Malegam panel: brave but messy report
Posted on February 2, 2011 | Author: Swaminathan S Anklesaria Aiyar | View 302
In its anxiety to protect borrowers from excessive debt, the committee may kill newer MFIs, especially those in remote areas most in need of financial inclusion.
The Malegam committee has made a brave effort in its report to keep the microfinance industry alive while pacifying politicians in Andhra Pradesh who want to shut the industry down, accusing it of causing suicides. In the process, the committee has fallen between two stools, combining many sensible suggestions with others that are seriously flawed.
Since politicians have accused microfinance institutions (MFIs) of usurious profiteering, the committee suggests an interest cap of 24%. It assumes that MFIs can get funding at 12%. It says the lending margin (difference between an MFI’s borrowing and lending rate) should be capped at 10% for large MFIs with portfolios above . 100 crore, and at 12% for smaller ones. This amounts to a double cap: a 10-12% cap on the margin, plus an absolute 24% lending cap.
Problem: MFIs simply cannot get all their funding at just 12%. The committee has looked at historical data that do not mirror today’s realities. Yes Bank recently raised its interest rate to 17% for one MFI. Other MFIs are negotiating loans at 15-16%. Every time the RBI tightens monetary policy, interest rates go up. How can you cap MFI lending rates when there is no cap on their borrowing rates?
In trying to check profiteering, the committee may kill newer MFIs with high start-up costs, especially those in remote areas most in need of financial inclusion. Such MFIs lose money even with lending rates of 36%. The double cap may squeeze out all but a few large MFIs, including the major culprits of multiple lending and overlending!
The committee fails to address a basic question: why cap the margins and maximum loan of microcredit NBFCs when there is no such cap on other NBFCs? Even banks charge 24-30% forsmallpersonalloanswithoutcollateral. Credit card rates are also 24-30%.
The proposed interest caps are aimed at AP politicians and media critics, who think usurious interest rates are leading to suicides. The committee should have made sample calculations to illustrate the impact of interest rate cuts on the weekly equated installment of borrowers.
Fact is, if interest falls from 30% to 24% for a loan of . 8,000, the weekly installment falls by only . 7! It is absurd to suggest that . 7 per week is the difference between healthy and suicidal borrowing. In the MFI model, the bulk of the weekly installment is principal, and interest is a small component. Any MFI cap needs to be much more flexible than the Malegam norm.
The committee is so anxious to protect borrowers from excessive debt that its recommendations will strangulate small businesses. The committee says total indebtedness should not exceed . 25,000. But many studies the world over show that poor families already have much higher debt levels — loans from friends, relatives, moneylenders and pawnbrokers.
No MFI agent visiting a village for half an hour per week can discover the true assets and liabilities of borrowers who have every incentive to hide the truth.
The committee may be right in thinking that consumer debt exceeding . 25,000 can be dangerous — although poor families routinely borrow much more for weddings. The committee wants at least 75% of MFI loans to be for productive purposes. Elementary economics says that money is fungible, and you cannot say how one single element of cash inflow is used for which spending purpose. The IRDP scheme tried to enforce the productive asset clause, so the same buffalo was displayed by every villager wanting a loan. Why aim for a repetition of this farce?
Inflation means a buffalo costs up to . 25,000, up from . 10,000 not long ago. Soon the proposed combined MFI lending limit of . 25,000 will not buy even for one buffalo. Much worse will be the plight of other small businesses wanting to scale up. Lending norms must be indexed for inflation.
I have heard village women argue that they need . 50,000 for a good shop. They also say the MFI model is terrible for business. If an MFI gives her a loan of . 15,000, she can stock her shop with several items and attract good business. But weekly repayments mean that within six months her net loan is down to . 7,500, so she lacks working capital to stock her shop well. And after 10 months her MFI loan is so small that her shop shelves are half empty. Such people use multiple loans to manage their stocks. The committee fails to recognise either the gross insufficiency of . 25,000 as an enterprise limit, or the rationale of multiple borrowing in some circumstances.
MFIs can be asked to give two classes of loans. One would be small credit loans for consumption. Two would be micro-enterprise loans that can gradually be ramped up to . 2 lakh to enable small businesses to scale up. There is a dire need for microenterprise credit, which banks cannot meet but MFIs can. In Latin America, MFIs lend mainly to microenterprises rather than poor women. Compartamos charges 70% interest and is repaid by microenterprises, unflawed by sorry tales of suicide.
The committee says no MFI should devote more than 10% of its business to activities other than lending. This is plain wrong. MFIs have created a client platform in villages which banks cannot. This platform should now be used for a wide range of services, such as life and health insurance.
Many villagers buy animals, so MFIs should provide veterinary services and insurance. By bulking purchases of basic goods, MFIs can get villagers big discounts to retail prices. Such examples can be multiplied. Instead of aiming for such diversification of MFI services, the committee goes in the opposite direction.
There is no space in a short column to discuss all the other issues, on some which the committee has made sensible suggestions. But the RBI needs to take on board critiques of the report, and amend several recommendations that cry out for change.