Macrotruths of microloans

Macrotruths of microloans

The microfinance industry in India, indeed in most of the world, suffers from several misconceptions. The most egregious of them all, assiduously promoted by the industry, is that it carries a special halo because it helps the very poor. Microfinance is no magic wand that dispels poverty. Indeed, if it had any such powers, Bangladesh would have abolished poverty long ago. All that microfinance does is to fill the gaps between temporary mismatches in cash flows faced by the poor.

As far as the non-profit microfinance institutions (MFIs) are concerned, they are a form of charity, subject to all its limitations. The for-profit institutions, on the other hand, despite their pretensions, are nothing but moneylenders. They justify the high interest rates they charge to their borrowers on two counts —the risk involved and the high costs of lending to a dispersed set of small borrowers in the rural areas. But the proportion of bad loans on their books is far lower than for commercial banks, so it is unclear why lending to the poor should be viewed as more risky. And the operating margins and return on assets are very high, which indicates that their high rates ensure high profits.

That said, the other misconception is that the MFIs are rapacious loan sharks, out to exploit the poor. The fact is they perform a useful service. It’s no use saying that the non-profit MFIs or the bank-sponsored self-help groups are better for borrowers. There simply aren’t enough of them around—for which borrower would go to the for-profit MFIs if they can get financing at cheaper rates? That the MFI industry has grown so rapidly is testimony to the fact that they are needed in rural India. And as competition intensifies and more funds are attracted, interest rates too will drop.

At the same time, nobody wants farmers committing suicide because of high interest rates. What the Andhra Pradesh government should have done was to talk the matter over with the MFIs and arrive at a workable compromise. Instead, as a result of its hasty action, MFIs are in deep trouble, bank exposure to MFIs is in jeopardy and although borrowers may be happy they don’t have to repay their loans at the moment, they will soon have no alternative but to go to the village moneylender to borrow at extortionate rates. The government action will hurt precisely those people they seek to protect—the poor. The solution is simple—dispel the hypocrisy around the business, accept MFIs as moneylenders who fulfil a legitimate function in society and regulate them as such.

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