India that has a very large section of poor and vulnerable population. 
What is the purpose of microfinance? Microfinance helps people to overcome poverty by giving target populations collateral-free loans and other financial services to support income-generating businesses. Microfinance, by definition, focuses on the most vulnerable i.e. the poorest and women among them.
Microfinance consists of making small loans, usually less than $200, to individuals, usually women, to establish or expand a small, self-sustaining business. For example, a woman may borrow $50 to buy chickens so she can sell eggs. As the chickens multiply, she will have more eggs to sell. Soon she can sell the chicks. Each expansion pulls her further from the devastation of poverty[1]. It also develops in her a sense of independence and self-esteem within her own family and community. Thus, in multiple ways the money and the credit process help to bring about positive changes in individuals’ lives and society as a whole. 
Microfinance also makes sense in business terms for the groups / institutions which are involved in lending money. This happens through the recycling of funds. As loans are repaid, usually in six months to a year, they are re-loaned. This continual reinvestment multiplies the impact of each dollar loaned.
There are two models that have evolved in the microfinance sector. One is the more structured Grameen bank example of an institution lending money to small borrowers. But at the community level there has always been a second functional model, based on self-help groups, though at a much smaller scale. In the second model, microfinance was developed as a tool for fairly homogeneous groups within the community that were involved in small savings that could then be extended as loan to a needy member. Because of the pressure from members loan repayment was also quite regular and smooth.
Further, like Muhammad Yunus, the founder of Grameen Bank in Bangladesh and the driving force behind recent microfinance initiatives states in an interview to Business India dated November 14, 2010, the money that microfinance banks/institutions lend must also come out of deposits only. That is, in both models the money for the loans comes out of deposits/savings by the people in the community. The money does not come from the commercial capital market with its strong profit motive. But this is not the trend in India.
So, how can microfinance be of maximum benefit to those whom it aims to help?

1. by giving credit to the most needy
2. by keeping the interest rates and any other costs involved low
3. by keeping the formalities for taking loan simple
4. by strengthening the groups that are critical to effective functioning of the microfinance model

Now let us briefly look at the SKS story and what went wrong. A successful IPO and a corporate governance issue drew a lot of public attention towards the company. But microfinance and microfinance institutions had been attracting negative attention even before these developments because of alleged suicides by poor people unable to repay loans.
What are the new trends in microfinance?
Ø  From an initiative having a distinct community flavour and based on groups, microfinance is now almost entirely under the control of large microfinance institutions and other finance companies.
Ø  The money is sourced for microfinance loans from commercial capital markets.
Ø  The interest rates have grown manifold. In some cases it is as high as 30-60% including several other costs in getting the loan.
What are the arguments put forth by the institutions for changes in the microfinance sector?
1.   The need for loans among the poor is very high and can only be met with capital from the commercial market
2.   Even if interest rates are higher for loans from the microfinance institutions, there are fewer other costs unlike a loan from banks in terms of processing the loan etc.
3.   In the absence of collateral, interest rates will be high as risk is high
4.   Microfinance institutions are doing a unique service by reaching out to the poor spread far and wide whom banks are unable to reach
 
What is the reality? None of the costs actually justify such a steep rise in interest rates. Also, the earnings are not used for the benefit of the poor. They are more often going into the pockets of the rich as returns on their capital or as fat salaries for the microfinance institution’s staff.
Do we see the seeds of a similar crisis in all institutions disbursing microfinance? The answer could be in the affirmative. Microfinance is a tool to assist the poor to emerge out of the vicious cycle of poverty and vulnerability. By having high rates of interest and driven by institutions run by capital with a profit motive, the core principles of microfinance are compromised and changed. Thus, the loans given out by these institutions may further increase vulnerability of the poor and may be totally out of the reach of the very poor.
 
Analysis also reveals that the availability of easy credit has led to a completely new trend. Excessive borrowing by the poor – both in terms of number of loans and total amount borrowed. And more often now, the loans are not taken for any economic activity but simply for consumption. Given the fact that often women are the borrowers, there may be a lot of social pressure to borrow and spend for festivals or important events in the family. This will only further push them into a vortex of poverty.
 
Interest rates in the sector have to be brought down substantially. Also, the recent trend that public sector banks preference to extend credit to microfinance institutions rather than directly to the self-help groups of the poor must end. By doing this, banks have contributed to the present crisis.
 
We have come a long way since microfinance was introduced as a tool towards development. Microfinance may fail to serve its original goals of poverty alleviation and development. It could have become a means for further exploitation and aggrandizement by a few. This is substantiated by the recent cases of suicide.
 
What can be done to stem this crisis? Firstly, interest rates have to be brought down through Government intervention. Secondly, the proliferation of private players in microfinance has to be checked. Again, the Government has to play a critical role in this. Thirdly, if there is a shortage of capital this can be garnered through tax free bonds at low rate of interest from the general public. This will increase accountability and reduce the greed for profit. Lastly, as many experts suggest a microfinance regulatory authority has to be set up to monitor developments are not exploitative of the poor in the long run.


[1] Source: Grameen Bank