Micro scope

Indian Express, 11 November 2006

While Finance Ministers and RBI Governors often ask commercial banks to lend more to rural areas and to farmers, the formal financial sector is rarely able to meet their hopes. While local money lenders who know the borrower are able to earn more than 50 percent interest on the loans they give to poor farmers and to the landless, banks find the same farmers unattaractive as customers. Money lenders would lend at high rates of interest that took into account the higher risk of lending to the poor. But commercial banks lending to the poor cannot charge high interest rates to account for the high default risk, high transaction costs, lack of information and lack of collateral. Even for the farmers, going to the nearest commercial bank branch is not so attractive. It is often costly, time taking and difficult to open bank accounts. The time taken for loans to be sanctioned tends to be long and there may be bribes involved. But most importantly, banks are unhappy to give out small loans to risky borrowers as they have to adhere to regulations about interest rates for small sized loans.

The principle behind the microcredit revolution is to give loans, primarily to women, in very small amounts and without collateral. A loan is given to a member of a group and is guaranteed by the others. Though the borrower does not have collateral to offer to the bank, the social pressure that is put by others is often enough to make her repay the loan. The groups of individuals who save and give loans primarily out of their own deposits are known as self help groups (SHGs). The SHGs do voluntary savings, manage accounts, collect and give interest within the unit. They may also be involved in other business activities together or may have common occupations.

Today there are Micro Finance Institutions (MFIs) who work with SHGs at the local level. In India we have our own model of MFIs based on a framework where banks lend to SHGs. The National Bank of Agriculture and Rural Development has taken the lead in SHG-bank linkages. Through this new opportunities for commercial banks to lend to the poor have been created. The bank lends to an SHG which lends to its members thus overcoming the information assymetries that the bank would normally have faced. Since 2000, priority sector lending to agricutlture (that banks are required to do) can be done through MFIs. This means that for what they lend, banks get refinance from NABARD at 6.5 percent interest. In contrast to the Grameen Bank of Bangladesh created by Nobel Peace Prize winner Prof Yunus, the commercial bank is not directly involved with the choice of individuals in the group and does not deal directly with them.

It makes business sense for the commercial bank. A commercial bank would typically charge an MFI 12 percent. The MFI would then incur a service charge and lend further the SHG at about 16-18 percent. The borrower would get the loan, for example, at 20 percent. This is cheap for her compared to the money lender and that is why she would like to continue the credit relationship and not default on the loan. If she defaults, the whole group gets cut off, so the group either puts pressure on her to repay, or helps her repay the loan. If the bank had lent to industry it might have received 10 percent interest. Therefore, once the bank has dealt with the questions of transaction costs and information assymetries and risk by lending to the poor through MFIs, the poor are a commercially attractive proposition.

Microfinance in India has been growing very fast in the last six years. Andhra Pradesh has seen the fastest growth in microfinance in India. The functioning of Women Self Help Groups in Andhra Pradesh have attracted the attention of media and aid agencies from all over the world, next only to the Grameen Bank of Bangladesh. Recovery rates are reported to be about 98 percent. Interest rates are higher than the formal sector (18 to 24 percent) but lower than moneylenders (40 to 50 percent). However, its reach is reported to be around 2 million, far less than the reach of Grameen in Bangladesh.

As the sector has grown, new challenges and difficulties have emerged. Events in the Krishna District of Andhra Pradesh is one example. A new regulatory framework that is suitable for microcredit is now being developed so that the sector can witness healty growth. As long as there is a large informal sector that offers opportunities for profitable small businesses , and as long as poverty levels are high, India will need credit structures which cater to the needs of the poor. There is, therefore, a large potential for growth of microfinance in India for many years to come.

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