Opinion

Financial inclusion beyond microfinance

Usha Thorat | Updated on April 12, 2011 Published on April 08, 2011

Ms Usha Thorat   -  Bijoy Ghosh

The challenge in microfinance lies in taking advantage of economies of scale and passing on the benefits to the customer while providing a reasonable return to the investor.

Financial inclusion is more than microfinance. Microfinance has shown how the poor are credit-worthy, how through regular savings and loan repayments, using group solidarity or guarantee, they have alleviated distress amongst low-income households, enabled consumption smoothening and facilitated self-employment and micro-enterprise.

For borrowers who only had recourse to moneylenders and loan sharks, microfinance provided access to formal sector finance with very little formality and documentation. The MFIs have demonstrated innovative methods and technology to enhance outreach and attract equity which could be leveraged to make further investments to enhance coverage. They have been able to reach the last mile that banks have found difficult.

The number of loan accounts serviced by MFIs in India increased from 10 million in 2007 to nearly 27 million in 2010 while loans outstanding increased from $840 million to $4 billion.

On the other hand, the critics of microfinance have argued that the interest rates are too high and investors in such MFIs have obtained huge returns on their equity. Grameen Bank Founder Muhammed Yunus would argue that financial services to the poor cannot be rendered by profit-oriented enterprises. Others would argue that unless there are profits to be made, there can be no sustainable scale-up of business so as to cover the unreached and excluded.

Consumer protection

The whole issue boils down to what is considered to be abnormal or supernormal profits and what is considered to be cost covering and enough for the business to be sustained.

The challenge ultimately lies in reducing costs through the use of technology, taking advantage of economies of scale and passing on the benefits to the customer while providing a reasonable return on capital to the investor. However, as has been the experience in microfinance, it is important that incentives are not distorted. Commissions have been given on basis of more clients and giving more loans.

Executive remuneration has been based on profits generated. These, in turn, encourage imprudent lending and inappropriate practices such as multiple lending. As the credit risk gets transferred away from the MFI's books through securitisation and assignment, there are no in-built measures to curb multiple lending and excess loaning to the same household.

The MFIs are also accused of coercive methods of recovery. In India, matters came to a head in 2010, when one of the State Governments enacted an ordinance that effectively stopped collection of micro-debt and prohibited any new micro-loans in the State unless certain conditions were met.

In this context, the RBI set up a committee under one its Board directors, Mr Y. H. Malegam.

The report was submitted in January 2011. The committee has made a wide range of recommendations aimed at consumer protection. The crux of the recommendations is that lending to MFIs can be considered priority sector lending only when certain conditions are met by such MFIs. These include a cap of 10 per cent /12 per cent on the MFIS' margins, a cap of 24 per cent on interest for individual loans, rules for ensuring transparency, cap of Rs 25,000 on size of loans, limit of Rs 50,000 on the income of the borrower to be eligible for micro finance, 75 per cent of the total loans of the MFI to be for income generation purposes, all loans to be only to members of JLG/SHGs and setting up a comprehensive credit information and referencing, MFIs to establish code of conduct and institute grievance redressal procedure, regulator to mandate Client Protection Code, and corporate governance principles to be laid down by the regulator.

The Committee has also said that if its recommendations are accepted, the need for the Andhra Pradesh Act will not exist. The recommendations are under examination by the RBI.

Inclusion in mainstream

What I would like to emphasise is that financial inclusion is not just microfinance, although it plays an important role in providing credit access to the poor. Financial inclusion implies access to a mainstream bank account which, in itself, includes such accountholders in the economic lifeline of the system and provides him/her a savings product that is eligible for deposit insurance.

Hence, financial inclusion has to ensure access to deposit insurance and the mainstream payments system through commercial banks, either directly or through various forms of electronic or mobile banking or through business correspondents.

Financial inclusion has to be seen in the context of inclusive growth. The sections of the population that need access to affordable credit to be able to increase their income levels are the landless labourers and marginal farmers in agriculture and allied activities, and the small and micro entrepreneurs in industry and services sectors in the SME sector.

This sector is ridden with problems of owning the title to land even though they may have the rights to the usufruct of the land — they have problems of not being able to provide sufficient collateral.

Where the risk is perceived to be higher, lending agencies are usually risk-averse, especially as there are other opportunities. In this context, the policy on financial inclusion will have to address the design of appropriate credit guarantee or credit enhancement schemes with suitable disincentives for misuse or moral hazard.

The public policy intervention in this area calling for fiscal support — directly or indirectly — will have to be carefully crafted looking at the international experience of such schemes and their effectiveness.

(Excerpts from a speech delivered in Kuala Lumpur on April 5 at an event co-sponsored by CGAP OECD AFI and Bank Negara.)

(The author is Director, Centre for Advanced Financial Research and Learning. >blfeedback@thehindu.co.in)

Published on April 08, 2011

A letter from the Editor


Dear Readers,

The coronavirus crisis has changed the world completely in the last few months. All of us have been locked into our homes, economic activity has come to a near standstill. Everyone has been impacted.

Including your favourite business and financial newspaper. Our printing and distribution chains have been severely disrupted across the country, leaving readers without access to newspapers. Newspaper delivery agents have also been unable to service their customers because of multiple restrictions.

In these difficult times, we, at BusinessLine have been working continuously every day so that you are informed about all the developments – whether on the pandemic, on policy responses, or the impact on the world of business and finance. Our team has been working round the clock to keep track of developments so that you – the reader – gets accurate information and actionable insights so that you can protect your jobs, businesses, finances and investments.

We are trying our best to ensure the newspaper reaches your hands every day. We have also ensured that even if your paper is not delivered, you can access BusinessLine in the e-paper format – just as it appears in print. Our website and apps too, are updated every minute, so that you can access the information you want anywhere, anytime.

But all this comes at a heavy cost. As you are aware, the lockdowns have wiped out almost all our entire revenue stream. Sustaining our quality journalism has become extremely challenging. That we have managed so far is thanks to your support. I thank all our subscribers – print and digital – for your support.

I appeal to all or readers to help us navigate these challenging times and help sustain one of the truly independent and credible voices in the world of Indian journalism. Doing so is easy. You can help us enormously simply by subscribing to our digital or e-paper editions. We offer several affordable subscription plans for our website, which includes Portfolio, our investment advisory section that offers rich investment advice from our highly qualified, in-house Research Bureau, the only such team in the Indian newspaper industry.

A little help from you can make a huge difference to the cause of quality journalism!

Support Quality Journalism
This article is closed for comments.
Please Email the Editor
You have read 1 out of 3 free articles for this week. For full access, please subscribe and get unlimited access to all sections.