What’s microfinance upto?

SUBIR ROY

AFTER half a century of growth, microfinance seems to be currently going through one of its periodic off-colour patches. In July, the Reserve Bank of India (RBI) asked microfinance lenders in Bihar and Uttar Pradesh (UP) to go slow on disbursement as a precautionary measure as it saw signs of over-heating in the previous three months.

What happens to microfinance in these two large and fairly impoverished north Indian states is important because together they account for a quarter (25.3 percent) of the total number of microfinance loans. They are also among the fastest growing in the sector for half a decade now. Bihar, in particular, has overtaken West Bengal and Tamil Nadu to become the state with the largest MFI (Microfinance Institution) loans in the country.

The current travails of the sector are illustrated by microfinance company Spandana Sphoorty Financial taking the dramatic decision to stop lending to new customers who do not have a credit history. In a few branches where there are signs of high stress, it has even stopped taking on new customers with or without any earlier credit history.

To understand the importance of what has taken place, it is critical to understand that microfinance lenders lend without any kind of security. All the comfort the lenders have is to get the borrowers to form groups and undertake to ensure that all group members abide by disciplined repayment.   

There are several reasons why repayment has suffered lately. A heatwave set back agricultural schedules, depressing the sentiment of farm workers and affecting the level of attendance at group member meetings. Disruption was made doubly worse as the country had to go through a long general election process lasting seven phases. Particularly affected were Bihar, UP, Madhya Pradesh, Maharashtra and Odisha.

This is not the first time that the sector has met with a setback. Historically, the first and the worst was the blowout in Andhra Pradesh in 2010 when scores of defaulting borrowers, unable to take the pressure of strongarm collectors, died by suicide.  Then came the setback caused by demonetisation in 2016 and thereafter followed the pandemic which hit in 2021. Microfinance has recovered from all these. The ability to keep going forward depends on being able to change regulations to respond to new changes. 

The cardinal reality is that micro loans are not a magic pill to alleviate poverty but do make a material, if marginal, difference in poor people’s lives. If we come to the current reality of the reason for Spandana’s action it is necessary to appreciate that there is no need for any history of credit record in microfinance.

It all began with the practice of giving small loans to poor women in villages and urban slums without security for short periods, which they would repay in easy instalments and thereby become eligible for another slightly bigger loan. Women with good credit records would get successive rounds of loans which would make a big difference in their lives.

A borrower being unable to repay a loan would make her ineligible for a fresh loan. So a microfinance lender would, at worst, lose the last loan if a borrower failed to pay the last one and would not get the next one. Seeking to keep a record of credit history for such borrowers and taking a decision on it as done by Spandana is not so critical.

Microfinance lenders know that borrowers will sometimes temporarily use the money to meet urgent family needs like a child’s school fees or the cost of treating an illness and still pay back eventually. A serious illness is, of course, only treatable by selling a family asset like a plot of land but that is a different ballgame.

Microfinance does not claim to address problems like family emergencies. A bank official, on the other hand, who finds a loan borrower is defaulting, will ask a borrower to deposit some more collateral security.

There is also a difference in the way the two kinds of lenders determine the interest rates they charge. Microfinance lenders charge interest rates keeping in mind that some poor borrowers will default (the husband of the borrower may lose the power to earn a living) and the loan will have to be written off. Microfinance lenders will typically have to secure finance at a higher rate than banks which are generally larger. 

However, sometimes bank officials will charge a stiff lending rate to microfinance borrowers simply because they find that the market at that particular time allows them to do so. They are legally permitted  as RBI rules now do not lay down any interest rate ceiling for microfinance lenders but ask them to lay down the rationale of their lending and keep within their parameters. As a result, the entire  sector at times faces public criticism for charging a high rate of interest to very small borrowers. 

At the end of the day microfinance is a mission. Those who do well and grow are able to change into NBFC-MFIs (Non-Banking Financial Companies-Microfinance Institutions) and small finance banks. One of them has, in fact, become a universal bank — Bandhan Bank. As they grow they become indistinguishable from generic commercial lenders. For example, adverse mention in the media currently has affected the share price of Bandhan Bank.

Spandana has recently acted as a commercial lender but needs to keep in mind that it is also a microfinance practitioner which has to abide by a different culture. The inability to do so raises the question — are  some microfinance deliverers losing their ethos? If this is so then are we seeing the beginning of the end of microfinance as we have known it? 

Subir Roy is a senior journalist based in Kolkata