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The right questions on microfinance……Govind Sankaranarayanan
Microfinance has served its customers reasonably well so far, but as it comes of age, it admittedly deserves a closer look In the wake of success comes misplaced debate. The success of August’s public issue of SKS Microfinance has placed an entire industry under the public lens. The Reserve Bank of India has recently entered this debate, too, indicating worries about bank lending to this sector. Enough questions are being asked, but they are not necessarily the right ones.
Are we right to worry about the future of this sector? Microfinance has served its customers reasonably well so far, but as it comes of age, it admittedly deserves a closer look—just not for the reasons usually cited. There are some commonly held views about this business that have to be fine-tuned.
First, there is a concern that microfinance companies lend at a rate, between 24% and 28%, that is felt to be usurious. This is now well recognized as a false concern, because the alternative for the poor is to go into the arms of unregulated moneylenders. Moreover, the necessary due diligence required to manage small loans is intensive and expensive: If microfinance companies were lending at much lower rates, one would truly wonder whether they were conducting the required.
If 28% is what is being charged by the market, presumably that is what it costs to have large numbers of people in many small towns to monitor small-ticket loans. Critics should note that the more microfinance evolves into a large industry, the more competitive forces will bring prices to the right levels.
Second, there is a perception that technology is the solution to the problem of high-cost lending. But microfinance’s success is based on the opposite: It is about peer pressure among borrowers and the close relationships between loan officers and borrowers. A seemingly sterile technology-based lending model that is now proposed can’t replicate that.
Third, there is a somewhat more justified worry that by lending to microfinance, banks are actually exposing themselves to some kind of higher systemic risk. The existence of this risk cannot be wished away. Financial inclusion is a reasonably honourable agenda, but India has to remember that it cannot cancel out the attendant risks. By definition, inclusion will involve lending to those who were previously unbanked, and who lack a clear repayment track record. To suggest that expanding lending to these groups of customers has no risk greater than lending to, say, a Mumbai firm needs greater explanation.
Defenders of microfinance will counter that group lending and peer pressure can make a difference to delinquency, keeping it low; but this is another intriguing suggestion. We should note that delinquency levels among reasonably well-off urban personal loan customers varies between 6% and 10% while those of good microfinance companies currently is at around 1%: This is not surprising, since peer pressure probably works better within a very narrow setting. It may well lose its efficacy once borrowers attain a certain scale—as microfinance borrowers are sure to do while the industry keeps lending.
Microfinance proponents also don’t account for the fact that unsecured personal loans have higher delinquency rates once they cross a certain size. It’s stretching credibility to believe that the microfinance industry can operate with the same paradigms as it matures.
Fourth, there is a real danger that microfinance will soon be seen as a substitute for genuine manufacturing-led growth. It is not. The wealth a poor villager creates thanks to the likes of SKS is no match for what a well-intentioned firm, with solid execution capabilities, can achieve when it arrives at that village.
Neither lionizing nor demonizing microfinance will work here. The trick is to understand the dynamics that have allowed it to grow so fast and extrapolate whether these will continue in the future.
* Govind Sankaranarayanan is chief financial officer and chief operating officer-corporate affairs, Tata Capital. He writes on issues of governance.
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