MFIs: Malegam misses the point
Posted on February 3, 2011 | Author: T T Ram Mohan | View 290
Though the committee deals with the issue of regulating MFIs, it has not defined their role in financial inclusion.The panel's recommendations to tackle multiple lending and excess borrowing are difficult to enforce.The panel fails to appreciate the obvious fact that banks, not MFIs, should lead the way to the goal of financial inclusion.
Microfinance institutions (MFIs) have grown at an explosive pace in recent years. This growth has come at a steep cost: heavy concentration of loans in one state, Andhra Pradesh; overborrowing by the poor; extortionate interest rates; and questionable recovery practices.
These and the spectacle of promoters reaping huge gains in the name of uplifting the poor have caused a severe political backlash against the sector.
The RBI, which has hitherto adopted a hands-off approach to the sector, was obliged to set up a committee under Y H Malegam to go into the entire gamut of issues related to microfinance and make suitable recommendations. There were really two main issues that the committee needed to address.
One, what precisely is the role of MFIs in financial inclusion — is it to be a dominant role or a supporting one? Two, given that MFIs have a role to play, how best do we regulate them? The committee has addressed the second at length but steered clear of the first.
The regulations recommended are sweeping in nature and will definitely have the effect of reining in MFIs and ushering in consolidation in the sector. Since RBI committees are supported by the central bank’s own secretariat, they do reflect the RBI’s thinking even when they mostly comprise outsiders. The recommendations show how far quickly the RBI’s own thinking has evolved on the subject.
Last year, the RBI had indicated that it did not favour capping interest rates in the sector. Now, the committee wants a cap of 24%. In addition, it wants to cap the interest margin.
The RBI has had to change its mind because it has found that what was being said about extortionate interest rates levied by MFIs is true. The larger MFIs have been charging an average interest rate of 37%; the smaller ones 29%. In addition, there have been hidden charges.
The Malegam committee now wants only three components in any loan made by MFIs: the interest rate; a processing fee of not more than 1% of the gross loan amount; and the insurance premium.
The Malegam committee also attempts to tackle multiple lending as well as excess borrowing. To prevent multiple lending, it stipulates that a borrower should not be a member of more than one joint liability group/ selfhelp group and that not more than two MFIs should lend to the same borrower.
To prevent over-borrowing, it wants the aggregate value of all outstanding loans to a borrower to be restricted to . 25,000.
If the RBI accepts these stipulations, it could end up over-reaching itself. The issue is not the appropriateness of these norms. It is the enforcement of these norms at the grassroots. How on earth will the RBI ensure that MFIs adhere to these norms across millions of borrowers?
And who is to say that no borrower should have loans in excess of . 25,000? Or, for that matter, that the interest rate should never exceed 24%?
The best way to ensure credit discipline, whether in respect of borrowing limits or interest rates, is to mandate that all bank loans to MFIs should be through a consortium. This puts the onus for setting appropriate borrower limits and interest rates squarely on the banks.
The banks should be free to determine whether, in particular cases, borrowing can exceed . 25,000 or whether an interest rate higher than 24% is acceptable. The onus for monitoring of end-use of funds will also be on the banks.
The banks may appoint agents or assign staff for the purpose. Consortium lending to MFIs will ensure that the sort of runaway growth in MFI assets that we have seen in the recent past, fuelled by indiscriminate bank lending to MFIs, does not recur.
The more important policy question is the proper place in the sun for MFIs. In the prevalent neo-liberal philosophy, policy-makers have been more than ready to accept that the private sector is best placed to bring about financial inclusion. Some are even tickled by the thought that removing poverty through the provision of credit can actually be a profitmaking activity. What better than market economics married to poverty removal?
It is the acceptance of this philosophy that must explain why the SHG-Bank Linkage Programme has come to be overshadowed by MFIs in the last two years: the share of SBLP in outstanding loans has dropped from 74% to 60% between 2008 and 2010. MFIs have grown in relative importance not just because they are more aggressive or efficient but because of ‘lazy’ financial inclusion on the part of banks.
Since loans to MFIs qualify as priority sector lending, banks have found it expedient to meet their targets through loans to MFIs.
This philosophy ignores the fact that banks have lower costs and hence are in a position to deliver loans at lower rates than MFIs, while also providing other financial services.
Moreover, profit-oriented financial inclusion is bound to create problems, however best we try to regulate MFIs. Banks, not MFIs, must be in the forefront of financial inclusion. The Malegam committee conspicuously fails to make this point.