Microfinance Focus, November 22, 2010 (J. Charitha Ratwatte): At a time when we in Sri Lanka are considering the passage of new legislation to regulate Microfinance (MF), it would be an appropriate time to consider recent events in Andhra Pradesh in India. There has been an unprecedented crackdown on micro lenders in Andhra, based on an ill judged decision that a spate of suicides by poor farmers in the State was caused by harassment of borrowers by recovery agents of micro lenders operating in the State.

In typical South Asian political fashion, the State politicians, instead of dealing directly with the problem, legislated an emergency order to suspend all debt collections forthwith. Reddy Subramaniam, Andhra Pradesh’s principal secretary stated that “the state government is not against the microfinance industry, what the state government has objected to is the way microfinance is being practiced to achieve hyper profits”. As a result Commercial Bank credit to micro lenders immediately seized. Borrowers soon stopped making repayments, anticipating loan waivers based on political patronage, putting whole MF system in jeopardy. MF is huge in India, with an estimated 30million borrowers and a loan portfolio of $6.5 billion.

The Government of India’s reaction was immediate, Pranab Mukherjee, the minister of finance wrote to the chief minister of Andhra Pradesh recommending ‘corrections’ to the emergency order, which caused the crisis. He stated that there were no plans to introduce a separate regulator for the microfinance industry, as he believed the Reserve Bank of India was sufficiently vigilant. This is interesting since Bangladesh has recently created a separate regulator while Sri Lanka is in the throes of drafting legislation for the purpose. The Andhra Pradesh MFI’s sought judicial redress and obtained a court order allowing them to resume collecting repayments.

At inception, microfinance was exclusively a not for profit venture. However, very high repayment rates, traditional for profit banks and financial houses not working with the poor and marginalized, leaving a wide gap in the market, fuelled a humongous demand and the need to access capital far in excess of what donors would provide at subsidized rates,  resulted in resort to commercial capital, to meet the hugely expanding demand.  The special positive and unique factors characterizing microfinance,  joint and several group liability, the fact that the poor were good repayers, the close contact the MFIs had with the community, the intimate knowledge they had of individual borrowing families, led to a boom in the pull factor which in turn led to increasing reliance on commercial capital. Recently SKS Microfinance based in Hyderabad raised $350 million in and initial public offering.

Due to the successes in poverty alleviation attributed to microfinance, Governments also got involved, for example in India the microfinance sector has been designated as a priority sector by the Reserve Bank of India to which Commercial Banks must devote 40% of their lending.  Another example is the state setting up its own MFI’s such Sri Lanka’s Samurdhi and Gemidiriya, to compete with nongovernmental & commercial microfinance actors, the classic problem, endemic to South Asia here is that all borrowers from state connected agencies live in eternal hope of loan waivers, based on past experience. Leasing Companies and Finance Companies also have set up microfinance schemes, which critics say are mostly small individual loans being made against collateral and far different from the traditional MF practice of joint and several liabilities and collateral free lending, etc. The attraction has been high repayment rates. Microfinance was conceived as a methodology to save the poor from loan sharks and usurious money lenders, by donor funded charities.

The advent of for profit MFI’s , as against the traditional not for profit institutions which were pre dominant,  has resulted in allegations that MF is being practices to gain what Andhra’s politicians have called ‘hyper profits’. This coincides neatly with the so called ‘socialist’ ideology, now fast disappearing even from locations such as Cuba, North Korea and Venezuela , that ‘profit’ is a bad word. Microfinance was never cheap, the issue was always equitable access to credit, not interest rates per se.  Even non profit MFI’s charged interest rates of 30% or more to cover costs of mobilization of funds and outreach to marginalized groups including women.

But the need for more and more funds to meet the increasing demand for microfinance and the potential for profitability due to high re payment rates, resulted in  many Indian MFI’s turning into for profit  companies  and raising more than $500 million  in private equity  from foreign venture capitalists, specialized MF funds and high net worth investors. The Reserve Bank of India’s priority ending requirement led to a flood of funds into the sector, estimated at around $ 6 billion in credit. All safeguards put in place by the not for profit MFI’s, such as, know your borrower and his / her family capacity to repay, source of income, viability of the venture to be undertaken with borrowed money etc. were sometimes overlooked in the rush to disburse and recover.

Over borrowing, where a poor and marginalized  family would borrow from government agencies, (as indicated above, there is a feeling in South Asia, based on past experience,  that government loans will inevitably be waived) MFI’s, commercial banks, money lenders, cooperatives  and a number of other micro lenders led to very high indebtedness, resulting in inability to repay all the loans. The lack of a unique identification number for every Indian, made it impossible for lenders to check the level of borrowing and indebtedness of micro borrowers. In Sri Lanka there is an advantage that every Sri Lankan has a unique identity number in the National Identity Card (NIC) and building a data base of micro borrowers is not too difficult, the technology and infrastructure is in place. It only requires implementation.

In fact, this can be done by the MFI’s themselves, may be a role for the Lanka Microfinance Practitioners Association. In India the Micro-Finance Institutions Network has adopted a Code of Conduct requiring transparent interest rates, a limit of three companies lending to a client and the prohibition of ‘abusive, violent or unethical’ collection methods. The Network is also pooling members’ client records to better assess borrowers. With Sri Lanka’s unique NIC number, to build a data base of micro borrowers to track over borrowing is relatively simple. In India, the Unique Identity Authority of India, headed by Nandan Nilekani, formerly of software giant, Infosys, is just putting the ‘Adhara’ system, of giving every Indian a unique identity number, into place. Sri Lanka is very far ahead in this aspect. But we have not used the available infrastructure, as in so many other areas, to build an on line accessible data base of borrowers.

Sri Lanka is proposing new legislation on a Regulatory Authority for microfinance, the Authority’s first task should be to build a data base of micro borrowers, accessible to micro lenders to avoid the Indian tragedy of over borrowing and the resultant suicides and other distress and the resultant characteristic reaction by populist politicians, looking for a scapegoat, which causes a crisis in the whole microfinance industry across the board, as in Andhra Pradesh. It recently transpired at a discussion organized by the LMFPA and GTZ Promis that reportedly the National Development Trust Fund, the successor to the Janasaviya Trust Fund, had an on line data base of the NIC numbers of all its Partner Organizations’ clients. If this is available, operational and updated, it would be a huge advantage towards building a data base of microfinance borrowers.

On this aspect of over borrowing, another factor which will assist Sri Lanka MFI’s would be, to research and prepare a profile of indebtedness of a given community. This profile would be based on criteria such as the number of MFI’s , commercial banks, leasing companies, finance companies, cooperative rural banks, thrift and credit cooperatives, money lenders, Samurdhi Banku Sangams,  operating in the locality. All these institutions have to register under some existing law, and the information is in the public domain. Information like sustainability of the economic base of the locality, number of families on government welfare programs and Internally Displaced Peoples allowances would be made available. This would allow an MFI to assess the level of risk and the potential for multiple debt liability being a hazard, on the basis of the debt profile of the community, before deciding whether to operate in that community.

Politically immature and knee jerk reactions, such as legal restrictions on debt collection, caps on interest rates, as in Andhra Pradesh and Bangladesh, are anti poor, shot gun responses which will have negative influences on the long term effectiveness of the microfinance industry, which has a proven and well established track record of pulling millions of poor and marginalized people out of poverty in the context of an open and free market economy.

About the Author: Mr. J. Charitha Ratwatte is an Advocate & Attorney at Law of Supreme Court of Sri Lanka since 1982. He holds 20 years experience in service of Government of Sri Lanka and retiring from the post of Secretary of Finance. He was Secretary to six Ministries and CEO of Apex Micro Finance whole sale lender and Youth Savings and Credit Micro Finance Cooperative Institution. Currently, Mr. Ratwatte is the Managing Director of Sri Lanka, Business Development Centre, a non profit provider of Business Development Services, International & National Consultant.

(Disclaimer: Views expressed in the article by the author are his own and do not necessarily represent those of Microfinance Focus. Microfinance Focus does not take any responsibility for correctness of the data presented by contributors.)