Flawed microfinancing a trap for the poor
By Shahid Javed Burki
Monday, 10 January, 2011
THE poor and the middle classes have always paid more to borrow for their needs than do the rich or those who belong to the upper middle class. This is one reason why the people lower down in the income distribution scale find it difficult to move up the economic ladder.
Often – more frequently than should happen – the poor needing money and borrowing expensively dig themselves in a deep hole.
The hole keeps on getting deeper as they attempt to climb out of it. The existence of this dilemma has been recognised for centuries and is one reason why the world’s major religions frowned upon the practice of usury. Some of them – Islam among them – banned outright charging interest to lend money.
How the poor get into deep trouble when they turn to the “markets” to borrow was investigated decades ago in harrowing detail by Malcolm Darling (1880-1969), a British official, who, working with the peasantry in the Punjab, became sensitive to the problem in his seminal work, The Punjab Peasant in Prosperity and Debt. The book was published in 1928 and had a profound impact on the making of public policy in British India.
Darling’s book led to the passage of the Agriculture Marketing Acts in a number of provinces including Punjab and Sindh. The main purpose behind these acts was to provide some protection to the Muslim peasantry against the predatory lending practices by the traders and money-lenders. Since the peasantry in these two provinces was mostly Muslim and money lending was done mostly by Hindus and Sikhs, the British feared that the increasing indebtedness of the poor could lead to communal troubles and disturb public piece in their domain.
Darling traced the impact of borrowings by the poor peasantry at almost usurious rates using their share in output as collateral. Much of the borrowing was for non-productive purposes such as weddings and other social obligations.The high rates at which loans were obtained meant that capital outstanding built up rapidly. Most borrowers found it hard to get out of debt once they had become part of the cycle of borrowings and repayments.
The question of how to meet the financial needs of the poor without putting them under an increasing burden of debt was answered creatively by a Bangladeshi professor of economics soon after his country gained independence. Muahmmad Yunus founded the Grameen Bank which lent small amounts of money to the poor, in particular poor women, to start small businesses.
The innovation factored into its lending practices by the bank was to use the community as the collateral. The poor borrowers fearing being ostracised by the community in which they lived tried hard to remain current with their payments.
Grameen went on to become a large bank and its founder was given the Nobel Peace Prize in 2006. Its success spawned a number of similar efforts in other countries in South Asia. According to one assessment “in Bangladesh alone more than 1,000 micro-enders, including government institutions, banks and charities, have about $2.2 billion in outstanding loans to some 30 million borrowers”.
First non-government organisations and later government institutions got into the microfinance business in other South Asian countries including India and Pakistan. In India more than in Bangladesh, the formal, for-profit sector joined the non-profit organisations in providing small but expensive loans to the poor.
By the middle of 2010 India’s microloans totaled $46.5 billion of which 30 to 40 per cent were in just one state, Andhra Pradesh. It was revealed that some big players had entered the field. It was reported that “India’s biggest microfinancier whose shareholders include US-based funds such as Sequoia Capital, raised $350 million in an initial public offering that cast a spotlight on the fortunes being made in the industry” The large companies were borrowing from banks at rates of 11-15 per cent but were charging 28-30 per cent which they said was needed to cover the cost of making tiny loans averaging $250 each to 30 million widely dispersed poor borrowers.
But the large lenders were not using the community pressure that was an important part of the Grameen model. They resorted to strong arm tactics that were common with traditional moneylenders. In early October newspapers in India carried the news that as many as 30 rural borrowers had committed suicide in the state in the last few months following their inability to pay back loans contracted from microfinance institutions.
On October 8, “reflecting a growing Indian backlash against an industry once touted as the financial salvation of the poor, the Andhra Pradesh cabinet approved a special ordinance that it said would stop the ‘harassment’ of small borrowers by microfinanciers”.
There was thus an explosion of business in what was once considered a niche activity. The business came under scrutiny in India and Bangladesh. According to one report, “aggressive lending has turned microfinance – once touted as a magic bullet against poverty – into a trap for the poor, who struggle to repay loans with interest rates ranging from 20-50 per cent, prompting authorities [in Bangladesh] to cap the rate at 27 per cent in November”.
The microfinance industry came under international spotlight following the release of a documentary produced by Norwegian TV that questioned the benefits of microfinance and alleged Muahmmad Yunus of misappropriating donors’ money. This was with reference to the decision taken by the Grameen Bank’s founder to transfer a grant the institution had received from the Norwegian government to a new entity created under the name of Grameen Kalyan.
While the Grameen Bank was treated as a commercial entity liable to pay taxes, the new organisation, having been registered as an NGO, was exempt from any tax obligation. Sheikh Hasina Wajed, the Bangladeshi prime minister called this action a “trick” and accused Grameen of “sucking blood from the poor.” Pakistan entered the field of mi crofinance later than Bangladesh and India. The first significant effort was made by a non-government organisation. Kashf Foundation started operations in 1996 but met with limited success. The poor just didn’t want to borrow. But the founders persisted and now the organisation has 152 branches around the country and has dispersed more than $200 million to more than 300,000 families.
According to Nicholas Kristof, a New York Times columnist, “done right, microfinance can make a significant difference. Kashf borrowers are more likely than many others to enjoy improved economic conditions – and that’s what I’ve seen over the years as I’ve visited Kashf borrowers”.
Kashf’s success led the government to come into the field. It established a microfinance institution called the Khushali Bank in 2000 which began its operations in 2003 after receiving the support of the Asian Development Bank. According to the Bank’s 2009 annual report, the Khushali Bank had built relationships with 2.5 million small borrowers. It reported that it had almost 330,000 active borrowers with total revenue of Rs1.339 billion or $16 million.The bank was also encouraging small earners to save; in 2009 it had 75,000 savers with total deposits of Rs190 million, or $2.2 million.
Pakistan appears to have escaped the problems both Bangladesh has encountered in recent years because of the relatively small size of the microfinance sector and the presence of large banks on board of the state-run Khushali Bank.
The role the private sector is playing in the field is small compared to Bangladesh and India. That notwithstanding the country could still face the same crises that have visited other parts of South Asia unless the regulators keep a watchful eye on the industry.