Is RBI to blame for microfinance industry's woes?

Yes, according to the Economic and Political Weekly (EPW), which said the central bank’s policy of not allowing microfinance institutions (MFIs) to hold savings “ raised the risk of client default and MFI collapse.”

In an article entitled “What’s wrong and right with Microfinance?”, the weekly argued that “in their enthusiasm for protecting people from fraudulent savings programmes, central banks formulate regulations that stop MFIs from offering savings products. This protects people from fraudulent operators but often means they need to store savings at home or in petticoat banks on their person”.

In contrast, in Bangladesh, MFIs hold compulsory savings from clients and if a client gets into difficulties with repayments, these savings provide a buffer for the MFI and client to manage potential defaults, EPW noted.

Of course, that might change with the new Microfinance bill, which is likely to allow MFIs to access public savings . It will also make the RBI the sole regulatory authority for the industry.

A lack of regulation has only exacerbated the other problems of the $5.3 billion industry, which was once touted as a savior of the “poorest of the poor”.

First, while the idea of microfinance was to provide very small loans to very poor people and lift millions out of poverty, the organisations involved became more and more commercial, shifting from their original character of being non-governmental organisations. The mode of finance also changed from being donor-led to bank-led. In fact, in the case of SKS Finance, it opted to raise funds through the equity markets.

Overall, the big criticism hurled at MFIs is that they raised funds at low cost (typically from banks) and lent to poor clients at exorbitant rates, citing high costs of administration. It was hardly the ideal way to implement the goal of financial inclusion.

According to some experts, MFIs also diluted the “basic spirit” of self-help groups (another kind of microcredit intermediary) and exploited some of their weakness, while focusing on “scale and profit”, according to this article in Business Standard.

Second, for financial institutions catering to the very poor, they charged very high interest rates - as high as 36 percent , according to_The Economic Times_. Worse, as many as 87 percent of borrowers of MFIs were unaware of the interest rates charged to them by the lender, according to a survey carried out by NCAER. To be honest, it was only a matter of time before these clients defaulted.

Worse, several MFIs used strong-arm tactics to recover money from defaulters, which reportedly caused a spate of suicides and brought the industry into considerable disrepute.

Third, the industry became highly competitive, most visibly in Andhra Pradesh, with the result that there was an all-out race to increase loan portfolios among institutions at any cost. Officials threw caution to the winds when sanctioning loans to borrowers. The same borrower was given multiple loans from different MFIs. Loans were even given for consumption rather than for income-earning assets.

The _ Economic and Political Weekly _alsonoted that in 2009 in Andhra Pradesh, the four big MFIs and many smaller MFIs were adding clients by 5-10 percent every month (more than 100 percent if you consider the annual rate) in some districts. It was an unsustainable model and, inevitably, went bust.