|Volume 5 Issue 04 | April 2011|
Transcending the Current Conflicts in the Microfinance Sector in Bangladesh
SYED M HASHEMI considers the ground realities of microfinance.
The backlash against microfinance
Microfinance impacts and poverty alleviation
What critics and many advocates fail to appreciate is the real raison d'être of microfinance. It is about financial sector deepening, about opening access to the nearly three billion people in the world still without formal financial services, it is about providing a range of services -- credit, savings, remittances, domestic transfers, insurance, pensions, etc. -- that we take for granted, but that is unavailable to the majority of the world. And even with credit and savings, it is not just about borrowing to set up economic enterprises. It is about payment for school and books, for health emergencies, for buying food stock when prices are low, for travel to the city to look for employment, and so many other activities that we use finance for. It is really about ensuring poor people have the same access and the same choices in the financial sector that we the privileged have. It is about democratising the financial sector.
And in terms of impact, microfinance is held to an extremely unrealistic bar. No development intervention, be it schooling, or health or access to justice, can claim to singularly lead to poverty alleviation. Just as the structures that create and reproduce poverty are multidimensional, so too are the sites through which poverty alleviation needs to be contested. What good are microenterprises if the market is so restricted that no one will buy their products? How can improved schooling and health be achieved through increased demand from microcredit clients if there are supply side failures -- no schools or no health care services? Yet what even the most rigorous econometric tests show is that Bangladesh MFIs have succeeded, through finance and only through finance, to ensure consumption smoothening of their clients. This means MFI clients are significantly better than others in addressing food insecurity, especially in the lean season. The difference in going to bed hungry or with a full meal is no mean achievement. To be fair, many impact assessments also show significant increases in earnings, in accessing health services, children going to school, contraceptive use and women's empowerment, though they do not establish a causal connection. This is not because there is no connection but because such expensive and complicated studies had earlier never been conducted. But two points need to be made. First, all perception studies indicate that MFI clients consider this access to have great positive significance in their lives. Second, unlike other development interventions, microfinance is fully financially sustainable and hence does not require subsidies or any financial outlays from the state or donors.
Interest rate caps
Several points need to be made here. First, for poor people, the only real alternative to micro credit is moneylenders charging over 10% a month, and with tied credit, often 200% to 300% a year. The reason that microcredit started and expanded was precisely because the commercial bank rate was not available to the poor. If MFIs were to stop lending, the real beneficiary would hardly be the poor.
Second, MFIs provide access to financial services at the doorstep of clients and meet with them on a weekly basis. And they provide much, much smaller loans to the poor than commercial banks do to their clients. This necessarily entails high costs that need to be covered through charging high interest rates. The cost of capital for MFIs is also much higher than that of commercial banks. MFIs often borrow at commercial rates of interest and then add to that the transaction costs, loan loss provision, inflation adjustment, etc. If commercial banks could lend to the poor at their regular interest rates they would drive MFIs out of business. They can't.
Third, many consider a 10% spread between the cost of capital and interest rate charged to be an appropriate limit. However, a review of the top MFIs in the world, including all Grameen replicates suggest that outside of Grameen, this is never achieved.
Fourth, a careful understanding of the financial lives of the poor reveals that given the multiplicity of financial needs and the range of strategies they employ to address these needs, what matters most to them is the reliability of access to finance, especially savings services. And even with credit, since repayments are very small regular amounts, what matters is regular financial inflows through multiple sources of earnings. Consider a 50 week 5,000 taka loan for petty trade. For clients paying a flat 15% rate of interest, this amounts to weekly instalments of 115 takas. This is a small amount since payments are weekly. If the interest rate were 10% flat, the weekly instalment would be Taka 110 -- a difference of only five takas per week. For poor people, the opportunity to start a new economic activity or expanding an ongoing one with microenterprise loan, and the knowledge that MFIs are reliable and timely sources of financing, far outweigh the difference in weekly interest payments of takas five or even 10 or 15. In fact, that is why poor people turn to MFIs even with high interest rates (70% in Mexico, for example) rather than subsidised government agencies with much lower interest rates.
Fifth, especially in Bangladesh, since almost all MFIs are non-profits, retained earnings are never siphoned off for private profits. They are used to massively scale up services to the poor. In fact, the key to scaling up should not be through subsidised government funding (that can be used so much more effectively for other social sectors) but through accessing commercial funding and market based interest rates to allow for reinvestment of earnings. Also unlike some MFIs in other countries, salaries of senior management in Bangladesh MFIs are still generally modest, so surpluses are rarely used to finance lavish management lifestyles.
Finally, what interest rate caps will do is deliberately distort the market so that a credit rationing of sorts will take place. MFIs will be forced to select less risky, better-off, clients who can afford larger loans so that MFIs can generate sufficient revenues to maintain sustainable operations in the face of interest rate constraints. In effect interest rate caps can easily lead to a mission drift away from poorer clients and from poorer, economically depressed, hard to reach areas.
Coercive practices and credit discipline
In Andhra Pradesh in India, a great drama is being played out where coercive practices in certain instances of some MFIs have led to a widespread attack on MFIs generally. While this masks the real reason for the conflict, an intense turf battle between government-led Self Help Groups versus private MFIs, it draws out the need for MFIs to engage in responsible finance. The focus of the public discourse, if we are serious about the needs of the poor, has to shift from interest rate caps and vilification of the sector as coercive, to one on client protection. New ideas need to be developed to ensure transparency on interest rates and all charges, financial education so that poor people understand the choices they face and so that they can make informed decisions, better and more ethical staff-client interface and mechanisms for clients to seek redress against grievances.
There also needs to be greater understanding of when and why coercion occurs. Why does the contract between the MFI and the client break up? Is it because MFIs are “blood thirsty” and hence force clients into contracts they cannot deliver on? Is there something systemic about the model so that credit expansion has to occur for institutional sustainability? Are the methodologies for client screening inadequate? Careful research is required to ensure we have a better understanding of the dynamics of “coercion” to ensure client protection. And to determine how best to manage the inherent tensions between zero tolerance on delinquency and real repayment problems that clients may face.
Multiple loans and over indebtedness
Many critics suggest that clients borrow from one MFI to pay off another in a circuitous survival strategy. Even a cursory examination would however indicate the fallacy of this argument. What is true of moneylender credit (where large lump sum repayments are made) is not true of microfinance. Most MFIs collect small weekly repayments. Such repayment records are copiously maintained and delinquency carefully tracked. A greater than 30-day non-repayment generally raises alarm bells. Hence, unless clients are borrowing small amounts from MFIs each month to pay off other MFIs, they would soon be identified as delinquent. So unless MFI records are deliberately tampered with, the likelihood of borrowing from one MFI to pay off another would be rare. What, however, can and does happen is borrowing from an MFI to repay a non-formal loan or diverting loans for other uses.
The second problem, the one on increased indebtedness, is the really serious issue. It is likely that multiple loans could lead to indebtedness and worsening client conditions, especially in a milieu of credit-led microfinance. While no large-scale study has yet identified this as pervasive, it is of serious concern. Any individual MFI, of necessity, will screen clients to ensure their earnings justify the loans being sanctioned. But such screening is based on partial information since they are not privy to credit information of other MFIs. Hence the heightened risk of collective loan size far outstripping borrower repayment capacity. What is required therefore is what credit agencies the world over use -- a credit information bureau that maintains records of not just loans and credit history but also earnings and repayment capacities of individuals. But this requires sharing of client information that many MFIs are yet to buy in to. It is time that MFIs in Bangladesh weigh the advantages of a credit bureau against the real threat of a systemic crisis stemming from mass defaults due to high indebtedness.
Portfolio quality and repayment problems
Microfinance Regulatory Authority
Confidence building issues:
Syed M Hashemi is Director, BRAC Development Institute.
© thedailystar.net, 2011. All Rights Reserved