Microfinance is not a significant tool for poverty reduction

It is generally believed that microfinance reduces poverty significantly. You just give credit to the poor and they would deploy it in income-generating activity. The poor would thus graduate out of poverty. Several stakeholders in this social business concur with this view Now, international development agencies, too, have joined the chorus.

However, in our country, several government-sponsored, highly-subsidised microfinance programmes such as the Integrated Rural Development Programme and Differential Rate of Interest have failed to deliver.

They were long on intent and short on delivery models. It is now made out that MFIs have overcome the bottlenecks through expensive but highly accessible loans. But there is a huge gap between reality and heady rhetoric. MFIs have become adept in creating a reality of their own.

Even before the disaster struck the Andhra Pradesh microfinance industry by way of suicides by hapless borrowers, there were murmurs about the efficacy of micro-credit as an important poverty reduction tool. Microfinance was such a feel-good programme, few dared to question its usefulness.

Milford Bateman is a rare voice who dared to differ. In his book Why Doesn't Micro Finance Work? he rejects the idea of microfinance as tool for significant reduction in poverty.

With well-reasoned arguments and empirical evidences he sets out to demolish the myths of microfinance.

He has extensively researched microfinance programmes in several poor and emerging countries, including India.

Myth 1 — microfinance supports income-generating activities: The public justification for MF programmes is that they help start or expand an income-generating micro-enterprise.

PR material and publications on MFIs highlight this. But empirical studies reveal that over 70 per cent of loans are used for purposes other than income generation. More often than not they resemble consumer loans of commercial banks. .

Rather than get into microfinance business, it is the fundamental duty of the Government to provide basic education, healthcare, and relief and rehabilitation.

And these cannot be addressed through credit, as this can only lead to a debt trap.

Incidentally, Jobra village in Bangladesh, where Dr Mohammad Yunus started micro loans in 1976, is still reportedly mired in poverty.

Myth 2 — MFIs can be self-sustaining: Bulk of the MFIs are unlikely to reach financial self-sustainability. Of the 10,000 MFIs currently estimated to be operating in the world, only 3-5 per cent will become financially self-sustaining. Only the largest and most aggressively commercialised are likely to survive.

Myth 3 — microfinance is what poor need and want: MFIs have put in circulation estimates of a huge demand-supply gap in micro-credit.

Thus, commercialisation becomes an urgent necessity and demands removal of all obstacles. There is a world of difference between potential demand and effective demand.

The assumption that every poor person could be turned into an entrepreneur is farfetched.

It is anybody's guess as to the percentage of poor wanting to run enterprises in preference to wage employment in the formal sector.

The cruel joke in some of the States is that people have far more easier access to liquor than health, education and jobs.

Myth 4 — it is not high interest rates but the availability of micro-credit which is a problem for the poor: Displacing ultra expensive interest rate of moneylenders is one of the justifications for establishing the microfinance industry.

First of all, it is not always true that the rates charged by MFI are less than those by moneylenders on an annual percentage basis.

Several studies in various countries on interest rate elasticity show that the poor react positively to low interest rates and they feel the need to shop around.

Even in our country National Sample Survey data had brought out that a large proportion of micro-credit clients are worse off after accessing loans. The Survey goes on to explain that since higher interest rates on micro-credit do not provide scope for savings, it seldom propels the poor out of poverty.

The business models of the new MFIs are centred on increasing volumes, which generate high profits through high interest rates which, in turn, leads to increasing commercialisation and more clients. It ends up in one section of the hungry feeding the other. It would hit a roadblock sometime.

Myth 5 — higher repayment rates prove that borrowers are succeeding with their expensive micro loans: Higher repayments hide more than they reveal. There is no measurable connection between success of micro enterprise and high repayment. This is more due to the devious contractual structure, namely, group collateral and multiple borrowings.

More often than not the poor take fresh loans to repay earlier loans and are awash in debt.

There is a huge disconnect between repayment and development as the poor have fall-back strategies to repay micro loans and also the ingenious social collateral designed by the MFI to take care of likely failure of micro enterprise.

There are measurable achievements on outreach in terms of number of micro-credit clients but when it comes to its impact there is no significant evidences of its positive impact on poor communities, much less on poverty reduction. The impact assessments at best are lazy.

We need independent and objective impact assessment studies by eminent academic institutions which provide good insight rather than self-serving stories, generalising a few success stories and amplifying them.

Milford Bateman, in his concluding remarks, reiterates that almost all the fundamental building blocks that go into making up today's microfinance model are largely nothing more than self-serving myths. He goes on to observe that the MF industry has proved to be supremely adept at creating its own reality. Thus, he argues that microfinance does not work and is not working in the present models.

Poverty reduction and sustainable economic development is a complex interplay of economics, politics, ideology, self-interest, ethics and empowerment.

There is no shortage of these models in our country. The National Dairy Development Board's Operation Flood programme is an example worth emulating. Where do we go from here? Our endeavours to reduce poverty need a new direction and a new beginning. This is far more important than quibbling on behind the curve or ahead of the curve regulation.

Hope and hype are best friends in filmy theory. Does art imitate life?

(The author is former CMD, Corporation Bank. The views are personal.)

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