musings from the attic

India may cap interest rates charged by MF institutions

Reports in the press suggests that the Indian government may seek to cap the interest rate that microfinance institutions are allowed to charge loanees. This is in response to the crisis which I blogged about here.

I believe that this would be an extremely positive and timely intervention by the central government of India. When private profit making companies display the level of excesses showed by some of these so-called microfinance institutions, then the onus is on the governing authorities to step in to protect the interests of the weak, the meek and the poor.

This crisis would not have arrived at such an end if those who claimed to be serving the needs of the poor did not seek to benefit from the poor. Had they been sincere in their efforts to help the poor to exit poverty by extending credit for income generating activities, then things would not have reached the current situation. Instead these so-called microfinance institutes decided to start making money from their activities. Rather than helping their loanees increase their stock of wealth, wealth was being extracted from them; and that too at an alarming rate.

By capping interest rates, the message would be clear. If you seek to make a fast profit off the poor then you are not welcome. Please find some other business activity to engage in and prosper there. But if you are genuine about bringing access to finance to the poor at an affordable rate, then by all means carry on.


Microfinance crisis in India

Recently there has been bad press with regards to the microfinance sector in India. You can also read about this situation herehere and a related article here.

The problem stems from microfinance lenders providing loans to the poor, mainly women, who are then not able to repay the loans and end up taking on more loans to repay previous loans and thereby fall into a debt trap from which they cannot escape; the consequences of which has been suicides, people running away from their homes, property seizures, etc. In a number of states in India, public officials have gone on record urging these poor farmers not to repay their loans.

The problem is not the concept of microfinance. Rather the root of the problem lies with unscrupulous people and organizations who have gone into “bottom of the pyramid” lending under the guise of microfinance, with the intention of making quick profits from the poor. Many of these lenders charge interest on their loans well in excess of 60 – 70%. I have even heard of cases where people were charged in excess of 100% in interest.

Microfinance started off with the intention of providing access to finance to rural poor, especially women so that they can engage in income generating activities with the intention of pulling themselves up by their bootstraps out of poverty. It was discovered that with very small sums of capital investment, people can engage in economic activities to generate income for themselves. These people would start small businesses, dairies, chicken farms, or cottage industries and with the proceedings from these activities, they would then pay back the loan. This was how Grameen Bank pioneered the concept of microfinance.

Grameen Bank, along with its founder was awarded the Nobel Peace Prize for their work in bringing access to finance to millions of people in Bangladesh and around the world. This attracted significant interest in microfinance, and many people both good and bad jumped into the microfinance bandwagon. And microfinance programs proliferated across the world.

Many of these lenders who came into microfinance were in it to make money for themselves, and not because of the social goals with which microfinance was pioneered. They aggressively pushed loans to people who were not prepared to take on these loans – they did not have financial knowledge, or any understanding or idea what they were going to do with their loans in order to increase their incomes and crucially how they would repay the loans they took – while charging very high rates of interest. Out of desperation, these borrowers would take loans from other lenders to pay off the first lender. This would continue until the debt became too large to handle. Also, the lenders would in many cases use violence, both physical and mental, to force the farmers to repay. In many ways, these lenders are behaving just like the loan sharks were in the days before microfinance was pioneered.

The solution to prevent such loan shark activities in the microfinance are threefold.

Firstly, society (and more so the poor) needs to resist the activities of individuals or organizations who seek to make such unreasonable profits from the poor. It needs to be made clear to these loan sharks that it is unacceptable that they can seek to reap such profits from the backs of the poor.

Second, this crisis in India has shown the need for stronger regulation of the microfinance sector. The first thing that can be done is to set a limit on the amount of interest charged by the lenders.

There will be people who will be dead set against this kind of regulation; but the fact is that microfinance deals with two highly sensitive subjects – the poor and money – and so regulation is unavoidable. Especially since the lives of people are at stake. The private sector has shown time and time again that it is incapable of policing itself. Given a choice of steady growth with small profits and fast growth with large profits, lenders will almost always go for the second option.

Thirdly, countries need to have an organization which will act as the regulatory body and monitor the activities of microfinance lenders. Such a regulatory body will be empowered to protect the interests of the poor who borrow from microfinance lenders. In Bangladesh, such a body exists to watch over the activities of microfinance lenders.

What started off as a good idea is being abused by some for their own personal gain. It is a question of definition. What is and is not microfinance? Providing access to finance for the poor under terms which favour and help them should be considered as microfinance. But providing loans with extreme interest rates which do not favour the poor cannot and should not be considered as microfinance. Its time to take “microfinance” back from these loan sharks.