By Najmul Hoda,

Microfinance Focus, April 3, 2012: The poor and the poorest have a right to be serviced affordably, appropriately and accessibly, reads the Millennium Development Goal campaign named end poverty 2015. There is no denial of the fact that microfinance has emerged as a key strategy in reaching the Millennium Development Goals and as an effective tool in the provision of financial services to the poor and the near poor. However, despite the claims of overwhelming success of microfinance in financial inclusion and poverty alleviation, the microfinance sector in India has faced some critical problems highlighting shortcomings in the institutional or functional framework.

Several reports suggest that the efforts of the existing microfinance institutions are directed mainly towards growth and outreach. The industry also lacks rigorous analysis of the institutional, incentive features and benefit-cost or statistical studies of impacts tends to be biased towards women, lack features of fund mobilization. The diagnosis of the crisis in Andhra Pradesh reveal similar problems like lack of credit discipline, rapid expansion of credit in highly concentrated markets, lack of proper incentives for sound underwriting or customer care, lack of internal controls, reliance on credit-only services, and dependence on basic bank debt.

Finally, the single biggest problem with conventional microfinance, and for that matter all interest-based finance, is that the borrower has to make his interest payments even if he is unable to meet them. At a time when a young business should be concerned with innovation and expansion, an interest payment looms unavoidably large at the end of the month. Further, interest based transactions tend to focus attentions on the process-oriented task of repayment rather than on the result-oriented task of increasing profit. Loans can also be taken for consumption or to fund special events such as weddings. The fungibility of money, which is routinely overlooked by microfinance proponents, blurs the distinction between investment and consumption borrowing. This results in increased problems for the poor rather than alleviating it.

The existence of co-operative based microfinance is rare and may provide remedy to the existing problems in the microfinance industry. The reason for the recurring problems of same nature across the industry is that a majority of microfinance models work on the same or an altered method of group lending. In a recent article David Hulme, an expert, suggested that the industry must strive to keep its costs as low as possible, expand incrementally and focus as much on savings services as on loans. Such features are deeply embedded in the co-operative structure. Co-operative has a long history and began nearly 150 years ago in Europe expanded across the globe as a movement.

The financial co-operatives usually non-profit and provides financial services: savings, checking accounts, loans, insurance, and fund transfer services (although the weaker and smaller ones are not capable of offering transfers). The reliance on the members’ own savings as the source of funds fills a major gap found in the case of other models. Cooperatives generally have higher levels of cost recovery and fund a greater proportion of their loan portfolios with mobilized deposits than NGOs with similar clienteles. The co-operatives may be grouped into federations at regional or national level to offer supervision, liquidity management, refinancing, and/or technical support that might be difficult to find at the local level. Even small financial cooperatives typically have the legal and institutional capacity to provide a wider range of more flexible financial services than NGOs, particularly if membership in a federation provides them with access to a liquidity pool. A cooperative has a huge potential for scale depending upon the nature of its common bond.

A really interesting model is that of Al Khair Cooperative at Patna. The model allows the member to engage in participatory finance. The system of participatory finance allows the members to decide on aspects like interest, transaction cost, loan disbursements, financial products and liquidity. The Al Khair experiment allows a great scope of innovation in terms of financial products. The members can decide on interest free borrowings and lending thereby reducing their transaction considerably compared to the prevalent market rates. Innovative financial products like micro-ventures may be introduced and the profit sharing may be used for cross subsiding the transaction cost incurred in the consumption loans.

The co-operative structure provides the requisite institutional structure for catering to these needs. A financing system based on profit sharing with the micro-entrepreneurs should be able to provide interest free consumption loan, while still leaving enough in the reserves to show as profit. There are indeed risks of non-repayment due to business failures but the same exists in any collateral free loan lest the institution resorts to any illegal means. The interest free deposits by members would come as a boon for the microfinance institutions that do not have any other option but to charge a higher interest rate from the poor clients to meet their cost. There is a strong need to study such institutions for more detailed insights and the potential for their mainstreaming. Hopefully, the interest free co-operative microfinance may provide the much needed change the industry is eagerly waiting for.

(The author is pursuing PhD from Birla Institute of Technology Noida and also heads the Research department of a microfinance institution in India)