BackThe failure of a hopeful idea
The failure of a hopeful idea
PremiumHemant Mishra/Mint
The poor remain poor because they lack resources. And the formal finance sector does not want to lend them because they are too poor, costs are high and they hardly have anything to offer as collateral. That is, they are trapped in the vicious circle of poverty. This was so until the arrival of microfinance—successfully demonstrated by the Bangladesh model that the poor are “good" borrowers. It was held that it would help eradicate poverty. That was the premise of the model in India until the bubble burst sometime last year.
The premise of microfinance is group lending where all members are held accountable for repayment, thus ensuring social ties and customs, and the fear of being ostracized works as the invisible collateral. Theoretical economic models on “joint liability", “sequential financing" and “contingent renewal" were put forward to show the stability and success of the model. Rigorous empirical validation was hard to come by, but there were plenty of anecdotal stories to show its success in mainstreaming the poor.
What went wrong? Recent literature has pointed to the fact that it was essentially a regulatory failure. Lack of a regulatory framework for microfinance institutions (MFIs) and their practices were largely responsible for the kind of chaos seen in Andhra Pradesh, the success story of MFI lending. An offshoot of this line of argument has also been that it is not the failure of the model, but of individual, errant, MFIs. In essence, the crisis is more an accident than a symptom of a serious disease.
There are now valid questions being raised about the model itself. These ranges from anthropological issues (in Bangladesh as well as India) to the larger issue of breaking down of social customs and norms (one interesting book on this subject is Microfinance and its Discontents: Women in Debt in Bangladesh, 2011, by Lamia Karim). Questions have also been raised on the economic models behind these ideas.
The real questions are what do the poor do with the money and can they really afford the high rate of interest (24-60% per annum) usually charged by MFIs. Quite simply, a poor person would have to generate a rate of return of minimum 30-35% just to repay the debt and get some decent living out of the investment. Not only is this really impossible with the kind of assets that they can buy with the small amount of money made available to them, but even getting sufficient returns to pay the interest is difficult, considering that most of them have low skills with hardly any financial training. This factor should be seen along with the fact that most of such investment is in agriculture and livestock where returns are low. Investment in these sectors is also risky because of natural factors such as rainfall and disease, and due to price fluctuations in markets for such output. The situation is all the more serious because, in many cases, to increase the loan portfolio, MFIs also financed pure consumption loans.
But then how did the model work if the likelihood of paying this rate of return is so low? Recent studies suggest that this was done merely by rolling over the debt, with more and more MFIs competing with each other to offer money. But, in many cases, it was also the selling off of assets that helped the poor repay loans. But wherever it has been successful, it probably worked because the institution of microfinance was not purely a financial transaction. In almost all these cases, agents prepared poor households by imparting skills, providing financial literacy, creating markets, providing insurance and managing risks. These were essential strategies, with microfinance being only a part of the chain.
What Indian MFIs forgot was that other than money, the poor also lack skills, education and the ability to create productive assets for steady income flows. This was not the case in India. Success of MFIs was measured not by their ability to lift people out of poverty, but by the rate of return on investment. MFIs, which were seen as a saviour of the poor from the moneylenders, were the same old, but much bigger, sahukars.
But this also means that the problem cannot be seen only as a regulatory failure. The solution does not lie in knee-jerk reactions such as those of the Andhra Pradesh government and our own central bank proposing ordinances and Acts that fail to address the real issue. MFIs cannot be a solution to the large-scale poverty that ails our rural areas. Nor is this the solution to financial inclusion. Financial inclusion requires much more than regulating MFIs. Financial inclusion cannot be measured by the number of bank accounts. The objective of financial inclusion has to be integrated to a strategy of making poor enterprises viable through building skills, training, insurance and market access.
Himanshu is assistant professor at Jawaharlal Nehru University and visiting fellow at the Centre de Sciences Humaines, New Delhi
Comments are welcome at theirview@livemint.com
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