FUNDS FOR MICRO FINANCE INSTITUTIONS: A SUGGESTION

Dr. N K Thingalaya

Micro Finance institutions (mFIs) are expanding rapidly their operations specially in the southern states in the recent years. It is reported that seven Indian microfinance companies are listed among the World's Top 50 Microfinance Institutions. However, one of the common complaints of most of these institutions is about the funds constraint, as they cannot raise deposits from the public. Consequently, the cost of funds, which they could procure, is invariably high and that is considered as the justification for their charging very high interest rates to their borrowers. The Report on Costs and Margin of Micro Finance Institutions, based on a study undertaken by College of Agriculture Banking, Pune has estimated the cost to the borrowers of mFIs varies from 12 percent to 40 percent in different states in India. Commenting on this high range of interest rates, the Report on Currency and Finance 2008 has concluded, “From the experience of several pilot projects in India as well as in other countries, the operating cost of providing credit to small borrowers could be reduced significantly, implying that there is a large scope for reducing interest rates on small loans” (RBI 2009). Perhaps, if the mFIs could get funds at relatively cheaper rates, they could lend at rates lower than what they charge now.

Recognising the efforts made by mFIs in extending micro-credit to a steadily growing number of poor, I suggest that there is an imperative need for regulating the proliferation of these institutions. Financial inclusion, which the banks are now trying to achieve, would be operationally more meaningful if the credit delivery mechanism is modulated to reach the un-reached at a reasonable cost. Considering the diversities of rural India, the banking sector may take a long time to accomplish this task. Intermediary agencies like Self Help Groups and mFIs have to be strategically used to achieve the goal. They need the support of financial sector for augmenting their resources, so that they can reap the benefits of large scale operations.

Augmenting their Resources:

One way of augmenting the resources of mFIs would be to enable them to draw from the banking sector, at reasonable rate of interest, without affecting the profitability of banks. The amount to be availed cannot be of an unlimited volume; but could be a small percentage of the total bank credit. There is one lending programme of the banking sector which fulfills these conditions, if it could be used for augmenting the resources of mFIs. It is the Differential Rate of Interest scheme, which is a part of the social banking programmes, designed to ameliorate the economic conditions of those living below the poverty line.

Differential Rate of Interest (DRI) scheme was one of the earliest micro credit schemes introduced by the banking sector as early as in 1972. Its objective was to extend loans at a concessional rate of 4 percent to families below the poverty line. The annual target fixed for each bank was one percent of their outstanding level of total advances made during the previous year. Lending one percent of the total advances at concessional rate to the deserving poor, it was opined, would not adversely affect the overall earnings of banks. Though this scheme has been in operation for over 37 years, it has not been able to achieve the desired goal till date

DRI advances, according to the latest available data, amount to Rs.634.46 crore, constituting only 0.06 percent of the total bank advances as on March 2007. The number of accounts in operation under this scheme is 2.60 lakh. What is more distressing is the fact that the number of these accounts is steadily declining during the last ten years and also the percentage share of these advances is diminishing. In 1997, for example there were 14.29 lakh accounts and the amount of advances was Rs.654.76 crore, accounting for 0.34 percent of the total advances.

The gross advances of the banking sector are Rs.28,57,525 crore according to the Quarterly Statistics on Deposits and Credit of Scheduled Commercial Banks, March 2009. One percent of the credit outstanding would amount to Rs.28,575 crore, as against the current level of DRI advances of Rs.634 crore. Over Rs.27,000 crore could be earmarked by banks for lending to mFIs at an interest rate of four percent. Disbursal of this amount could be made in a phased manner, in about three years to begin with, to avoid the enhanced flow of credit all too suddenly. Thereafter, annually one percent of the incremental credit could be devoted to lending to mFIs.

Introducing Regulatory Framework:

At present, the activities of mFIs are not under the purview of any single regulatory authority. Though NABARD and SIDBI have built up links with mFIs, they have no role to play in regulating the functioning of these agencies. A few of the mFIs have received adverse publicity recently for having adopted strong arm tactics to recover their dues. The state governments have become silent spectators, when the atrocities committed in some cases have created political unrest. Recovery performance in the lendings to Self Help Groups has been good, largely due to the peer pressure in ensuring prompt repayment. In the case of micro finance extended to individuals, the peer pressure is absent and delinquency enters in, though not very rampantly.

It may be recalled that the Indian banking sector has escaped the disastrous impact of the global financial melt down because of the regulatory framework implemented by the Reserve Bank of India. Hence, it is necessary that a regulatory framework is put in place with NABARD as the single regulator. There is an information gap pertaining to the overall performance of mFIs at the all India level. NABARD can publish annually the data relating to the performance of the mFI segment as is being done by the Reserve Bank of India for the banking sector.

References:

RBI (2009): Report on Currency and Finance 2008: Chapter: Financial Inclusion, Reserve Bank of India, Mumbai.

Thingalaya N K (2007) A Micro Finance Model for Rural India in Nitte Management Review, March 2007.

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