Demonetization: Micro-finance may have to write-off 7% of outstanding loans, or Rs 7,000 crore

microBy Moin Qazi*

Reviewing the impact of demonetisation on its first anniversary, it is evident that several sectors have suffered severe setbacks. The microfinance industry is one of them. According to Microfinance Institutions Network (MFIN), a self-regulatory organisation of the NBFC-MFIs, the MFI industry which has a total loan portfolio of just over Rs 1 lakh crore, may have to write-off 7 percent of outstanding loans, or Rs 7,000 crore, because of delinquencies due to demonetisation.

“Demonetisation affected a lot of businesses where cash was used extensively including MFIs. But the impact has been extended in case of MFI sector due to non-monetary influences on the ground after demonetisation,” says Ratna Vishwanathan, CEO, MFIN. She explained that the non-payment after the first three months were more influenced by people who were politically motivated or had vested interest and wanted to create a place for themselves in the business post demonetisation.

Microfinance has been facing trouble lately because of what observers feel is the dilution in the purity of its mission. In its initiation, microfinance was a financial tool being used for social good. It has now become more of a social tool used to generate money, losing its original sheen in the process. This is one reason why microfinance often hits periodic roadblocks and default crises. A number of rigorous field studies have shown that even when lending programmes successfully reach borrowers, there is only a limited increase in entrepreneurial activity and no measurable decrease in poverty rates.

One concern is that as microfinance becomes more commercialised and increasingly concerned with large-scale impact, profits will take precedence over a social mission. Anything not strictly financial is cut in the name of “efficiency.” Profit-minded shareholders see training for entrepreneurs, financial literacy and counselling, skill training, or even the extra five minutes a caring loan officer might spend with a client as a cost rather than an investment.

These small-denomination loans are often used for a variety of purposes. It could be for small business or for coping with unpredictable incomes by making funds available to meet their basic needs and manage shocks such as death or illness. Done right, these loans have shown promise in allowing some borrowers to build sustainable livelihoods.

Owing to circumstances beyond their control, a lack of skills and business acumen, a proportion of poor borrowers encounter hardships in repaying loans. While microfinanciers suggest that such problems are overcome through ‘social support’, this is often not the case.

Is microcredit transformative? Evidence shows that borrowers very rarely start businesses. Most buy durables for their homes. Studies have found no substantial evidence that small loans lift people out of poverty. The reasons for this are fairly simple.  Most microfinance loans are not even used to set up businesses but instead to fund household consumption. In such cases, the motivation is to buy the basic necessities needed to survive or to pay for unavoidable expenses such as getting their children married off.

As a result, borrowers do not generate any new income that they can use to repay their loans. They end up taking new loans to repay the old ones, wrapping themselves in layers of debt. Even when micro-loans are used to fund new businesses, poor entrepreneurs often face a lack of consumer demand since most of their potential customers are also from poor households, struggling to make ends meet.

“We must think beyond the standard microcredit model. Modern microfinance—savings and insurance, and more flexible credit products—often have generated larger impacts than simple credit,” says Dean Karlan, the well-known microfinance researcher and founder of Innovations for Poverty Action. “Financial services can make important differences in people’s lives, but we need more innovation and evidence to determine what is best to do, and meanwhile we should set our expectations appropriately.”

To ensure a smoother and dependable client base, microfinance has to rejig its agenda and properly refocus so that both social mission and business goals are balanced. Similarly, people should be made aware of modest gains that microfinance can deliver. The fairy tale narrative has done harm both to the industry, the society and has left the investors dismayed.

Microcredit still has a place in development economics. Paired with other development tools like cash transfers, microlending can offer a sustainable investment option for small entrepreneurs, leading to a renewal in its mission to fight poverty.

Political leaders must realise that hope and rhetoric are great for burnishing one’s electoral credentials but not for figuring out what needs to be done. The poor are no longer quiescent. They can distinguish populism from genuine concern and demonstrate it through suffrage. Politicians may be right when they say that MFIs must practice microfinance responsibly. However, they must also ensure that they are allowed to practice it sustainably.

Fixing one point on the economic continuum will not make a difference unless all parts of the continuum improve at the same time. What the politicians need to do is focus on the crippling economy which can barely breathe in an environment of suffocation created by the severe currency crunch. What the rural population actually needs, and what can help MFIs, is more of economic oxygen.

Several MFIs endorse smart microfinance being espoused by the Smart Campaign but it is important that it is practised on the ground. What is smart microfinance? Microfinance industry leaders from around the world came together in 2008 to launch a campaign to establish the Client Protection Principles. These principles are appropriate product design and delivery, prevention of excessive indebtedness, transparency, responsible pricing, fair and respectful treatment of clients, the privacy of client data, and mechanisms for complaint resolution.

The principles of smart microfinance are globally recognised as the basis of safe microfinance. They build strong, lasting relationships with clients, increase client retention and reduce financial risk. When they deliver transparent, respectful and prudent financial services, financial institutions ensure that their clients use financial services well and build a foundation for healthy operation for years to come.

To put the principles into action, the Smart Campaign was launched in October 2009. Today, it is a global effort with over 4,000 signatories, a wealth of tools and resources, and an ambitious action agenda. One of the campaign’s fundamental mantras is: ‘Protecting clients is not only the right thing to do; it’s the smart thing to do.’

When these features are weak or missing, even well-intentioned lenders feel pushed into harsh practices. When word gets out that a lender is soft, mass default can quickly infect the whole portfolio.

Poor people need to have access to safe, sound, reliable and respectful systems in order to fulfil their financial needs. Microcredit still has a place yet in development economics. Paired with other development tools—such as cash transfers and savings—microlending can offer a sustainable investment option for small entrepreneurs, leading to a renewal in its mission to fight poverty.

Institutions need to be more diligent in their lending but politicians also need to be wary. In aiming at the occasional overstep, they may destroy microfinance itself. That would be a great disservice to the world’s poor. Let us get back to our fundamentals once again.

*Contact: moinqazi123@gmail.com

 

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