Micro Lending: Challenge and Opportunity   S. Natarajan, Business Line Published on May 25, 2004   The objective of micro finance is not commercial lending in a rural background, but to reach out to sections of society who are unable to engage in an economic activity.

 

MICRO-finance institutions (MFI) have emerged as a vehicle to supplement the role of nationalised banks, co-operative credit societies and regional rural banks in giving credit to the rural poor. Micro-finance or micro-credit has become a buzzword, and the loose use of this term has created some confusion about the exact definition.

 

Micro credit ? conceptualised by Mr Mohammed Yunus of Grameen Bank in Bangladesh ? means making available loans to the rural poor, particularly women, without collateral, for income generating activities that will help reduce poverty levels. It is different from a conventional bank lending system that looks for asset backing and collateral to be eligible for loans.

 

This is an important initiative for economic growth in developing countries such as India, which will help to cut the vicious circle of poverty that is so acute in rural parts of the country. Recognising the need and importance of rural credit, the government initiated efforts to give credit to the poor, through fiats on nationalised banks (loan melas), but this was more of a political gimmick and turned into a financial disaster for the banking system, and could not be sustained.

 

Micro-finance developed its own methodology for lending by creating self-help groups (SHGs) as the nucleus for the lending programme, and credit was given at a rate that was commensurate with the sustainability of the programme being undertaken by the group. The model has worked well as demonstrated by high recovery rate, in excess of 95 per cent, which incidentally is a shade better than the recovery rate on loans to industry that are given after credit evaluation using sophisticated tools and models.

 

If one looks at the potential users of micro credit, at the lowest level are people who do not get food to eat and do not have shelter. Credit to these people is to help them take up economic activities that earn incomes for life sustenance, to guide them to generate surpluses and savings over time. Obviously these borrowers cannot be expected to pay market-related interest costs.

 

At the next level are people whose basic needs are met and want to improve their incomes and, thereby, standards of living. These borrowers may use the loan for marginal improvements in agricultural practices, acquiring low value income producing assets to supplement existing activities, start cottage industry and handicrafts, and so on. While these activities have higher returns, it may still be inadequate to sustain market interest loans.

 

The absence of direct links to end user markets and the dependence on intermediaries reduces the inherent profit margin of many of these activities. It must also be remembered that these borrowers also have limitations in terms of scale of operations and ability to use capital efficiently, at least in the initial years. What they need is low cost credit without stringent security conditions that will help them to increase their incomes by building a strong economic base.

 

People at the next higher level are economically well off, credit worthy, and fewer in number than the first two categories, though their credit requirements will be much higher.

 

Their credit needs are adequately met by banks and these borrowers are powerful enough to influence many decisions taken in their village. There is competition among banks to "bag" these accounts, and new generation private banks would like to get a slice of this business, which is safe and profitable, while also helping to meet rural lending norms.

 

Micro credit deals with the first two categories, as they need low cost loans given in a non-conventional way. The third category is capable of raising money under the conventional system.

 

This is where the ambiguity of the term micro credit starts. The objective of micro finance is not commercial lending in a rural background, but to reach out to sections of society who are unable (not incapable) to engage in an economic activity, help them by giving credit and other inputs to earn returns and build assets, at the same time encouraging the habit of savings.

 

We have read recently that high profile institutions are interested in micro finance lending. One assumes that these new institutions will not charge such usurious interest rates as the private money lenders. At the same time, it is reasonable to expect that they will not be interested in funding any borrower unless the returns are high, considering their cost of operation, provisioning for delinquency in accounts, and compulsion to earn profit for their shareholders.

 

In a recent article on micro finance in a business magazine, it was stated that the effective cost of micro lending was 24-26 per cent, based on a nominal lending rate of 15-18 per cent! This is high cost by any standards.

 

This cost may not be a deterrent for the affluent farmer. However, as a tool of economic development the role of micro credit should be seen as a solution to making available affordable loans to the rural poor, in a way that is a winning proposition for both the lender and borrower. The cost of credit is a very key factor in this scheme and should not get underplayed. It is important to realise that interest rates in micro finance will have to be less than market rate, and this is one of the important distinguishing factors of this model, compared to other forms of lending.

 

This leads to the question of low cost of funds to the lender and how this can be organised. A part of the MFI's capital is funded through grants, donations, contributions ? sources without repayment or servicing obligations or at very low cost. These may come from international agencies and donors, and constitute one source of the total capital required.

 

The MFI should be free to raise balance funds required, as any other commercial entity, from the market in any cost efficient manner. Unfortunately, the present regulatory framework does not support the MFI borrowings and this needs to be changed. Being a financial institution, funds management and low cost of capital are key issues and these are to be dealt with professionally. Fiscal concessions and exemptions can also play a role in reducing the cost of money to the MFIs.

 

In order to ensure the success of this model, an integrated approach to lending is necessary. Besides capital, rural India needs several other complementing services such as education, health care, drinking water, sanitation, public transportation, and so on. If the SHGs are provided all these facilities, through an integrated programme, it will constitute a bonding or affinity that ensures discipline and commitment to the rules by all members, including prompt repayment of loans.

 

This integrated programme will make the rural Indian more productive, and improve his economic status, which is the ultimate aim. Any credit programme that looks at lending in isolation will fail unless it is integrated with these social requirements. With the entry of high-profile institutions, the rural poor can expect better times ahead. It is hoped that there is orderly development of micro finance so that the intended beneficiaries of this programme are reached and their financial and non-financial needs met through an integrated approach. The potential borrowers are very large in number and spread geographically, and micro lending in this context presents a major challenge and an opportunity.