How micro-finance institutions beat nationalised banks

In his budget speech, the Finance Minister hailed bank nationalization as visionary and revolutionary. Yet nationalized banks have, by and large, not reached the poor. However, micro-finance is now reaching people whom nationalized banks could not.

Households getting micro-credit now outnumber poor households. Outstanding micro-finance loans total 80 million. Some borrowers have multiple loans, so net beneficiaries may total 60 million households. This is more than the 55 million poor households, and more than a quarter of India’s 220 million households.

Of course, many poor households are still left out, while non-poor households have got loans. MFIs have yet to reach or saturate large areas in India. But they are spreading fast across most states.

I am a co-promoter of three MFIs: Arohan in Kolkata, Sonata in Allahabad and Mimoza in Dehra Dun. Within 39 months of existence, Arohan has reached 100,000 poor women. The three MFIs together have 250,000 borrowers, and within three years should reach one million people. In another three years they may reach one million each. I am astounded that small ventures can scale up so fast.

When launched, these MFIs expected to lose money for four years. But they broke even after two years, because loan defaults were below 0.5% against the expected 2%.

Once, MFIs started with loans of Rs 3,000 in the first year, going up to Rs 4,000 in the second year, and so on. But now some MFIs start with Rs 10,000, go up to Rs 15,000 the next year, and soon.

They typically charge around 30% interest. This looks usurious. But moneylenders lend at 50% or more, seize the land of defaulters and make them bonded labourers. MFIs, by contrast, rely on group lending for repayment. If one member of a joint lending group defaults, the others cannot get credit, so they put social pressure on the defaulter to pay up.

Credit card companies charge an annual fee plus interest at around 30%. MFIs, like credit-card companies, give small, unsecured loans, and their interest rates are no higher. In both cases the interest rate reflects the high cost of handling very small loans.

Some advocates claim that micro-loans convert poor women into entrepreneurs and greatly reduce poverty. Alas, that’s a gross exaggeration. Loans of Rs 5,000 at 30% interest cannot end poverty.

Many studies (like a recent one of Hyderabad’s slums by Bannerjee, Duflo, Glennerster and Kinnan) show no short-term link between micro-credit and poverty or consumption. Only one in five loans in Hyderabad created new businesses. Still, beneficiaries spent more pushcarts and cooking pans (for new businesses) and less on tobacco and alcohol. Localities with MFI branches had one-third more businesses than others. In due course, this could have a significant impact on poverty.

Poor people have demonstrated an insatiable appetite for micro-loans, and repay them. This proves there is great demand, and that it’s viable. Even if it does not reduce poverty immediately, mere access to finance is a boon.

Banks lose heavily in small loans to the poor—their wages are five times higher than in MFIs, and politicians encourage poor borrowers to default. These two problems, plus corruption, sank the Integrated Rural Development Programme, which provided subsidized microcredit through nationalized banks in the 1980s. Banks now give loans to MFIs (classified as a priority sector), which then led to the poor. This raises interest costs, but has proved viable.

New problems are cropping up with MFI expansion. Without technical assistance, some businesses fail. Competition in some states is so intense that MFIs accuse rivals of stealing their clients through unethical offers. Some women have borrowed from four or more different MFIs, and could get into debt traps, which also hit MFIs through higher defaults. Moneylenders are said to have entered the MFI business, using thugs rather than group loyalty to enforce payment. Some private equity funds are investing in MFIs, fuelling misgivings that these have become purely commercial and shed their original social mission.

These misgivings are legitimate but exaggerated. Microfinance will always differ from commercial ventures in one respect—the loans go almost entirely to women. Although many husbands appropriate the money, MFIs nevertheless confer status and power on women in a country with oppressive male domination. That’s a huge social change.

In Bangladesh, where microfinance originated, female empowerment has spurred higher women’s education and falling fertility. Mullahs have attacked MFI offices as threats to traditional male and religious dominance. Even if microfinance does not create instant poverty reduction, it creates profound social and gender changes. That makes it doubly inclusive. For that reason alone, micro-finance achieves what nationalised banks cannot.

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