Micro-finance (MF) has been one of the most ground- breaking innovations of the 20th Century. The benefits of MF are undeniable. It has been responsible for empowering women, unlocking the entrepreneurial spirit of the rural populace and improving the quality of life of countless people. Exponential growth of Micro Finance Institutions (MFI), such as Grameen Bank and BRAC indicates the phenomenal success of MF.
However, emergence of new challenges within the organisational structure of MFI and the implementation of its products seem to indicate that some of the lustre of MF may have faded and provides some sobering thoughts about its current method of operation. This article will demonstrate that the original vision behind MF has been compromised as the industry has evolved. This could lead to unpleasant outcomes both for Bangladesh and MFI. There is still time to alter the course. However, this would require MFI to acknowledge that its current organisational structures may have become inadequate, analyse the problems critically and develop solutions that would ensure the sustainability of MF for the future.
REVOLUTIONISING LANDSCAPE OF FINANCE SERVICES: MF has revolutionised landscape of the finance services. Mainstream banking institutions, historically, excluded the rural population from their potential list of customers. This is because these people were considered to be too risky for financial products, namely loans, according to traditional risk indicators. Since poor people, mostly the rural populace, are unable to offer any collateral for their loans, lenders would have to bear higher risk while lending to such people because the creditors would have no opportunity to recover their money in the case of default. Mainstream financial institutions seem to believe that the interest rate they would have to charge to make these loans commercially viable would be prohibitive. Their lack of foresight and complacency mean that the rural population of Bangladesh is systematically marginalised by the financial industry.
Enter Prof. Yunus. A trained economist by profession, he must have identified that there is a market failure in relation to financial products for the rural population of Bangladesh. His genius lies in his ability to see beyond the obvious. To him a poor housewife with malnourished children and a bad-tempered husband in the rural areas of Bangladesh is more than what meets the eye. He must have thought that this person must be immensely resilient and creative to be able to endure such hardship and ensure the survival of her family. If someone could nurture that creativity and resilience, then these women could drastically change the course of their lives along with the economy of Bangladesh.
Prof. Yunus must have realised that to change the banking industry and help the marginalised he had to develop a product that could enable poor people to enjoy the benefits of modern finance while at the same time effectively managing the risks for creditors. He invented a financial product which has become widely known as micro-credit loans (MCL). Limited MCL lenders' exposure per loan because the value of each loan is so little that loss arising from the default of one person is insignificant. The genius of Prof. Yunus lies in his recognition that the success of MCL requires a multi-dimensional approach because the rural inhabitants not only suffer from a chronic shortage of capital but also an acute deficiency of knowledge and information about effective resource management and strategic planning.
With the help of foreign donors, he established informal institutions and social groups which provided critical assistance in relation to strategic and financial planning, moral and emotional support, and management training for the borrowers. The development of this multi-dimensional product further reduced the risk of default because the rural population, particularly women, had the opportunity to learn how to manage their finances, prepare for unexpected events and take financially savvy decisions. This meant that these marginalised people would have the necessary skills to be engaged in productive activities with the MCL and generate sufficient income with which they would be able to service their loan payments and obtain financial independence.
IS SOMETHING AMISS? In the early days of MF, effective interest rates of 40-50 per cent were quite common, even though it has come down since then. Although the interest rates seem high when compared to commercial loans, one has to realise that these rates were far more competitive than the rates that were being offered to such people by loan sharks. Factoring in the administrative and operational costs of MCL, one could argue that the interest rates for MCL were justifiable. Furthermore, the fact that the repayment rates of such loans have consistently exceeded 90 per cent indicates that these loans were in high demand and that they were sustainable.
However, repayment rates do not provide complete information about the MF industry. Because the figures do not explain how the loans have been recovered. Since MF borrowers do not sign any legal documents, given their socio-economic status, they are effectively at the mercy of MFI. There have been innumerable incidents where local collection officers have coerced and abused borrowers to pay their loans. There have been cases where local collection officials have continuously harassed hapless borrowers to make their payments. In some extreme cases, they have been known to confiscate property belonging to the borrowers, without any legal authority, as payments in kind.
Since most borrowers are uneducated, they are unable to protect themselves from such unauthorised and aggressive collection methods, which mean that they end up being victimised. The point is that such enforcement policies are not justifiable under any circumstances. If the objective of MCL is to empower the disenfranchised and assist them to break free from the shackles of poverty, then MFIs have a moral obligation to ensure that their borrowers are not subjected to such draconian collection methods. Given the rise of such incidents, one has to critically analyse the current model to determine if something is amiss.
SUPPORT SERVICES AND TRAINING SCHOOLS: The reason for the rise of such draconian practices could be attributed to a number of reasons. This scribe has been informed that the support services and training schools, which are essential for the success of MF, have been suffering from chronic underinvestment for the last decade or so. Since foreign donors have directed their resources to other projects, MFIs have significantly cut back on such services to minimise costs and maintain profitability. This means that the borrowers of MCL do not have access to the information and knowledge that are crucial for them to plan and manage their finances, and become financially successful entrepreneurs. Given the fact that most of the borrowers are not well versed in the intricacies of financial and business planning, it is no wonder that they are unable to sustain their businesses which were meant to provide them with enough income to pay for the loans and sustain their regular expenditure.
Furthermore, structural complacency seems to have crept into the administration of MCL. This writer has been informed that local officers have been under a lot of pressure to meet their disbursement and collection targets. So, local officers are less inclined to critically scrutinise loan applications and have a high incentive to use any measure to recover loans. Lack of scrutiny for loan applications means that people are increasingly taking out MCL to finance their consumption. In some cases, the MCL has been handed out even when the loan officials were aware of this fact.
This shift in the disbursement policy does not bode well for the future of MF. One can draw alarming parallels with the sub-prime loan debacle that culminated in credit crunch. Both of these financial products were designed to provide access to capital to individuals who were considered to be too risky by mainstream financial institutions. The promoters of both products, furthermore, had to develop innovative methods to manage that risk so that the interest rates on these loans were viable. Moreover, the people who were meant to scrutinise the loan applications to determine the viability of a loan had started to ignore their obligations to expedite the disbursement of capital. Finally, both of these products were used by their borrowers to finance their consumption, even though MCL was conceived primarily to foster productive activities. This does not bode well for MF.
If MFIs want to protect their independence and avoid the fate of banks like Northern Rock of Britain, they must critically analyse their organisational structures and innovate new solutions to tackle these challenges. It is prudent that MFIs reinstate and invest heavily in the support services because the rural populace needs proper financial and strategic guidance just as much as they need capital. Without proper guidance, the marginalised people would become even more vulnerable because they would become overburdened with debt and ruin themselves financially.
CODIFY MCL AGREEMENTS: It would also be a good idea to codify MCL agreements. One MFI claims that it does not require the borrowers to sign any legal instrument because it does not wish to take any borrower to the court of law. MFI seems to conveniently overlook the fact that the objective of a legal instrument is to provide protection to both creditors and lenders. Since a legal instrument would delineate the measures that creditors can take against a non-compliant borrower, it would mean that overzealous collection officers would no longer be able to abuse borrowers who fail to meet their payments. MFI institutions could argue that legal instruments would make MCL inaccessible. The accessibility issue could be easily resolved by developing standardised MCL agreement and encouraging the borrowers to learn about their rights and obligations at the training institutions.
Finally, MFIs need to develop robust control mechanisms to ensure that the MCL applications are thoroughly scrutinised. This is crucial for the long-term success of MF, because that will determine whether both the borrowers and the lenders are able to benefit from the transaction. Since MFI would have to suffer the loss if borrowers default on their MCL, it has a vested interest to ensure that loan applications are critically scrutinised. To facilitate this process MFI could use mathematical models with key indicators that could determine the probability of default. It must also ensure that their employees fill in correct and accurate information to determine the viability of a loan application. To discourage employees from misrepresenting information on loan applications, MFI has to enforce a policy whereby wilful misrepresentation would lead to immediate dismissal.
If an applicant fails to qualify for a MCL, the MFI should consider providing assistance to them to develop a feasible business plan. Since the objective of MF is to assist the marginalised, MFIs have a moral duty to assist people who fail to qualify for a MCL to eventually obtain it. The advantage of applying such a model is that it would drastically reduce the probability that people would use MCL to finance their consumption. By promoting investment in productive activities, MFIs would ensure that the disenfranchised rural populace is able to break the fetters of poverty and enjoy a better life.
MCL has been one of the most powerful agents of change within Bangladesh. It has been responsible for helping lots of people to break free from poverty. It would be ironic if the innovation that was meant to mitigate poverty ends up being a tool to further entrench it. The scribe is a great believer in MF, but he is concerned about the current course it has taken.
