The business of MFIs 3


There’s been a lot of hullaboo about MFIs – Micro Finance Institutions recently. First the big IPO from SKS microfinance and then more recently allegations of strong armed tactics by MFIs in recovering loan amounts.


MFIs
So, what are MFIs? Micro Finance Institutions lend money in small amounts to people who wouldn’t otherwise get credit from regular financial institutions like banks, etc. Their customers could be rural or urban. The amounts they lend could be as little as a few thousand rupees. Naturally, a bank does not see any value in lending such small amounts – their paperwork and red tape will cost more than that!
Why are their interests so high?
MFIs borrow from banks in order to lend to their customers. It is a marriage of convenience really – banks don’t have the time and energy to go after small customers, the customers don’t have all the paperwork that banks need and MFIs can make money by being the middlemen. The interest rates at which MFIs borrow from banks is high too, as the customers are classified as high risk. MFIs (ideally) don’t just go lending money to people, they have a lot of ground work to do first. The community is a very important aspect of this lending – as most of the customers have little or no collateral to offer in return for the loan, the community and the social pressure is the biggest motivation to pay back. And, this community does not get built overnight. Also, fiscal discipline is a habit that has to be taught slowly. All this takes time, a lot of people and I doubt if MFIs could stay in business if their loans were cheap.
The customers are better off inspite of these high interest rates, because their only other sources for credit are moneylenders and loan sharks. The usual interest rates they charge start from Rs. 4 per Rs. 100 per day – calculate how much it will be annualized.
Strong arm tactics –
If everyone paid back their loans there would not be any problem right? Yes, and that would happen in an ideal world. But in the real world, that’s not how it works. MFI field agents first nurture a community by lending to a few people first. These people are encouraged to become fiscally disciplined and pay back their loans. In time, more people in the community borrow from the MFIs and emulate this seed group of peers. When MFIs are evaluated by banks, they consider the numbers of such reliable customers too. So, the incentive for the MFI is to keep working to increase the number of reliable customers. However, it’s a lot of hard work and some times their field agents take a short cut by repeatedly lending to the same set of reliable customers, and sometimes lending them more than necessary.
Now, if a customer uses the loan for an income generating activity, everything is ok. But what will happen if gets excess credit? Suppose X wants to get married. Since he has easy credit available now, he goes beyond his means and spends that money – but he has no means to pay it back. And there, you have it – a bad loan for the MFI. If the amount lent was small, as it ideally should have been, the loss can still be absorbed as some bad loans are to be expected and factored in anyway. But since the customer was lent repeatedly and maybe even in excess, the field agent is now in a tight spot. And may resort to strong arm tactics.
Also, imagine a situation when the erstwhile loan shark gets into this business and is now legally doing what he already was? Will he really change his ways? Fear and intimidation are the weapons which have always worked for him, why would he abandon them now?
The above is just my understanding (and some insights I got from talking to my sister) and is in no way complete knowledge of the situation. I would be happy to be corrected wherever I am wrong.

3 thoughts on “The business of MFIs

  • Reply
    Rajan Alexander

    When we started out in development a couple of decades ago, we instinctively targeted to reduce the influence of money lenders, if not eliminate them completely. Why? They were the traditional oppressors and exploiters in society. Micro-savings and revolving loans worked very well until the most fancied MFIs burst into the scene. MFIs operate under these two beliefs: “Having access to expensive credit is better than no credit” and “the observed rate is where demand equals supply”. These two beliefs were ironically the very same fulcrum the traditional money-lenders operate with.

    The result is an “Animal Farm” situation where we are now not able to distinguish between “pigs” and “humans” and vice versa. In fact, money-lenders have got a make-over by packaging themselves as MFIs. A good example is Mohd Yunis of Grameen Bank comes from a traditional money-lending caste. And of course, he got the Nobel Prize and so did Al Gore & Pachauri. Thank God the Nobel Committee did not confer Gandhiji the same distinction, by clubbing him with these scamsters.

    The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 – showing how much the market had confidence on their profitability while “banking with the poor”. The promotors of SKS became multi-billionaires over-night! MFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn’t match! Profitability that permits SKS to pay Rs 1 crore as bonus to their just fired CEO!

    And how do they attain profitability?

    A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the microfinance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Microfinance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300. For those of us in the field, this conduct of MFIs is no surprise.

    MFI research puts irinterest rates between 25-30%. But my experience (and this is my 30 years in the field) put this figure several times higher. Even if we take this range which they described as the lowest in the world, the only benefit of such loans is for working capital and not capital formation. What is the kind of subsidies Rata Tata gets to produce a one lakh car? We all are aware that a mere 0.5% rise in banking rates can crash the stock market, so sensitive is their profitability linked to interest rates. Compare this with those the poor is asked to bear.

    AP’s share of outstanding microfinance loans represents nearly 40% of the sector’s total portfolio, according to CRISIL. Now if MFI is all about access to the poor, we can ask the question, why the clamour to be concentrated in a state which belong to top-five in development in the country? We would have thought they would have gone to the five lying at the bottom rung of the country. But no, they avoid it like plague. It is easy to see they do this on repayment potential of states. The interests MFIs pursue are interests of self sustenance and their own growth. The poor is hardly in the radar except for rhetoric. In fact, it is on the blood and coercion of the poor, MFIs like SKS can giveaway Rs 1 crore as bonus to the CEO.

    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. Rather than regulate MFIs, I for one will welcome the day of their demise. Loan sharks cannot be regulated

  • Reply
    Ajay Reddy

    When we started out in development a couple of decades ago, we instinctively targeted to reduce the influence of money lenders, if not eliminate them completely. Why? They were the traditional oppressors and exploiters in society. Micro-savings and revolving loans worked very well until the most fancied MFIs burst into the scene. MFIs operate under these two beliefs: “Having access to expensive credit is better than no credit” and “the observed rate is where demand equals supply”. These two beliefs were ironically the very same fulcrum the traditional money-lenders operate with.

    The result is an “Animal Farm” situation where we are now not able to distinguish between “pigs” and “humans” and vice versa. In fact, money-lenders have got a make-over by packaging themselves as MFIs. A good example is Mohd Yunis of Grameen Bank comes from a traditional money-lending caste. And of course, he got the Nobel Prize and so did Al Gore & Pachauri. Thank God the Nobel Committee did not confer Gandhiji the same distinction, by clubbing him with these scamsters.

    The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 – showing how much the market had confidence on their profitability while “banking with the poor”. The promotors of SKS became multi-billionaires over-night! MFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn’t match! Profitability that permits SKS to pay Rs 1 crore as bonus to their just fired CEO!

    And how do they attain profitability?

    A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the microfinance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Microfinance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300. For those of us in the field, this conduct of MFIs is no surprise.

    MFI research puts irinterest rates between 25-30%. But my experience (and this is my 30 years in the field) put this figure several times higher. Even if we take this range which they described as the lowest in the world, the only benefit of such loans is for working capital and not capital formation. What is the kind of subsidies Rata Tata gets to produce a one lakh car? We all are aware that a mere 0.5% rise in banking rates can crash the stock market, so sensitive is their profitability linked to interest rates. Compare this with those the poor is asked to bear.

    AP’s share of outstanding microfinance loans represents nearly 40% of the sector’s total portfolio, according to CRISIL. Now if MFI is all about access to the poor, we can ask the question, why the clamour to be concentrated in a state which belong to top-five in development in the country? We would have thought they would have gone to the five lying at the bottom rung of the country. But no, they avoid it like plague. It is easy to see they do this on repayment potential of states. The interests MFIs pursue are interests of self sustenance and their own growth. The poor is hardly in the radar except for rhetoric. In fact, it is on the blood and coercion of the poor, MFIs like SKS can giveaway Rs 1 crore as bonus to the CEO.

    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. Rather than regulate MFIs, I for one will welcome the day of their demise. Loan sharks cannot be regulated

  • Reply
    Ajay Reddy

    Dear Rajan,
    Thank you for the very informed reply – gives more information than my original post. However, it seems a bit one-sided, surely MFIs can’t all be bad?

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