SHGs (Self-help groups) need to return to their original fundamentals of being strong grassroots institutions and the market for credit needs to be segmented
The focus of concern in the recent past, and leading up to the Andhra Pradesh microfinance crisis, has been the risk to commercialized microfinance organizations or MFI-NBFCs. Very little has appeared in the media on the risk borne by the clients, until the reported suicides in October brought their risk squarely into the political domain. This post focuses on the risk borne by clients.
First I would like to distinguish between two groups of clients: The first group is the poor who need credit and other opportunities for livelihood activities to survive. The second group is not poor; their livelihood strategy largely includes non-farm activities but they cannot grow to meet their aspirations without access to credit even at market rates.
My position is that the poor need substantial investment, besides credit, for them to move beyond survival and increase their incomes.
This investment includes institutional support- like the self help groups (SHGs) at the base – which provides the poor with the space to set their agenda to support their livelihood strategy. The services required to support livelihood strategies of the poor and to build these participatory institutions like SHGs need subsidy.
In short, this requires a long term perspective.
I do not think the business model of the MFI-NBFCs, which is driven by venture/private capital, quick disbursements, weekly repayments, high profits and remunerations for senior staff, a focus on valuations and IPOs and a quick exit, is appropriate for this group. Short term credit at commercial rates cannot help improve lives of the poor.
In fact, this business model increases the poor’s risk, often beyond a level that they can bear. The SHG model with links to banks (as it was originally conceived) is the appropriate strategy for this group.
Weekly repayments increase the borrowers risk and vulnerability to local power groups. Incomes from agriculture are lumpy not weekly; incomes from animal or dairy farming are usually monthly.
In order to repay the MFI loans weekly, clients are forced into activities that can help them earn daily, like wage-labor, or push them into a cycle of multiple borrowing, where they have space to borrow from one and repay to another.
The second group, the non-poor, who cannot get credit from banks because they do not have land records or fixed assets to provide collateral, are better suited to be clients of MFIs.
This group does not have the confidence and skills required to negotiate with banks if they need credit for activities in the non-farm sector and do not have access to working capital from formal financial institutions.
The business model of MFIs can meet the needs of this group provided profit is not maximized to an extent where there is little difference between them and the moneylenders. Good governance of MFIs can play a greater role than regulation; but evidence indicates that good governance is in short supply.
The SHG model is not an effective model for fast disbursement of credit. Therefore, it is not appropriate for this second group which needs credit.
Risk and the official policy promoting inclusion
Inclusion of the poor (the first group) into the formal financial system of the country involves considerable risks and costs on their part.
The SHG model was an attempt to lower this risk and costs for the poor by providing an intermediary institution which the poor managed. The banks that lent to them were satisfied even though the profits were low because their loans were categorized under “priority sector” lending and repayments far exceeded those from rural development programs in the past.
Between 2003 and 2008 the Reserve Bank of India (RBI) carefully managed India’s integration into the global financial system. Unfortunately the RBI did not take the same careful approach with the MFI-NBFCs in their rapid growth on the grounds that it was urgent to integrate the poor into the international financial sector.
Its focus was pushing the official financial system further into the interior on one hand and, on the other, a “hands off” approach as far as the MFI-NBFCs were concerned, encouraging them at most to self-regulate.
The MFI-NBFCs have not included the marginalized into the country’s financial system but instead included them directly into the international financial system which is not only inappropriate as a first step but raises the level of risk that clients have to bear.
Moreover, the emphasis on credit disbursement to SHGs increased when they were adopted by the Andhra Pradesh Government as part of its official strategy to mitigate poverty. Fortunately, high profits and remunerations were not part of the Government’s strategy.
The SHG Bank Linkage Model had grown till 2000 with adequate investment in building the institutional capacity. When it became part of AP state government policy in 2000, pressure was exerted by dedicated Government officers at the district levels to grow fast and achieve targets.
As a result, the quality of SHGs declined and their earlier emphasis on mobilizing savings, managing repayments and building a supporting environment for a livelihood strategy, considerably weakened.
Instead, SHGs were formed to achieve targets, with the wives of the Panchayat president and secretary dominating proceedings. They borrowed from banks and lent outside the groups at higher rates, at the cost of neglecting their own members.
Official reports focused on disbursements; corrective measures were taken to balance the spread of credit in areas where growth was slow. However, no investment was made to add value or to support increases in productivity and diversification.
Investment in institutions, the very essence of SHGs, was no longer a priority. Instead, the Government was in a hurry to disburse and increase financial inclusion.
Risk and interest rates
MFIs argue that high interest rates are justified because the risk of lending to small borrowers is high, the cost of delivery at the doorstep is high and finally the rates are far less than those of the private moneylenders.
However, high interest rates when offered by MFIs increases risk for the poor.
The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%.
In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 %(the highest being 41.29%).
The report also says that economies of scale have not led to lower interest rates or lower yields. This implies that MFIs maximized their profits and competition did not decrease rates as it was expected to.
The largest MFI recorded a 116% jump in net profit at Rupees 81 crores ($18 million) in the second quarter ending September 2010 as against the corresponding period last year.
The level of profit required to meet all costs, cover risks and expand operations is lesser than the level of profit required to meet all these costs and, in addition, attract venture and private capital, and pay salaries higher than the remunerations of the CEOs of the largest private banks.
What should be the interest rate? The figure of 24% is floating around in official circles. The problem is that the effective interest rates of MFIs are far from clear. There appears to be a difference of 5% to 10% between the rates as provided by the MFIs and the rates that emerge from an analysis of the books of clients.
MFIs also argue that the cost of credit from banks is high and that they should be allowed to mobilize public deposits if interest rates are capped. Interviews with clients show clearly that they do not have an idea of what they actually pay over and above the capital. They are satisfied if credit keeps coming.
In fact interviews with those clients who had succumbed to the temptation of multiple borrowings showed clearly that they wanted to borrow from several MFIs to maintain a cash flow to cope with repayments as well as their expenditure. This increases their risk substantially. In contrast, interest rates of SHGs in Myrada stabilize after two years or so between 12% and 14%, which is about 3% -4% above cost of credit from banks.
Non-profit MFIs who do not pay high salaries but still pay adequately enough to attract experience and capital from banks manage to make a surplus at interest rates between 17% -19%, where the average cost of credit is around 9%-10% and annual growth rates are 40% -50%.
For-profit MFIs should be able to manage their affairs and attract sufficient capital (not venture capital and high valuations) by charging effective rates ranging from 15%-17% above the average cost of credit. This would enable them to charge interest rates in the range of 24% -29% instead of their current rates which are 20%-30% above the average cost of credit.
The poor in SHGs are able to manage interest rates of 12% -14%. They have also managed with interest rates higher than 14% in the initial period of group formation until they have built up their group’s common fund. In my experience, they can cope with interest rates of around 17%. The risk involved is manageable and the cushion provided by the SHG can help them tide over urgent needs.
The non poor in the second group can cope with higher interest rates levied by for profit MFIs but the rates should not exceed 30%.
Competition among MFIs has not reduced rates, neither has self regulation.
Interest rates, commissions, salaries, profits have to be regulated by the board of an MFI. A decision by the Board to opt for an IPO will force management to focus on quarterly figures because the logic of financial markets dictates that it should.
This will further integrate the marginalized into the free market system increasing the risk of the clients who are particularly vulnerable.
SHG is not a good model for speedy disbursement of credit; but it is a good model for lowering the risks of borrowers as well as lenders. SHGs have savings which they use to cushion irregular cash flows; they are able to adjust to urgent and unexpected situations. Myrada’s analysis of its SHGs shows that their common fund increases year on year.
The SHG model, with lower interest rates and risk, is most appropriate to financially include the poor, while the product offered by for profit MFIs is appropriate for the non-poor who are in need of credit.
–Aloysius P. Fernandez, Chairperson, National Bank of Agriculture and Rural Development (NABARD) Financial Services, India and Founder of Myrada; the views expressed here are personal.
For more information on the history of the SHG movement in India, click here.
A longer version of this post was published by Microfinance Focus on December 13, 2010.
This post is the next in a special blog series on the microfinance crisis in Andhra Pradesh, India. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by this crisis and what it means for the future direction of microfinance. We welcome your participation in this discussion through comments.
