The Hindu Business Line : Why not a safety net for the money-lender?

The farmer suicide is perhaps the most discussed but least understood issue. Is the money-lender, who is blamed for all the rural suicides, wholly guilty as charged?

Essential service

Money-lenders perform an essential service. Commercial banks will never supplant them. Take the money-lender out of the rural areas, the rate of suicides and the degree of despair will only rise, not abate. The structure of their pricing (interest rates) is the irritant.

The usurious pricing is due to two sets of factors. The first is the poor quality of security, lack of proper registration records, and poor enforceability due to legal delays, besides the low ticket size and the high unit transaction cost. The second factor is the embedded (in interest rates) `premiums' charged for credit default.

Given the highly uncertain nature of the borrowers' cash flows and not much back-up of `quick assets', it would be foolish not to factor it in the price (the interest rate).

By diversifying risks, insurers bring down the credit default premiums substantially. Credit risk diversification is achieved normally by spreading the risks geographically or over time periods. For the rural money-lender, there are practical constraints in both.

Lender's perspective

Let's look at it from the money-lender's perspective. If there is a crop failure in his village due to poor monsoon, floods, or any other reason, his money is most definitely at risk. Since most money-lenders operate in one village or at best two-three adjacent villages, the scope for geographically spreading the risks is non-existent or limited. For commercial banks (or a general insurer) a credit failure in one zone is made up by normal/better performance elsewhere. Loss in one crop is made good by satisfactory performance in others. Not so for the village money-lender. So his interest rate builds in the likelihood of a drought/flood.

Often, insurers charge higher premiums to take care of high perceived risks at the start but refund a portion of the premium by way of no- or low-claim discounts at renewal. But a money-lender cannot go back and recover a higher interest from a defaulter post-facto. So the money-lender charges higher interest upfront but doesn't feel obliged to return anything by bonus or discounts as organised insurers do.

The other way the organised insurers bring down credit risk costs is by using the reserves generated by the superior performance of business in one time period to compensate for the adverse performance in other periods. But if a money-lender lends Rs 100 at 50 per cent in one-time period and recovers the whole Rs 150 at the end, the additional Rs 50 is not a kind of `reserve' or buffer for future failures. Rather the entire Rs 150 becomes his new base wealth to be as zealously protected as the original Rs 100 and hence he continues to charge his `normal' usurious interest rates on his new base.

Personal element

And there is personal element to this. Any crop failure is as much a danger to his the money-lender's wealth and survival as it is to his borrowers. Hence, in any adverse situation the follow-up is at its most vigorous.During normal times the failure is mostly individual, unlikely to threaten the money-lender's existence. One way this chain can be broken is to take the village money-lender into the formal credit insurance fold. For a low premium of, say, 2-3 per cent (all-India recovery rates for rural loans are stated to be 98 per cent), it may be feasible to bring down their fear-induced default premiums in interest rates quite steeply.

Geographical diversification (and to a degree even inter-temporal diversification) can be done by the insurer. No doubt he will pressure his borrowers to recover his 10-20 per cent (the minimum the insurers deduct from the claims) but that may not be as much as when his entire portfolio is in peril. This release from personal pressure will most definitely bring down the interest rate, money-lender pressure and the suicides.

Credit guarantee

The government should extend the scheme of credit guarantee (of the deposit insurance and credit guarantee variety) to the rural money-lender. For a premium of 2-3 per cent, it can reimburse 80-85 per cent of loan failures. Maybe even with a cap per borrower of Rs 2 lakh.

If the government intends to give rural credit subsidy it can route it through lower premiums or higher claim settlement ratios rather than through region- and crop-specific interventions which are highly politicised and not entirely justifiable.

(The author is Vice-President — Finance — JK Paper Ltd. The views are personal. He can be contacted at swaksha_ad1@sancharnet.in)

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