When Muhammad Yunus and Grameen Bank got the Nobel Prize in 2006, it created worldwide interest in microfinance. The movement Yunus started 30 years ago as a young professor at Chittagong university, who began lending his own money to poor women organized in groups, has now spread all over the developing world, and has reached 80% of the poor in Bangladesh. In India, microfinance still covers only 20% of the poor. When Yunus got the Nobel, the question my friends most often asked me was, “Why can’t we do it here?”
Photograph: Harikrishna Katragadda / Mint
The short answer is that we can, but haven’t been able to because of the government. The breakthrough in the credit delivery system Yunus pioneered was simple enough. It kept borrowers honest—with almost 100% repayment rates—though the loans were unsecured, for two reasons. First, they were responsible for each other’s loans, so that if one member of a group defaulted, all the members stood to lose their access to further loans. Second, and more important perhaps, was the knowledge borrowers had that timely repayment would be followed by a larger loan.
Unlike in India, where loans to the poor were seen as one-off events, with a single loan expected to raise a borrower above the poverty line, credit in the Grameen Bank system is seen as a continuing relationship between borrower and lender. After all, don’t we in the middle class keep borrowing, for a variety of purposes?
India was a late starter in replicating the Grameen Bank methodology. But by the late 1990s, we had a number of microfinance NGOs—many of whose leaders had attended training courses in Bangladesh—which started growing rapidly, with the same 100% repayment rates. They obtained their funds from the Small Industries Development Bank of India (Sidbi) and from banks, especially private banks, which saw lending to microfinance NGOs as a means of meeting their priority sector obligations. Several of India’s top microfinance institutions (MFIs) have today crossed, or are approaching, the one-million-borrower mark. However, the largest of these, Hyderabad-based SKS Microfinance Pvt. Ltd, is still half the size of Grameen Bank and a couple of other large Bangladeshi MFIs.
Indian MFIs are smaller because they are entirely dependent on borrowing from banks to fund their growth, and banks have to be cautious about the capital adequacy of their borrowers (although MFIs have perfect repayment rates, bank loans to them are unsecured). Grameen, on the other hand, funds its own growth entirely from the deposits it is allowed to accept as a bank. As Yunus said at a conference in Delhi recently, “Access to funds is the key to the whole problem (of growth). We are surrounded by an ocean of money. Why not allow the poor to drink out of it too?” He was referring to the vast potential of savings as a source of funds, and to the misconception that the poor are too poor to save, that what they need is credit, not savings facilities and services. On the contrary, savings is a more widely felt need than credit (Grameen has many more small savers than borrowers). While the poor need to borrow lump sums from MFIs to finance their larger investment requirements, they at the same time need to save small amounts regularly to provide for emergencies, smoothen their consumption over the lean season, send a child to school, and so on.
Currently, their savings take place through the ubiquitous informal sector, or in kind through investments in ornaments or cattle, or are just stuffed into the mattress. However, these mechanisms are riskier, low-yielding and less productive than if MFIs in India were allowed to offer small, convenient and relatively liquid savings deposits to their members, as they are in most other countries of the world. Allowing MFIs to accept the deposits of their own members (not the public) would not only increase their funds significantly, it would also lower their cost of funds. The interest they would have to pay on deposits, while still competitive with banks, would be lower than their cost of borrowing, and this would allow them to reduce their lending rates.
The microfinance Bill presented in Parliament in 2007 proposed allowing MFIs to accept savings in a limited away, subject to oversight by a regulatory authority. However, it excluded from its purview the large number of MFIs registered as non-banking finance companies (NBFCs) and section 25 (not-for-profit) companies, which constitute the bulk of the sector. The Bill was, in any case, stalled by the parliamentary standing committee on finance, whose Leftist members wanted to cap MFI interest rates as a condition for their support. This would have killed the sector at one stroke. MFI interest rates are higher than that of banks because the administrative costs of micro loans are much higher, especially as they are made and collected in convenient weekly instalments from the doorsteps of borrowers.
Unless the next government can educate the new standing committee, the sector is unlikely to get the enabling regulatory environment it has been demanding. The other agency that could make a difference immediately is the Reserve Bank of India. It should accept the recommendations of the Ranganathan and the Raghuram Rajan committees to allow MFIs registered as NBFCs to accept member deposits.
Prabhu Ghate is a former senior economist with the Asian Development Bank. Comments are welcome at email@example.com