Hobbling financial inclusion

Hobbling financial inclusion

Rural India is home to a recurring financial story that runs somewhat like this. Farmers borrow money at usurious interest rates and commit suicide once they realize they can’t pay back. This is followed by cries about exploitation of farmers by moneylenders and soon enough there is “regulatory" legislation that imposes conditions that make such exploitation difficult or impossible. One by-product of such legislation is that it makes financial inclusion difficult.

Andhra Pradesh (AP) is the new state where this plot is unfolding. The state government has issued an ordinance, the AP Microfinance Institutions (regulation of money lending) Ordinance, 2010, that came into force on Friday. Short of capping the interest rates, the ordinance imposes serious administrative costs on microfinance institutions (MFIs) that has the potential to kill them. MFIs, whose business model depends on lowering administrative and transaction costs as compared with banks, now have to register with district authorities in that state. They also will have to disclose the rate of interest they charge to authorities and their system of operating and recovery of money. In addition their registration can be cancelled at any time if there are complaints against their working.

Anyone familiar with the structure and working of financial institutions in India knows what this means. On the one hand, it will add a great deal of uncertainty in how MFIs work if not actively discourage them. On the other hand, the people who will suffer are the poor who need very small loans (often less than Rs1,000). The rural rich can at any time avail the services of nationalized banks. But the poor can’t: lack of collateral and proper documentation ensures that they remain financially excluded. What the AP ordinance does is reinforce this negative trend, all in the name of helping the poor.

Criticism of high interest rates is often couched in moral terms, but it ignores the economic logic behind them. The rates of lending are often graded with the risk of lending to the poor, who simply may or may not be able to return the lent money. The sooner the debate on MFIs is taken away from this domain, the better it will be for the poor of India.

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