Without access to savings and insurance, vulnerable households are likely to take as much debt as they can from MFIs (and now banks). A more holistic approach to financial inclusion will help avoid another bad debt crisis.

The twin effects of demonetisation and farm loan waivers have led to long and high-decibel debates on their impact on various aspects of the economy. The conversation however seems to have left out one significant segment of society–poor households who borrow, for non-farm based activities, from microfinance institutions.

The microfinance industry in India itself is at an inflection point. Several microfinance institutions (MFIs) have converted into small banks, a few universal banks have acquired full or strategic stakes in NBFC-MFIs, whilst others have taken a direct or business correspondent-bank partnership route for providing micro loans.

Banks are now embracing financial inclusion as a commercially viable proposition, rather than an obligation. For the first time in the history of banking in India, it is possible for financial services to reach every individual and small business at an affordable cost.

We have, no doubt, come a long way since the Andhra Pradesh crisis of 2010, with the credit bureaus, transparency, borrower education and improved collection practices.

For the first time in the history of banking in India, it is possible for financial services to reach every individual and small business at an affordable cost.

Today, with microfinance clients entering the mainstream, the formal banking system has an opportunity to cultivate a symbiotic relationship with vulnerable households to build their financial health rather than focussing on microcredit alone. And they must do this not only for the sake of their customers but also for their own financial well-being and profitability.

Microfinance

Was demonetisation a black swan event for the microfinance industry?

Until demonetisation, the industry strongly echoed the mantra of the historically ‘golden’ repayment rate of 99%. After demonetisation, we saw a slump in disbursements over November and December 2016, and an erosion in repayment rates. The disbursements have quickly bounced back, but repayment delays continue.

Non-performing assets (NPAs)–the position for accounts due beyond 90 days–which hovered at well below 1% of the portfolio in the past, are nearing a record 5% across the industry and even double digits with some lenders. The general belief is that these too will gradually come back, as they were impacted by an ‘external event’; that the client will be able to make up the missed EMIs at the end of her loan cycle. The RBI provided a grace period of 90 days before NPAs needed to be recognised. This period has since lapsed and delinquencies continue to loom higher.

The areas that showed particularly bad behaviour were those heading towards polls, with local leaders calling out to women groups to boycott repayment to MFIs saying that they would ensure loan waivers, along-side farm loan waivers.

Loan waivers are anathema to good credit culture, and if farmers or poor households need help to tide over shocks, there are other ways to deal with this–but that is a different story.

If the MFI client’s debt is really within prudent levels, and she understands that her access to formal credit will vanish if she defaults, why is she following the political Pied Piper to stop repaying her loans? We must introspect–is the drop in repayments the outcome of an ‘external event’ or is there something we are missing?

The changing nature of loan usage

MFI clients have exhibited stellar repayment rates and normally, they prioritise repaying loans as they value their access to formal financial institutions. However, incurring expenses towards for instance, an unexpected health scare or a child’s education, in the absence of a financial cushion, creates tremendous stress. Loans are used as a surrogate when other financial products would better serve such situations. There is also the tendency, amongst the most vulnerable MFI clients, not to refuse debt whenever it is available.

Loans are used as a surrogate when other financial products would better serve such situations.

My memory takes me back to when I would spend time with community women in financial literacy classes. Participants, many of whom were not necessarily loan clients, would role-play, and the classes were structured to mimic real life choices.

One of the situations dealt with the ability to take a loan from an MFI, and then a second, a third and so on.

“What do you think you would do with the money?”

“What factors would influence your decision to take the loan?”

The answers for taking the first couple of loans were usually well thought through: to repay the moneylender or for an identified need such as paying school fees, improving the home or investing in business. However, with successive loans the purpose became vague, and on probing, she would admit, “I will take the additional loan, as it may not be available next time or next year.” Or, “Someone else in my family or social circle could use it.”

Such clients are looking at cash flow and not the cost of money. INR 10,000 for INR 1,000 per month seems a good deal. In our financial literacy classes, when the trainer would explain the concept of interest and add up the EMIs to show how quickly they can balloon, there would be an ‘Aha’ moment; a recognition that debt should be limited to what you need and more importantly what you can pay from your own sources, not by taking another loan.

The ratio of vulnerable MFI clients whose monthly cash flow has been swallowed up by excess debt is rising. Though initially seen as a ‘boon’–money available at reasonable rates–regular repayments have mounted. This is causing enough financial stress for a critical mass of borrowers to willingly follow the pied piper who promises that the problem itself will go away.

Microfinance
This image is licensed under a Creative Commons Attribution 2.0

The continuous cycle of availability, coupled with group dynamics leads to evergreening–using fresh loans solely to pay off older loans–and stress for such type of borrowers. Higher delinquencies than the sub one percent–that is touted as the norm–are to be expected on an ongoing basis in a credit portfolio made up of vulnerable households, and should be factored in. Also critical is a need to go beyond loans, towards building financially healthier clients.

A three-pillar approach to financial inclusion

Whilst there is some basic financial training provided to most MFI borrowers–emphasising the need to borrow for productive purposes, the long memory of the credit bureaus and comparing interest rates with the money lender–it is not enough. Nor should we expect that one lesson on over-indebtedness will create a lasting impression.

Providers need to recognise at the outset that there is a tendency to take as much debt as is available, especially when cash flows are tight–and therefore adopt a ‘risk management’ approach towards the client.

She should have the ability to plan and manage her finances, understand other appropriate products and have easy access to both the knowledge and the products.

Providers need to recognise at the outset that there is a tendency to take as much debt as is available, especially when cash flows are tight.

Whilst financial products can be hard to understand for even highly literate consumers, the lack of this basic understanding leads to unmanageable levels of debt for illiterate, vulnerable customers.

It is in this context that financial inclusion should be built on a three-pillar strategy. It can be led by credit, but without savings and insurance products, and continuously building financial capability, there is a risk of accumulating debt, using evergreening to keep up the good repayment record, and eventually default when access to debt is disrupted.

Mainstreaming the microfinance client means getting it right–with a full suite of products that she understands and buys, not just increasing the debt portfolio. The opportunity is here and now–I hope it doesn’t get wasted.

The views expressed in this article are personal.
We want IDR to be as much yours as it is ours. Tell us what you want to read. writetous@idronline.org
Veena Mankar

Veena Mankar

Veena has over 4 decades of financial services experience, with both banks and non-banking finance institutions. She is Founder and Chairperson of Swadhaar, an organisation that has been engaged in financial inclusion for the past decade. She is the independent non-executive Chairperson at IDFC Bank Limited and also serves as an independent director on the Board of Liberty Videocon General Insurance Company Limited. In the past, she has been on the boards of factoring entities in India, Dubai and Egypt, and on the governing board of Sa-Dhan. She hopes her work through Swadhaar will contribute to a better and more equitable world.

1 Comment

  1. The hard truism is that microfinance has been saddled with misplaced expectations, and we have lost a sense of its more modest, even though critical, potential. It is actually a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It will make the poor a little more resilient, but it is not the answer on its own It has all to do with how we are using it and how we are defining the outcomes.
    “Microcredit is not a transformational panacea that is going to lift people out of poverty,” says Dean Karlan, Professor of Economics at Yale University and Founder of Innovations for Poverty Action, who studied the phenomenon in the Philippines. “There might be little pockets of people who are made better off, but the average effect is weak, if not non-existenSeveral MFIs endorse smart microfinance being espoused by the Smart Campaign but it is important that it is practiced 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, privacy of client data, mechanisms for complaint resolution
    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.
    Consumer protection in microfinance is not just about fair treatment and safeguard of clients’ individual rights, but also proper governance of microfinance institutions. The industry must be in a position to achieve its fundamental social mission of poverty reduction, while ensuring sustainability of operations. Microfinance institutions must deliver demand-driven, quality services to these clients, to low-income people and develop the industry in a health way.
    t.
    The practical question is not whether microfinance should continue, but how it can play to its strengths without damaging its social conscience. Before pundits and politicians reduce the questions and solutions posed by the occasional crisis down to sound bites and slogans, we must realise just how positive the effects of microfinance can be, for both financial inclusion and livelihood promotion, if handled correctly.
    Microfinance is actually a tool in a broader development toolbox, but in certain conditions, it happens to be the most powerful tool. It has all to do with how we are using it and how we are defining the outcomes. It needs to shape a more responsible capitalism. It is certainly not an easy choice by any means, but a right choice for wise investors and society alike. Similarly, politicians should be wary of the bad consequences of their narrow populism. We have the means of taming wrong tendencies – laws for punishing them, norms for shaming them, and cure for healing them. Let us not in our imperfect understanding or prejudice throw the baby out with the bathwater.

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