chotaLOAN

The concept of rural & marginalized financing popularly known as Micro-Finance has taken deep roots in the developing world after the successful experiment by Dr. Yunus in Bangladesh. The latest case of exemplary performance by one such institution SKS Microfinance has created waves in India. Primarily, conceptualized as a non-profit organization the company was among the first movers who tried to replicate Yunus’s model in India. Boosted by moderately high interest rates and excellent recovery rates over the past few years, the model has not only sustained the culture of small loans but also yielded profits for the company. It was recently listed and the stock shot up by more than 30% within a few days.  It is this listing that has opened Pandora’s box. Discussions today surround the suitability of the so called non-profit institutions being governed by the profit motive, the trend towards money laundering (rather than money lending) and the potential move towards the exploitative practices as already exist in form of the traditional money lenders. Not only this, there had been talks of capping the interest rates charged for these chotaLOANS.

Before going into the policy perspective regarding these institutions, lets first try to find out - Why such institutions are so successful? The answer is actually very simple. In countries like India where more than half of the population lives below a meagre income of $2 per day and where daily wage is the means of livelihood for most; millions of people in rural and urban areas need cash for their extremely small enterprises on a daily frequency. Consider your mohalla’s vegetable vendor or the sunrise doodhwaala, these people need amounts as small as Rs. 500-1000 to buy the items which they can sell to earn profits. These small profits sustain their livelihood. The problem arises when they are not able to finance these tiny amounts (less than what a movie & popcorns in the interval costs us!) and it is here that these micro finance institutions come into picture. If a vegetable vendor can get Rs. 500 in the morning and after day’s work if he is able to sell his quota for a net profit of Rs. 100, he would be more than willing to part with a fraction of the profit - a rupee or so. But if he does not have access to Rs. 500 in the morning he will sleep hungry that night. The rupee paid in return of Rs. 500 for the day doesn’t seems too costly - does it?. But if you look at it in terms of interest rate the annual interest rate turns out to be a whopping 73%. It is here where things have started getting hot -

Most of the micro finance organizations are involved in lending sums between Rs. 100 − 10,000 for short term loans. The rates charged vary from 20% to 50% depending on the kind and term of loans. The protagonists who champion the idea of regulating these interest rates put forward two main arguments - 

1. The comparative argument between the banking rates vis a vis micro finance rates to point out the colossal gap between the two. An agreed cap of ~24% is being favored for a policy decision. 
2. Secondly, they advocate that the noble activity of helping out the farmers and other marginalized sections of the society will soon turn into an insensitive profit churning machine if such institutions are allowed to retain profits and worse if they are allowed to distribute it to share holders.

There might be some grain of truth in the concerns but before taking up the task of regulation we have to look at  the other perspective as well.

As rallied and paraded by the protagonists - “Are the high rates of interest really high?” Consider this - Firstly,  a majority of these loans are unsecured unlike the commercial banking or the traditional money lenders. Secondly, while a customer representative in a commercial bank can cover 100 clients a day, most of these loans are offered through door to door marketing and the collection also takes place in a similar manner. Simply saying the distribution and collection costs are high.

Now coming to the second objection about making profits. Is making money so bad? I wouldn’t agree - While most of these organizations are making money today due to high recovery rates there is a lot of uncertainty. When the prime borrowers can default (as the crises of 2008 has shown), the probability of these marginalized borrowers defaulting is exponentially high. Their incomes are totally dependent on agricultural fortunes (most of the borrowers are directly or indirectly linked to agriculture) and the year the monsoons go bad, there will no end to their miseries forget about payment of debt. The point I am trying to make is that the profits earned by these organizations today can act as a buffer to continue financing tomorrow when the conditions might not be right but the need grave.

It is imperative that the policy makers look at the problem from the perspective of the poor who are getting benefitted from the organizations in question. Rather than limiting the role of these organizations in economic prosperity they should be incentivized to enhance their role in economic development. Along with lending even the process of small savings can be initiated (since they have a well established network and a deeper reach) to free the weaker sections from fraudulent lalas who have for centuries gulped their hard earned pennies. What we need policy for, is the innovation to stimulate entry of new players in the arena and expand competition. It is not only a question of right thing to do but also a question of right way of doing the right thing.