Interest rate reduction has to be accompanied by measures to tone up the economy and enable income generation
In the recent past, a number of media reports have shone a light on the plight of Sri Lankan rural folk, mostly women, who are caught in a debt trap, having taken loans from Micro Finance Institutions (MFIs) at interest rates ranging from 40 to 220%. The lenders’ aggressive methods of loan recovery have only added to the women’s agony, which has, in many cases, led to suicide.
The International Peasant Movement in a report in www.viacampesina.org dated March 18, 2020, quotes Chinthaka Rajapakshe, Convener of the Movement for Land and Agricultural Reform (MONLAR) as saying: ” About 200 people had committed suicide, during the last three years or so, as they were unable to pay back the micro-credit loans and many of those organizations had obtained the services of village thugs to recover money.”
In 2018, United Nations Independent Expert, Juan Pablo Bohoslavsky, reported that women were pressured by collectors to exchange ‘sexual favors’ for instalments and that there were cases of borrowers who tried to sell their kidneys to repay the loans. Bohoslavsky’s report also says that while the universe of borrowers is broad, women from more impoverished and war-affected areas are specially targeted by micro-finance financial institutions, which charge their loans with up to 220 per cent interest rate and apply compound interest.
More than 2.5 million Sri Lankans, mostly poor rural women, take loans from MFIs. Families take more than one loan. A debt collector in Kilinochchi told researcher Amali Wedagedera that he alone collects about LKR 2 to 3 million per month from up to 500 clients in his area. But MFIs are not flush with money. Daily Mirror quotes the Central Bank to say that Non-Performing Loans (NPL) in MFIs increased to 30% at the end of September 2020 from 17.3% at the end of September 2019.
Interest rate reduction
To combat the problem, interest rate reduction through State action is generally recommended by social workers. Globally, anything between 27% and 30% is considered reasonable for NFIs. But interest rate capping is not a panacea, studies indicate.
There are reasons why the MFIs charge higher interest than the regular commercial banks. Compared to the regular banks and other big financial institutions, the operating expenses of the MFIs are high. Therefore, everywhere in the world, MFIs charge higher interest rates compared to the formal banking sector (40 to 200%). These small institutions operate in remote areas, approaching their clients door to door. For this, they need to employ a large staff. The MFIs are not government welfare institutions meant to fund poverty alleviation programs using money from the public exchequer, but are businesses which have to be self-sustaining. The answer lies in making the surrounding economy grow and provide opportunities to earn money to pay back loans.
In his 2016 paper for the ADB entitled “Impact of restriction on interest rates in microfinance,” Sanjay Sinha says that restricting interest rates would actually kill MFIs or drive them to the urban areas to serve the already fully or partially banked, better off households. But by abandoning the rural poor, the MFIs would be abandoning their primary task which is to provide much-needed credit to the unbanked rural poor who have no collaterals to pledge to regular banks.
In Nicaragua, when its parliament introduced an interest rate ceiling in 2001 for MFIs, the annual portfolio growth of the MFIs fell from 30% to 2%. Some MFIs retreated from rural areas where operating expenses and risks were higher, Sinha points out. The MFIs’ presence in the rural areas is essential.
One should not lose sight of the fact that the MFIs have contributed to rural economic development and welfare. Bangladesh, is a shining example of what a well-run MFIs can do. In her 2006 paper in cairn.info titled “Microfinance: a Catalyst for Development at Macroeconomic Level?” Ranjula Bali Swain writes that in Bangladesh, MFIs helped raise per capita consumption, mainly with respect to non-food and household non-land assets and thereby helped borrowers lift themselves above the poverty line.
“MFI programs also had a spill-over effect on the local economy, which led to an increase in village-level welfare. Micro finance accounted for about 40% of the overall reduction in moderate poverty in rural Bangladesh,” Bali Swain says.
Micro enterprises need a market
However, micro or small enterprises need both entrepreneurship skills and a favorable local market to succeed. “The aggregate poverty impact of microfinance is limited or leads only to short-run income generation. In an economy with low economic growth, borrowing may only redistribute income rather than boost growth,” Bali Swain points out. Therefore, the ultimate success of micro-financing depends on the development of the local economy and also the national economy.
The way out
While curbing exploitative interest rates charged by NFIs, governments should help the people secure funds at reasonable rates. The Sri Lankan government has been doing since 2017-18, say Ahilan Kadirgamar and Niyanthini Kadirgamar (in www.opendemocracy.net dated on September 5, 2019). The authors have recommended strengthening of the co-operative movement and state-sponsored income generating schemes.
According to the Kadirgamars, the co -operative movement has suggested four steps to address the crisis: decreasing the debt stock through a moratorium on loan payments or debt write off; an interest rate cap to end the exponential increase in debt; alternative avenues for affordable rural credit including through the co-operatives; and policies to increase income streams through collective production as opposed to self-employment.
As a result, a one-time partial write off of loans in twelve drought-affected districts and a national interest rate cap on microfinance of 35% was announced. The interest rate cap, significant for flushing out unscrupulous companies, was instituted in December 2018 after a year of lobbying, and amid objections from the economic establishment that it would be interference in the market, they said.
“In the Northern Province, credit co-operatives combined their funds with government budget allocations in 2018 and 2019 totaling LKR 750 million, for a broad credit scheme reaching distressed households to keep them away from predatory lenders. A further allocation of LKR 1,750 million during the same period is building a hundred small co-operative industries throughout the war-torn Northern Province with the aim of increasing rural employment and livelihoods.”
“These measures are starting to show some results with fewer complaints of abusive lending practices and rural women avoiding microfinance companies due to greater social awareness. The new co-operative credit scheme during its first year has reached 10% of households in the Northern Province and is likely to reach 25% to 30% of households over the next year if the government’s promised funds are disbursed,” the authors said.
Further, the State should not abdicate its responsibilities towards the poor and leave all matters to NGOs and MFIs. It should put together income generating schemes to help rural folk specially the women, to earn enough to pay back loans.
Comparison with the US Model
In the United States, micro-finance is a roaring business because the unbanked poor there, who are quite a large number, can use borrowings to improve their status because of the thriving US economy.
In their May 2020 paper on “Microfinance in the US”, Fan Liu and Anne P. Villamil, point out that in 2013, 9.6 million US households were completely “unbanked”. The US Microenterprise Census, estimated that in 2012, US Microenterprise Institutions (or MFIs) served 329,538 individuals and disbursed 36,963 microloans. The total dollar value of these microloans was US$ 292 million. The share of such “nonbank lenders,” who charge “signiﬁcantly higher interest rates than banks”, grew to 26% in 2014 compared to 10% a decade earlier, the authors point out.
While in the Third World, micro-loans would mostly be for personal or household consumption or to meet an emergency (with a bit used for improving businesses or trades, in the West much of it may be used for income generation exploiting the opportunities offered by the thriving economic environment. Therefore, the long term solution for rural indebtedness in Sri Lanka lies in rural economic development with heavy investments by the State.