The challenges of inclusiveness in microfinance

(Mains GS 3 : Inclusive growth and associated issues/challenges)

Context:

• The Reserve Bank of India (RBI) in June published a “Consultative Document on Regulation of Microfinance” with the objective of promoting the financial inclusion of the poor and competition among lenders.

The microfinance:

• ‘Microfinancing’ was introduced in India as a solution to poverty and to empower women.
• Microfinance is a type of banking service provided to low-income and unemployed factions of the population.
• The financial institutions supporting microfinance offer services like lending, setting up bank accounts and providing micro-insurance products.
• Microfinance meets the demands of the rural poor and helps small-scale businesses flourish by providing greater financial stability.

The rate of lending:

• According to the consultative document RBI suggested that the current ceiling on rate of interest charged by non-banking finance company-microfinance institutions (NBFC-MFIs) or regulated private microfinance companies needs to be done away.
• Document stated that the rate of lending is biased against one lender (NBFC-MFIs) among the many (commercial banks, small finance banks, and NBFCs).
• As per RBI the rate of interest should be guided by the governing board of each agency and believe that “competitive forces '' will bring down interest rates.

Case study on microfinance:

• Microfinance is an important  loan portfolio specially for poorer rural households.
• The Foundation for Agrarian Studies makes their report on the finding of two villages in Tamil Nadu.
• Findings show that more than half of the total borrowing by households resident in these two villages was of unsecured or collateral-free loans from private financial agencies (SFBs, NBFCs, NBFC-MFIs and some private banks).

Socio-economic relation:

• Findings of the study also shows that there is clearly a caste and socio-economic class relation coming out  in terms of source and purpose of borrowing.
• The unsecured microfinance loans from private financial agencies were of disproportionate significance to the poorest households.
• The unsecured loans are mostly disbursed to poor peasants and wage workers along with persons from the Scheduled Castes and Most Backward Classes.
• The microfinance loans to these people were rarely for productive activity and almost never for any group-based enterprise, but mainly for house improvement and meeting basic consumption needs.

Higher cost:

• The cost of microfinance loans is much higher as the method of repayment creates a cascading problem.
• An “official” flat rate of interest on loans used to calculate equal monthly instalments actually implies a rising effective rate of interest over time.
• In addition, a processing fee of 1% is added and the insurance premium is deducted from the principal.

Growth of private agencies:

• The recent phase of growth of financial services in microfinance  is mostly  privately-owned for-profit financial agencies which are “regulated entities”.
• These entities have been promoted by the RBI and lending by small finance banks (SFBs) to NBFC-MFIs has been recently included in priority sector lending.
• In Post-COVID-19 period the cost of funds supplied to NBFC-MFIs was lowered but without additional restrictions on the interest rate thus it affected the final borrower.

Microfinance crisis:

• Microcredit mostly given by scheduled commercial banks either directly or via non-governmental organisations to women’s self-help groups in the decade of 1990.
• But the scope of high returns and lack of regulation attracted  for-profit financial agencies such as NBFCs and MFIs.
• By the mid-2000s  rapid and unregulated expansion of private for-profit micro-lending leads to widespread accounts of the malpractices of MFIs (such as SKS and Bandhan).
• The microfinance crisis of Andhra Pradesh led the RBI to form a new regulatory framework for NBFC-MFIs in December 2011 on the recommendation of the Malegam committee.
• Laterly,  the RBI permitted a new type of private lender, SFBs having the objective of taking banking activities to the “unserved and underserved” sections of the population.

Current statistics:

• As per the RBI’s consultative document, currently 31% of microfinance is provided by NBFC-MFIs along with 19% by SFBs and 9% by NBFCs.
• While the current share of public sector banks in microfinance (the SHG-bank linked microcredit) is 41% which seems to fall sharply.
• Thus the private financial institutions which have grown exponentially over the last few years, garnering high profits.

Conclusion:

• The further privatisation of rural credit and  reducing the share of direct and cheap credit from banks makes poor borrowers at the mercy of private financial agencies.
• Thus to meet the credit needs of poorer households stakeholders need to  strengthen public sector commercial banks and firm regulation of private entities.