Fading prospects of micro-finance

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Fading prospects of micro-finance

Monday, 08 April 2019 | Moin Qazi

There is a growing awareness that credit is not always transformative. Although certain people will be able to use micro-finance to transform and build their businesses, that is not the case with a majority of loan takers. Most are going to use it to smoothen out their consumption

Micro-finance continues to thrive despite being under fire. One plausible reason for the lingering faith in it is that it provides a convenient strategy to investors to demonstrate that they are active fighters against poverty and are trying to save the poor while at the same time, they make a substantial amount of money. It is built on a false belief that credit is the most vital need of the marginalised. It has now become a vast global industry and attracts the attention of a large number of Governments, banks, non-governmental organisations and firms.

The sector would have closed the March 2019 balance sheet with a credit portfolio outstanding of nearly Rs 2,00,000 crore, serving over 50 million end clients — of which 95 per cent plus are women and for whom this is the first credit facility in their life — through over one lakh employees, including more than 60,000 outreach staff. This financial interface translates to over a billion transactions per year and can be a potent platform to achieve financial inclusion in the six key areas as defined by the Reserve Bank of India — access to a bank account, formal credit facility, insurance cover, pension, savings accounts and investment options.

Earlier, debates over the true value of micro-credit programmes relied mostly on anecdotal observations. But now, we have a plethora of studies to draw upon. For years, the development community promoted a fancy narrative of micro-finance, transforming lives by millions. But that account has not been held up. The verdict is now clear: Micro-finance can at best smoothen temporary financial bumps. It has moved from being good to bad, from being lauded as the silver bullet for poverty reduction to being derided as the progenitor of financial instability. The exuberance surrounding it has now worn off. Critics argue that those who have benefitted from the industry overstate its value in order to keep the model going. The social mission has been abandoned and financial mission is now the primary aim. Micro-finance is basically the distribution of small loans to help the impoverished, who otherwise do not have access to loans to engage in a variety of economic activities and cope with the financial shocks. While the objective is laudable and has a powerful social and economic philosophy, the impact has been varied across different profiles.

A growing body of research suggests that micro-finance doesn’t work for all communities. It may have worked well in Bangladesh in the 70s but failed to keep pace with changing needs and behaviours of the client at the lower socio-economic pyramid. The poor take loans with crippling interest rates or sell their tools and possessions and, hence, lose their basic means of sustenance.

The present second generation micro-finance is far different from the first generation model, which focussed on organic growth. The success of the original model was largely on account of green field methods, where micro-finance institutions (MFIs) laboriously promoted their own groups, nurtured them and painstakingly created a culture of credit discipline and high repayment based on peer respect and mutual trust. These principles were then abandoned by many MFIs because of their urgency to grow fast.

There’s little doubt that the founders of these organisations genuinely wanted to  help the poor and low-income people improve economic and social prospects. Over time, organisational goals (growing big, making higher profits and achieving international fame) have displaced the original mission. Micro-finance, including micro-credit, is often considered to be an instrument that promotes empowerment. While it can stabilise livelihoods, broaden choices, provide start-up funds for productive investment and help the poor smoothen consumption flows, it can also lead to indebtedness and increased exclusion unless programmes are well designed. 

One concern is that as micro-finance becomes more commercialised and increasingly concerned with the large-scale impact, profits take precedence over the 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 as an investment. Since most micro-finance clients have little or no security or collateral to pledge,  providers instead turn to what is called  “social collateral,” which is built through groups of borrowers, who guarantee each other’s loans.

Debt may not be the appropriate tool to alleviate financial woes of low-income communities. It is one thing that has both the greatest promise and, perhaps, also the gravest peril. Debt or credit, the cash that we borrow from lending institutions, exists for a reason. Before you apply for it, you should ask yourself if you have a valid reason for it, or are you taking it just because people are lining up the way pollsters queue up for freebies? The second question one should ask is whether it is part of his/her financial plan. If it is, are you sure you are going to get a return higher than what you will pay? This financial return should also cover your own effort that will go into generating that return.

A vast majority of micro-finance clients have no prior business or banking experience and little formal education. The intermittent income  of clients makes it difficult for them to pay back loans. When micro-enterprises fail to make profits, clients are forced to reduce consumption, skip meals, sell their land, take additional jobs, fall behind on other bills, sell valuable assets or default their loan and go without household necessities.

The biggest problem is that people, who get these small loans, usually start or expand a very simple business. The most common business for micro-finance is simple retail-selling groceries, where there exists fierce competition and they don’t really earn enough money. Not only are borrowers often innumerate, illiterate and unfamiliar with interest rate calculations but usually, they have little or no awareness of local demand for goods and services. Consequently, they often fail to establish successful income-generating ventures.

There is now a growing awareness that credit is not always transformative. Although certain people will be able to use micro-finance to transform and build their businesses, that is not the case with a majority of the people who receive a loan. Most are going to use it to smooth out their consumption. As micro-finance finds itself at one of the most defining intersections in its evolutionary history, it needs to answer several hard questions. Can new-age technology provide new products, mitigate risks and reduce costs to bring about a paradigm change in the micro-finance sector? Will the group lending model and mono-product model continue to be relevant? Will regulations enable further growth of the sector?

(The writer is Member, NITI Aayog’s National Committee on Financial Literacy and Inclusion for Women)

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