It is refreshing that this year?s Nobel Peace Prize has gone to Dr. Mohammed Younus and the Grameen Bank. With the last few Nobel Peace Prizes having gone largely to diplomats, giving the prize to an institution in an underdeveloped country which has taken development to the masses is a welcome change.
In this context, it would be interesting to look at an edit page article in the Times of India a few days back where the author (forgot who) tried to argue that microfinance institutions (MFIs) have been more of a bane than a boon in Andhra Pradesh, and that they are no better (and sometimes worse) than conventional moneylenders.
The article went on to argue that interest rates charged are usurious (in the range of 25% – 30%) and didn?t speak too highly of the factoring methods (using goons, etc.) and gave out figures of suicides by farmers who are being covered under microfinance, and argued that this is much more than the suicide rate among farmers who haven?t availed loans under the microfinance scheme.
Now the basic problem with most of the microfinance schemes in India is that they have unabashedly copied the Grameen Bank model. The model revolves around weekly payments and self-help groups. I give you a loan and you pay me in Equated Weekly Installments (EWIs). You are supposed to be a part of a ?self help group? of five or so and you get loans in turn (at a time approximately three people in the group will have a loan). If anyone in your group misbehaves, the entire group gets punished so you better take good care of your group members.
It is an excellent model, with the only problem being that it is not exactly suited for the Indian context. The simple fact is that in rural India, the major demand for loans comes from agriculture, which involves large negative cash flows up front and (hopefully) large positive cash flows a few months down the line and the microfinance institutions here barely seem to understand this.
One of the fundamental principles of finance is that the cash flows of the source of funds should approximately match the cash flows of the application of funds. And therein lies the major failing of Indian microfinance. What Equated Weekly Installments implies is that if I give you a loan at the beginning of the crop cycle, I expect you to pay me a large part of it before the completion of the cycle! And the only way (in most cases) that you can make such payments is by going to the local moneylender, thus getting stuck in a debt death spiral.
The reason the model has worked so successfully in Bangladesh is because there the loans are not for agriculture. They are doled out to women so that they can start their own small businesses, which usually yield steady weekly cash flows ? you might notice that the cash flows from the business are in tune with the cash flows from the loan.
What has happened is that the model has been blindly copied from Bangladesh and thrust upon rural India. Without realizing the inherent flaws in the model, aggressive targets for rollout of the program have been set. Now, the people in the middle (those that have to implement the microfinance program) have no choice but to ?aggressively market? the scheme to the poor, and in effect forcibly sell it to people who don?t actually want it!
It is not that there is no demand for finance in rural India. In fact there is a huge latent demand, only that the demand is for a product with a different structure of cash flows. What is actually required is an instrument that makes sure that borrowers need not resort to secondary sources of debt in order to pay off this debt. The interest rate problem might not go in the near future ? the inherent risk in agriculture warrants such a high rate of interest; maybe crop insurance could help a little. Still, that can be slowly taken care of later.
This requires a paradigm shift in the thinking at two levels. First the parties involved (governments, not-for-profits and financial institutions) should learn to think beyond the Bangladeshi model. They should be more open to experiment, and large banks (especially PSU banks) should probably take a little more risk in the initial years to try out new models.
Second is at the level of the State and Central Governments. They should understand that the model that they have implemented here is flawed, revise their ?targets? accordingly. Apart from this, success should not be measured on the basis of ?number of families covered? or ?amount of loan disbursed? but on the impact it has on the users, that is the poor farmers. Under the current parameters, it is not tough for the MFIs to regularly meet the targets with zero (or even negative) improvements at the grassroot level.
Despite the roaring success in a neighboring country, microfinance in India has a long way to go. However, some effort from both the state and the not-for-profits can make a difference. It is best the effort comes sooner rather than later.