MFIs only give money to borrowers but they are not allowed to raise deposits. Unless and until they are allowed access to small deposits, their cost of money will remain high as banks and they will not be able to bring down the cost of tiny loans that they offer to poor people.
K.C. Chakrabarty, the senior most deputy governor of the Reserve Bank of India (RBI), who oversees rural credit, among other things, says microfinance institutions (MFIs) will be around for next 10 to 15 years till commercial banks are able to reach out to every nook and cranny of the nation, but these institutions will not be able to scale up. Usha Thorat, who used to look after rural credit as RBI deputy governor till she retired in 2010, says the biggest challenge of MFIs in India is to marry scale with responsible lending. Both of them were panelists at Mint’s Clarity Through Debate conclave on microfinance and financial inclusion in Mumbai last week.
According to Vijay Mahajan, founder and chairman of Basix social enterprises group, India’s oldest MFI, who also took part in the discussion, MFIs should be allowed to sell other financial products such as insurance and mutual funds. Besides, they need access to small deposits. Currently, MFIs only give money to borrowers but they are not allowed to raise deposits. Unless and until they are allowed access to small deposits, their cost of money will remain high as banks and they will not be able to bring down the cost of tiny loans that they offer to poor people. But Chakrabarty is firm that MFIs cannot sell every financial product available in the market without being overseen by the respective regulators. He is also categorical that MFIs will never be allowed to accept deposits—if they want to do so, they must convert themselves into banks.
Both sides—the regulator and the industry—are justified in what they are saying and this is why issues involving microfinance in India are complex. An October 2010 state law in Andhra Pradesh, promulgated after reports of a spate of suicides following alleged coercive collection practices of MFIs, has put the industry in a coma. Andhra Pradesh, India’s fifth largest state by population, used to account for one-fourth of the industry, and borrowers there are not paying back money. As a result of this, the size of the MFI industry has shrunk from Rs. 30,000 crore in 2010 to Rs. 15,000 crore. Banks are reluctant to give money to MFIs and private equity funds have lost interest in their business.
If the banking regulator sticks to its proposal on the amount of capital a microlender needs by the end of the fiscal year, quite a few large MFIs will be forced to close down business as they will have to write-off the bulk of their Andhra Pradesh loans that have turned bad and this will erode their capital base. Both the industry as well as the regulator are grappling with too many complex issues, including protection of customers as well as credit culture and irresponsible lendings by some of the MFIs, and the least relevant thing at this juncture is the rate at which MFIs should give money to their borrowers.
RBI has capped the loan rate at 26% and margin at 12%. If indeed an MFI needs to have 12% margin, the cost of money for it should be 14% (to be able to give loans at 26%) but that is not the case as bank loans are more expensive. After announcing the cap, RBI has raised its key policy rate many times and commercial banks, which account for 80% of MFI resources, have raised their loan rates. Besides, the rising risk perception about the industry has also jacked up the cost. If indeed RBI needs to cap the loan to protect the interest of poor borrowers, it should be linked to a benchmark rate and not arbitrarily, which is the case now. Besides the cost of bank loan, which has been rising, the delivery cost varies from state to state, and hence, there cannot be a uniform rate across India. The delivery cost in Andhra Pradesh, where borrower concentration is high, will possibly be one-fourth of the cost an MFI incurs in the north-east.
How much is too much is a matter of debate when a majority of poor borrowers do not have access to loans. Money lenders in Tamil Nadu continue to lend under the ritual of meter vaddi, where a person can borrow Rs. 1,000 and pay back Rs. 100 every month for next 12 months. Many retail vegetable vendors across India buy vegetables from wholesalers every morning and while paying cash in evening they pay 10% more—Rs. 1,000 for Rs. 900 worth of vegetables bought. They can afford to pay so much because the financial returns in activities that the poor engage in are pretty high. A Basix study shows the higher the capital employed the lower the financial rates of return. At the lowest level of capital employed (Rs. 500), the financial return is the highest but the net income per day is low. Which is why the poor can pay high interest rates and be borrowers for years and yet the income level does not improve vastly.