Microfinance At Crossroads : The Shifting Paradigm

 

Microfinancecartoon

Definition : Microfinance is the provision of financial services to low income clients who traditionally lack access to banking and related services.

Objective : of this blog post is to understand in very simple terms how the Microfinance industry has changed over the years and the way forward.

The Paradigm Shift : The Microfinance industry, after a relatively low key existence for many decades, has started attracting limelight, for reasons both right and wrong. This is how the paradigm is shifting.

Parameter Earlier Now
Are the poor risky to lend? This bottom of the pyramid segment was considered too risky to lend, keeping banks and prominent financial institutions away. With the established Microfinance Institutions (MFIs) earning profits, converting into banks and going public, bigger banks and mainstream financial institutions are getting attracted and are directly getting involved.
Commercialization Microfinance was a relative cottage industry championed by antipoverty and development activists Big banks, private-equity firms and pension funds are pouring in billions of dollars, resulting in the industry growing by 30%-40%. Banks are convinced there is money to be made.
Sophistication Limited sophistication, limiting the reach Millions are being reached with increasing sophistication and use of technology
Competition Limited competition, but that ensured stability of employees and adhering to processes. Intense competition. Disadvantages

  • Poaching of employees by bigger institutions from established MFIs,
  • Reckless lending.

Advantages

  • Lower interest rates
  • Multiple product offering (like life insurance, micro-mortgage etc)
Social Service or Profiteering? MFIs for social service that could ameliorate poverty and yet earn profit. Profit is a prerequisite to ensure returns to the shareholders/investors who are pouring in the billions.
Reach Less availability of funds meant reaching less number of poor With the MFIs slush with funds, reaching large number of poor is not a problem
Interest rates MFIs could easily charge up to 36% in India (on the pretext of high cost of funds – 15% and other costs), and even higher in some African countries. With spotlight on MFIs, there is little possibility of a high interest rate regime prevailing. For example, in India, the MFIs are already reducing interest rates by 2%!
Purpose of Microfinance Capital for entrepreneurs Capital for entrepreneurs as well as for purchase of consumer durables and for fulfilling other personal needs.
Recovery of bad loans Seldom controversial Reckless lending has resulted in default. Couple of suicide cases amidst accusations of forced recovery has made the matter politically sensitive.

Here is one of the video reports that has brought spotlight on the Microfinance industry in India for the wrong reasons.

At Crossroads : Clearly, Microfinance is undergoing a revolution, and the players in the industry as well as governments have a role to play to take full advantage of it instead of taking the wrong turn! Here is what the industry and the governments should do!

  • Lending should be strictly in the form of credit for entrepreneurs instead of being a consumer durable loan or a personal loan. That’s risky and defeats the purpose!
  • Governments should act as a facilitator and a watchdog, rather than being a player themselves (The Andhra Pradesh government in India is trying to be a player, which is uncalled for!). No politics please!
  • An upper limit on interest rates that can be charged from the poor (ceiling) should be determined by the central banks to avoid exploitation/profiteering. Only those institutions will then remain in the fray who intend to provide a social service that also earns money (and not the other way round!)
  • Reckless lending and/or multiple loans to the same family under competitive pressure should be avoided by MFIs. That’s a recipe for disaster.
  • Recovery agents should be regulated. They may employ illegal means for recovery without the knowledge of the management.

If the above points are adhered to, many of the ills that plague the industry today can be removed.

References

What are your views on the direction Microfinance is taking? What steps need to be taken to maximize the benefits of the revolution that is sweeping the MFIs? Your views are welcome!

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About Aman Sharma

Management Professional.
This entry was posted in Business, India and tagged , , , , , , , , , , , , , , , , , , , , , . Bookmark the permalink.

One Response to Microfinance At Crossroads : The Shifting Paradigm

  1. devconsultgroup says:

    Interest rates: The Poisonous Fangs of MFIsMFIs were touted to provide the poor access to affordable credit, reduce poor people???s need to use moneylenders and indebtedness. In short, provide a much kinder, cheaper alternative to the village loan shark. Instead, they evolved as the new class of institutionalized loan sharks which neo-liberals gave respectability to. MFIs did improve access to micro loans but failed in their touted mission to provide affordable and gentler credit and above all, one that lifted people from the clutches of poverty. Objects of institutional financial sustainability exhort them to charge interest rates and fees high enough to cover the costs of their lending and other services.MFIs argue that they need a spread apart from all costs to provide for contingencies and growth. Fine but the moot question is how much should be this spread.MFIs argue that economies of scale and competition will drive interest rates down. This remains only a theoretical argument. ???Mexican micro-finance institutions charge such high rates simply because they can get away with it???, said Emmanuelle Javoy, the managing director of Planet Rating, an independent Paris-based firm that evaluates micro lenders!!If at all, the average Indian MFI interests rates appear more benign than in Latin America or Nigeria, then it simply because other than factors internal to the MFI industry, the sector faces strong competition from governmental and NGO SHG micro-saving programmes in the absence of which, these MFIs would have formed a cartel. Past angry public and government reactions that resulted in a backlash against them, which included the arrests of MFI top leaders, like Uday Kumar of Share Microfinance Ltd as in 2007, keeps their profiteering impulses under check.The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. By 2014, they target to reach 110 million borrowers. Remarkably, despite two decades of operations, if statistics are to be believed, these MFIs only reach just 20 million people in the country, a good proportionate of them, multiple counted. Yet, they succeed in gaining an attention, so disproportionate to this minuscule reach. Act now to prevent they becoming an epidemic in the country. Act now, when they are most vulnerable.And how do know they are vulnerable? Because Vijay Mahajan, the father of MFIs in India tells us so:???We are facing collapse. Unless something changes on the ground, the industry as we know it is basically gone. ???Mahajan, we have news for you. The day when the likes of you are gone, that will be the turning point for the fight against poverty!What???s wrong with Micro-finance Institutions? Practically everything as the case of SKS illustrates.Read More: http://devconsultgroup.blogspot.com/2010/10/whats-wrong-with-micro-finance.html

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