Planning Commission deputy chairman Montek Singh Ahluwalia has written to Prime Minister Manmohan Singh, seeking intervention by the Reserve Bank of India (RBI) to stave off the snowballing crisis that India’s microfinance industry is battling in Andhra Pradesh, even as the southern state is set to introduce a Bill in the winter session of the state assembly to curb alleged exploitation of rural borrowers by microfinance institutions (MFIs).
A PTI report on Wednesday, quoting a senior bureaucrat, said there will not be any cap on interest rates charged by MFIs, but the ordinance, which was promulgated in October, will be “introduced as it is”.
“There will not be any modification in the Bill. We are very firm on curbing the coercive methods in recoveries,” the state’s principal secretary (panchayat raj and rural development) R. Subrahmanyam, told PTI.
Ahluwalia, who wrote to the Prime Minister in late November, has described the ordinance as “draconian” and said: “If implemented as it stands, it will lead to the collapse of the MFI sector.”
He declined to comment for this story.
Andhra Pradesh accounts for at least 25% of Rs 20,000 crore outstanding tiny loans.
The state promulgated the ordinance on 15 October and the definition of MFIs in the ordinance not only explicitly refers to non-banking financial companies (NBFCs) regulated by RBI, but also all companies engaged in any business of finance to low-income households.
This means it effectively covers all commercial banks, since banks are companies under the Companies Act, 1956, and they lend money to low-income clients.
According to Ahluwalia, since MFIs are NBFCs, and regulated by RBI, “the state government should not have acted in the manner it did” and “the lead in taking corrective steps should have been taken by RBI”.
Stating that the financial sector “cannot be made hostage to arbitrary administrative action”, Ahluwalia said, “we should urge RBI to step forward as the sole agency to regulate and control MFIs.”
RBI deputy governor Subir Gokarn on Tuesday said MFIs are under stress, but there is no threat to the system. On the sidelines of a programme on financial inclusion, organized by Kolkata-based United Bank of India, Gokarn told reporters MFIs play an important role in the banking regulator’s financial inclusion strategy.
RBI has constituted a panel, headed by chartered accountant Y.H. Malegam, to look into these issues and the panel is expected to submit its report by end of January.
Former RBI governor Y.V. Reddy has recently said for-profit MFIs should be treated on a par with money lenders. He is against any special treatment for these organizations and would prefer them to use their equity to give loans instead of raising resources from banks and on-lending them at a profit.
The Andhra Pradesh ordinance has suggested that all MFIs should register themselves with a district-level registering authority in each of the districts in which they are operating.
Besides, the loans should be repaid in monthly instalments and all repayment should take place in government offices. Currently, MFIs meet their borrowers at their homes or a place of mutual convenience, and loans are repaid in weekly instalments.
Also, MFIs must take prior approval from the registration authority to give loans to members of self-help groups (SHGs) who have already taken money from banks.
Public sector banks that roughly account for around 70% of the Indian banking industry have been giving tiny loans through SHGs. There are around five million such groups and 70 million consumers across India.
Some of the provisions of the ordinance—such as registration with district authorities, banning collection on a weekly basis, banning collection house-to-house contact—will militate against the basic business model of MFIs, Ahluwalia said in his note.
Ahluwalia is also against the idea that loans should not be given for “income smoothening”, or for consumption. There is no doubt that MFIs should give loans for productive purposes, but there is no reason why they should not meet their temporary needs as individuals need to cope with periodic cash shortages, he said.
According to Ahluwalia, banning MFIs from meeting their clients will drive borrowers to money lenders, who charge higher rates. “In fact, it is speculated that the money lenders, who have strong political connections, have encouraged overreactions by authorities,” he said.
Stating that the issue has been “politicized”, Ahluwalia said the district authorities have begun the process by “openly asking people not to repay loans” and even the opposition has “joined the movement”.
As a result of this, recovery rates have collapsed and banks have stopped giving loans to MFIs.
Nachiket Mor, chairman of IFMR Trust, a not-for-profit development and research body with a focus on microfinance initiatives, said the collections by MFIs have dropped from 99% to less than 50%, as borrowers have been encouraged not to pay back.
According to him, the nature of the repayment schedule should be decided by the customer and the lender, and is beyond the purview of the state government. Monthly repayment schedules are not in sync with the cash flow of the borrowers as low income households typically get their wages daily or weekly.
Finance minister Pranab Mukherjee recently said the government doesn’t want to “strangulate” the microfinance industry that is in the business of giving tiny loans to poor people. At the same time, he asserts that the industry should bring down interest rates to a “reasonable” level and stop using “coercive methods” to recover loans.
There are about 40 for-profit MFIs and the big five—SKS Microfinance Ltd, Share Microfin Ltd, Spandana Sphoorty Financial Ltd, Bandhan Financial Services Pvt. Ltd and Bhartiya Samruddhi Finance Ltd—account for at least 80% of the industry.
All of them have grown phenomenally in the past few years, with their consumer base varying between 1.8 million and 7.4 million.
In his latest book Fault Lines: How Hidden Fractures Still Threaten the World Economy, Raghuram Rajan, former chief economist of the International Monetary Fund and an economic adviser to India’s Prime Minister, said, “Although microcredit has a promise on a small scale, history suggests that when scaled up, and especially when used as an instrument of government policy, it will likely create significant problems.”