Feb 18, 2010

RBI wakes to the errant ways of micro-finance

The Reserve Bank of India (RBI) seems to be finally taking notice of the usurious micro-finance sector. After the Code of Conduct it had laid down for MFIs several years back, it is surely time RBI brings in strict guidelines for taming the MFIs.

This loot has to be stopped, the sooner the better.

I still don't know how can any sensible person justify 24-36 per cent interest on loans to poor clients. For Rs 5,000 to Rs 10,000 loan, the MFIs literally extract its pound of flesh and that too with a pious claim of helping the poor to emerge out of poverty.

It is no less than a crime. The only difference being that you don't use a gun in this case.

Readers would remember sometimes back I had brought to you the successful Akhuwat model from Pakistan. Under this micro-finance model, no interest rate is charged. Instead, community has become a source of continuing funding. In a recent communication from Akhuwat, I am told that over the years through its transparency and accountability, it has gained solid credibility. more funds are pouring in from from individual donors, institutional donors, borrowers (which have gained economic stability through Akhuwat micro-credit schemes) and now even the Government of Pakistan; in particular from Punjab, have shown interest in partnership.

The RBI needs to take a leaf out of the Akhuwat model. It cannot remain a mute spectator while the MFIs fleece the poor with impunity.

I am drawing your attention to an editorial in The Economic Times (Feb 18, 2009). Reading between the lines (and minus the bias for corporates that the business papers are known for), it becomes quite obvious that the RBI is concerned at the MFIs thirst for profits from the poor. 

Not quite a micro-issue
Micro-Financing Macro Problems?

The Reserve Bank of India (RBI) is right to worry about the burgeoning micro-finance sector. A key takeaway from the recent financial crisis is
that systemically large non-bank financial sector players can endanger financial stability. As the US Federal Reserve bailout of the mega US insurance player AIG shows, it is not the banking system alone that can threaten financial stability. Risk can come from non-bank players because of their inter-linkages with the banking system.

In India, though the RBI’s natural caution had kept the non-bank sector under check, extraordinary liquidity facilities had to be provided to mutual funds and to NBFCs in the early days of the crisis, suggesting the RBI cannot relax its vigil over non-bank players. It is in this context that the role of micro-finance institutions (MFIs), particularly profitmaking MFIs, becomes relevant.

This is not to say ‘profit’ is a bad word in micro-finance or that this is only for ‘not-for-profit’ entities. Many banks have partnered with MFIs that provide financial services to high risk segments of the population. Indeed MFIs do a great job in providing credit to sections that are unable to access the formal banking system and need encouragement. Above all, MFIs have shown how lowincome categories are a ‘bankable’ proposition.

However , as pointed out by former RBI governor Y V Reddy, there is a risk of profit-making MFIs being tempted to charge exorbitant rates of interest on loans made from funds lent to them by banks as part of their priority sector commitment. While MFI interest rates, 24-30 %, may seem fairer than the rates charged by the informal sector, ideally, the rate of interest charged should not be out of alignment with the cost of funds, transaction costs, risk costs and a certain margin.

In any case, there is a need for transparency. At present, the scale of bank lending to MFIs is not large enough to endanger the banking system. But it could be a potential source of instability if MFIs go the way of some western financial sector entities and in their search for high returns, lend to sub-prime entities. With sub-prime consequences!

http://economictimes.indiatimes.com/Opinion/Not-quite-a-micro-issue-Micro-financing-macro-problems/articleshow/5586091.cms

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