FAC E- O F F

Is micro-credit too costly?

SANJAY SINHA Managing Director M-CRIL* But is there a cheaper alternative?
AFELLOW airline passenger recently told me "MFIs loot the poor". A common
middle class perception. We have become socialised to the idea that the poor
need subsidies. Consider the alternatives for a poor woman in a village. The
most obvious, for a man at any rate, would seem to be to go to the local
bank and take your chances getting past the armed guard and then the
chaprasi. The manager will probably ask you which scheme you are applying
under and ask for a recommendation from a government functionary. If you are
lucky, a month or two of running around will yield a loan of Rs 5,000 at the
bank's PLR of 11.5%. "Cheap" loan for which you spent Rs 500 in cash
completing all the requirements and another Rs 500 in lost wages. Effective
interest rate, 47% per annum; chances of getting a loan in a month, 5%.
Second possibility, go to a moneylender; not any moneylender but one who
knows you since he is the only one who will lend you anything.

If you happen to live in some parts of south India the moneylender will let you have a
loan at Rs 3 per hundred per month (36% per year) but usually against
security of some form of jewellery or other valuables - even utensils are
mortgaged in this way. If you are less fortunate and happen to live in north
Bihar or the tribal areas of Orissa, Chhattisgarh or Assam, it will cost you
10% per month. Effective interest rate, 120%, chances of getting a loan,
70%. Third possibility, become a member of an MFI if there is one near you,
participate in their programmes (half an hour's meeting a week) and get a
loan at 30-40% effective interest rate; chances of getting a loan, 90%. Is
microfinance too expensive? Let the market decide. Anyone with a genuinely
cheaper alternative will not come to MFIs for a loan. If the MFIs flourish,
competition will force efficiency and bring down costs. Ask the cellphone
service providers, ask the airlines. Is microfinance too expensive? Ask the
MFI clients. The poor need competitive service providers. (*Micro-Credit
Ratings International Limited)



SHAMIKA RAVI Assistant Prof, Indian School of Business Balance financial and
social objectives SEVERAL factors have led to the current tense situation
visa-vis microfinance in India. Firstly, the interest rate. The stated
interest rate ranges from 10 to 25% per annum. But the effective interest
rate is anywhere between 20 to 45% per annum, which includes various factors
such as processing fees, the repayment frequency, number of instalments,
etc. This explains how a flat interest rate of, say, 15% per annum, can
amount to an effective interest rate of 38% per annum. Secondly, as with
most issues, when the government becomes an active player, the issue becomes
politicised. In Andhra Pradesh, which accounts for 40% of all microfinance
activities in India, the government has its own microfinance model.

This is the 'self-help group' banking model. So the state is not a neutral umpire
and faces competition from existing MFIs. Thirdly, the objective of MFIs to
serve the poor while aiming for financial sustainability calls for a fine
balance. They face high transaction costs as their business involves making
small loans to a large number of clients. One way to reduce these costs and
take advantage of economies of scale is by standardising products and
operations. Uniform treatment of clients and greater professionalism
translates into persistent efforts to collect repayment.

 The tradeoff in this case is reduced flexibility in contracts which may lead to debt spirals
when customers turn to moneylenders for help. Lastly, microfinance has grown
at an alarming rate over the years when financial products offered to
clients have increased in number, range and sophistication. In such a
scenario, concerns for consumer protection will naturally intensify and
expand to address issues relevant to the marketing and sale of microfinance
products. However, regulation such as capping interest rate might be akin to
"throwing the baby out with the bath water". It might exacerbate the
situation by putting several MFIs out of business and by driving clients
back to informal lenders who charge significantly higher interest rates.

Another likely drawback would be higher effective interest rates, reflecting
the new riskier political climate.

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