Why MFIs deserve priority: Financial Express 23rd November 2010

When Muhammad Yunus won the Nobel Prize for his work in the microfinance sector, we all applauded. When SKS went public and succeeded, it was interpreted as the market vindication of the business model. But suddenly today it has become a dirty word. Are we over-reacting emotionally to a sound business proposition?

The media has been full of views of ‘assault’ on the ‘MFI model’ to such an extent that even the owners are talking of lowering rates and sounding apologetic of their businesses. The view here is that we need to treat the MFIs, as we do any other business, in a dispassionate manner.

One, we need to realise that in a market setup, every commercial enterprise runs for profit and not on philanthropic terms and there is nothing wrong with this. The government can afford schemes like NREGA, which spend without creating assets that placate the poor but not the fiscal numbers. But the MFIs should not be criticised for working for a profit. While their funds go to the poor, there is some good that happens, but considering that there are costs while carrying out this business, one cannot question a return.

Two, the return is considered to be very high, which in a way is true, but there could be a justification for the same. Today, they borrow at between 12-15% from banks, incur incidentals of 6-7%, and make provisions for NPA, CAR and insurance, which comes to another 3-4%. Intuitively, the cost could cross 20%. Now, the question is what should be the return for such an enterprise that will make a lending rate acceptable? Do we apply such standards for other industries that also provide goods and services to the poor? The answer is No. One may recollect that when the mobile telephony business commenced, costs were multiple times what we are paying today. The force of competition brought this down, and the same will hold for MFIs, if the system is allowed to grow.

Three, is the 30% interest rate high? One cannot give a clear answer here. Today commercial banks charge similar amounts on credit cards and while RBI has sounded them on being transparent, the charges are still usurious. If one is talking of transparency, it is another issue wherein the MFIs may be told to explain the product to the borrower, which incidentally is never done when selling credit cards by banks.

Four, using counter-intuitive logic, the fact that people are willing to pay, let’s say 30%, as interest for a loan of Rs 10,000 means that they are doing it willingly as there is no alternative. The moneylender charges higher rates and hence the MFI makes sense for them.

Five, can the loans being offered by MFIs be provided by banks? The answer is that it is not happening in any significant measure. Therefore, the fact that MFIs are entering a rather virgin terrain is quite commendable as others have consciously had limited exposure here. Curiously, the BC model being spoken of partly reflects what the MFIs may be doing on the lending side.

Six, the latest data provided by RBI shows that overall NPAs of banks are almost equally divided between the priority and non-priority sectors. Given that outstanding non-priority sector loans are around twice that of priority sector loans, the probability of a loan going bad in the priority sector is almost 70% more than that in non-priority sector. The MFI segment would carry higher risk and is less attractive for banks. Also, there is interest rate subvention to the extent of 2% on farm loans, which enables loans at 7%. No such facility is available for MFI loans.

Seven, the use of force for recoveries has come under criticism. There are three issues here. The first is that there are legal processes that can be invoked if something wrong is being done. Second, we have similar tales on commercial banks regarding consumer and auto loans, where coercive measures are used, which, however, do not provoke a similar response. Lastly, in India, as a rule, we are sympathetic to defaulters and hence apply a double standard when someone does not repay loans. Defaulters across all segments have the upper hand with their lenders, which is not sustainable if we want a strong financial system.

Admittedly, there is certainly a case for bringing in more regulation and transparency to the operation of MFIs. But given that there are no alternatives available for this section, we need to develop this area and move beyond the politicisation of the issue. We need not eulogise the MFI business as being fit for the Nobel Prize, but, to borrow words from the legendary rock band Pink Floyd, this is just another ‘brick in the wall’. As a corollary, Teacher, leave the kids (MFIs) alone.