Micro credit and the financial system
Micro credit and the financial system

The 2010 microfinance crisis in Andhra Pradesh has raised some basic questions regarding the role that Microfinance Institutions (MFIs) can play in future in providing access to finance to the poor.  If the microfinance sector shrinks in future, what are the feasible credit alternatives we could think of for filling the gap?  A recent paper by the World Bank explores the alternatives (After the Microfinance Crisis – Assessing the Role of Government-led Micro Credit Alternatives, 2011).

Can the cooperative credit institutions cope with the challenge?  The World Bank conducted a survey in 2007 in three districts in Andhra Pradesh to assess the performance of rural credit cooperatives in particular Primary Agricultural Credit Cooperatives (PACs).  The findings of this Survey are interesting.  The findings also clearly reflect World Bank’s own bias in favour of private and against Government-led or Government sponsored institutions.  First, we find evidence that PACs were used as political instruments and that borrowers responded by prioritising all debt obligations (MFIs, informal lenders etc.) before repayment of PACs loans.  This indicates that the culture of repaying institutions with significant government involvement may have been low and that a private sector solution that is shielded from the Government’s interference may be desirable.  This is a very simplistic interpretation and it demonstrates how innocent are the World Bank experts about the Indian financial system.

But let us look at the deficiencies of PACs, as revealed by the survey.  First, Secretaries of PACs had an average of only 1.5 years of education.  They had been trained in accounting for less than two months.  Presidents of PACs on the other hand had higher qualifications.  This led to dominance of Presidents in the governance of PACs.  Admission and termination of members and credit decisions were influenced by them.  Loan decisions of PACs tended to favour certain members.  PACs Presidents do not look after members’ interests.  Then there is the role of politics.  For instance, agricultural credit increases by 5 to 10 percentage points in an election year.

The point is that our approach to streamline the operations of PACs should be: how to correct these deficiencies and develop PACs on healthy lines.  We cannot throw away the baby along with the bath water.

What is most unfortunate is that the World Bank experts have not cared to view the problems in the specific context of the evolution of the Indian financial system.  Otherwise they would not have made the following comment.  “If an expanded role for government has to be the solutions, care should be taken in ensuring the efforts of government interventions have the intended consequences”.

The World Bank experts seem to assume that MFIs are the ideal credit institutions to reach the poor.  This is tantamount to begging the whole question.  They should have cared to look at the Indian experience.  The ordinance of Andhra Government is quite explicit.  “Where as these SHGs are being exploited by private Micro Finance Institutions (MFIs) through usurious interest rates and coercive means of recovery resulting in their impoverishment and in some cases leading to suicides….”  The engagement of MFIs with borrower was shallow based on “touch and move on” business models, shorn of any development content.  The small loan size and short duration of the loan do not enable most borrowers to do much except to ease liquidity problems.  That is why Dr. Y.V. Reddy, former Governor, RBI stated that Microfinance is India’s subprime.  “Ultimately, it is something like subprime lending”: In fact there is evidence to show that profit-making MFIs were encouraging what were called “NINJA” loans – no income, no job and no assets – in the American financial crisis of 2008.

Part of the problem of World Bank experts is that they take a compartmentalised view of MFIs or cooperative credit institutions and are still not grown up from the now discredited market theology.  Financial system has to be viewed as an integrated whole.  The World Bank experts should have first understood the milieu in which they are discussing the role of cooperative credit institutions.  The evolution of the Indian financial system is unique in a number of ways.  We must pay a tribute to the vision of policy makers of the 1970s.  Much before financial inclusion became fashionable internationally, these policy makers took concrete steps to usher in financial inclusion.  Nationalisation of major banks in 1969, the phenomenal branch expansion programme – a programme unprecedented in the history of world banking – and fixing credit targets with a view to ensure a wider disbursal of bank credit.  Reaching the small borrowers and the poor thus became the objective of the whole financial system and not the exclusive preserve of profit-making MFIs.  The Indian financial system is thus a product of state direction and guidance.

Again, India is unique in building up its home-grown segment of microfinance  Public Sector Banks (PSBs), restructured Regional Rural Banks (RRBs), rejuvenated cooperative credit system, NABARD’s Self-Help-Groups (SHGs) Bank Linkage Programme (SBLP) which has emerged as a major channel of micro finance.  Then there is the Post Office, which already functions as a semi-bank with its 1.55 lakh branches and some 16 crore customers.  This holds out great promise for emerging as a major microfinance institution.  In the Indian financial milieu therefore, there is no space for the new breed of Shylocks who masquerade as profit-making MFIs.

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