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Volume 5 Issue 04 | April 2011



Original Forum

Readers' Forum

Democracy and Dogma --Jalal Alamgir
War in Libya: How will it end? --Ali Riaz
Dinosaurs in our Midst
--Mir Mahfuzur Rahman
On the Right Side of History
--Ikhtiar Kazi
Throes of Volatility
--Quazi Zulquarnain Islam
Judges and Constitutions
Photo Feature: Survival of the Fittest
Transcending the Current Conflicts in the Microfinance Sector in Bangladesh--Syed M Hashemi

Basant Festival and Nabo Barsho: Our Bridge across Culture and Religion--Ziauddin Choudhury

House of Cards --Shahana Siddiqui
Battling it out Between 'Two Feminisms' --Kaberi Gayen
'Women as Nation' and 'Nation as Women': Literary solutions to the Birangona problem
--Rubaiyat Hossain


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Transcending the Current Conflicts in the Microfinance Sector in Bangladesh

SYED M HASHEMI considers the ground realities of microfinance.


The backlash against microfinance
In spite of the great success of Microfinance Institutions (MFIs) in Bangladesh in providing financial access to over 20 million poor households, and that too through financially sustainable methodologies, the reaction here in Bangladesh, very interestingly, has been extremely ambivalent. While many celebrate the global focus Bangladesh receives in being one of the pioneering countries in promoting financial access, others, especially many policy makers and academics, see it as exploitative (through charging high interest rates and employing coercive repayment strategies) and ineffective (in improving client conditions and reducing poverty). In fact there has recently been a renewed spate of criticism, based often on flimsy evidence. This stems on the one hand from an over selling of microfinance by advocates, and on the other a failure of opponents to truly understand poor people and their financial lives coupled with a limited vision on how best to facilitate a democratisation of the financial sector.

Microfinance impacts and poverty alleviation
Probably the greatest disservice to micro-finance stems from over-enthusiastic advocates claiming it to be a magic bullet for clients' economic improvements and poverty alleviation. Many case studies and client testimonials and anecdotal evidence have buttressed these claims. And this stereotype of microfinance has been picked up and further exaggerated by a host of global leaders and princesses and first ladies. But when this claim is tested through rigorous impact assessments, it becomes difficult to establish causality and state unambiguously that microfinance and microfinance alone leads to poverty alleviation or significant increases in incomes. This then becomes ammunition in the hands of critics who then point to the irrelevance of microfinance.

What critics and many advocates fail to appreciate is the real raison d'être of microfinance. It is about financial sector deepening, about opening access to the nearly three billion people in the world still without formal financial services, it is about providing a range of services -- credit, savings, remittances, domestic transfers, insurance, pensions, etc. -- that we take for granted, but that is unavailable to the majority of the world. And even with credit and savings, it is not just about borrowing to set up economic enterprises. It is about payment for school and books, for health emergencies, for buying food stock when prices are low, for travel to the city to look for employment, and so many other activities that we use finance for. It is really about ensuring poor people have the same access and the same choices in the financial sector that we the privileged have. It is about democratising the financial sector.

And in terms of impact, microfinance is held to an extremely unrealistic bar. No development intervention, be it schooling, or health or access to justice, can claim to singularly lead to poverty alleviation. Just as the structures that create and reproduce poverty are multidimensional, so too are the sites through which poverty alleviation needs to be contested. What good are microenterprises if the market is so restricted that no one will buy their products? How can improved schooling and health be achieved through increased demand from microcredit clients if there are supply side failures -- no schools or no health care services? Yet what even the most rigorous econometric tests show is that Bangladesh MFIs have succeeded, through finance and only through finance, to ensure consumption smoothening of their clients. This means MFI clients are significantly better than others in addressing food insecurity, especially in the lean season. The difference in going to bed hungry or with a full meal is no mean achievement. To be fair, many impact assessments also show significant increases in earnings, in accessing health services, children going to school, contraceptive use and women's empowerment, though they do not establish a causal connection. This is not because there is no connection but because such expensive and complicated studies had earlier never been conducted. But two points need to be made. First, all perception studies indicate that MFI clients consider this access to have great positive significance in their lives. Second, unlike other development interventions, microfinance is fully financially sustainable and hence does not require subsidies or any financial outlays from the state or donors.

Interest rate caps
A regular charge, levelled against MFIs by many policy makers and academics, is that MFIs charge exploitative interest rates. The term “shudh khor” (money lender) applied to MFIs conjures powerful imagery of rapacious money lenders who have historically kept people indebted and forced them out of their property, their land, their livelihoods and their homes. And so the “moral” opposition calls for interest rates to be strictly controlled by the state.

Several points need to be made here. First, for poor people, the only real alternative to micro credit is moneylenders charging over 10% a month, and with tied credit, often 200% to 300% a year. The reason that microcredit started and expanded was precisely because the commercial bank rate was not available to the poor. If MFIs were to stop lending, the real beneficiary would hardly be the poor.

Second, MFIs provide access to financial services at the doorstep of clients and meet with them on a weekly basis. And they provide much, much smaller loans to the poor than commercial banks do to their clients. This necessarily entails high costs that need to be covered through charging high interest rates. The cost of capital for MFIs is also much higher than that of commercial banks. MFIs often borrow at commercial rates of interest and then add to that the transaction costs, loan loss provision, inflation adjustment, etc. If commercial banks could lend to the poor at their regular interest rates they would drive MFIs out of business. They can't.

Third, many consider a 10% spread between the cost of capital and interest rate charged to be an appropriate limit. However, a review of the top MFIs in the world, including all Grameen replicates suggest that outside of Grameen, this is never achieved.

Fourth, a careful understanding of the financial lives of the poor reveals that given the multiplicity of financial needs and the range of strategies they employ to address these needs, what matters most to them is the reliability of access to finance, especially savings services. And even with credit, since repayments are very small regular amounts, what matters is regular financial inflows through multiple sources of earnings. Consider a 50 week 5,000 taka loan for petty trade. For clients paying a flat 15% rate of interest, this amounts to weekly instalments of 115 takas. This is a small amount since payments are weekly. If the interest rate were 10% flat, the weekly instalment would be Taka 110 -- a difference of only five takas per week. For poor people, the opportunity to start a new economic activity or expanding an ongoing one with microenterprise loan, and the knowledge that MFIs are reliable and timely sources of financing, far outweigh the difference in weekly interest payments of takas five or even 10 or 15. In fact, that is why poor people turn to MFIs even with high interest rates (70% in Mexico, for example) rather than subsidised government agencies with much lower interest rates.

Fifth, especially in Bangladesh, since almost all MFIs are non-profits, retained earnings are never siphoned off for private profits. They are used to massively scale up services to the poor. In fact, the key to scaling up should not be through subsidised government funding (that can be used so much more effectively for other social sectors) but through accessing commercial funding and market based interest rates to allow for reinvestment of earnings. Also unlike some MFIs in other countries, salaries of senior management in Bangladesh MFIs are still generally modest, so surpluses are rarely used to finance lavish management lifestyles.

Finally, what interest rate caps will do is deliberately distort the market so that a credit rationing of sorts will take place. MFIs will be forced to select less risky, better-off, clients who can afford larger loans so that MFIs can generate sufficient revenues to maintain sustainable operations in the face of interest rate constraints. In effect interest rate caps can easily lead to a mission drift away from poorer clients and from poorer, economically depressed, hard to reach areas.

Coercive practices and credit discipline
One of the greatest achievements of MFIs in Bangladesh, and indeed all over the world, is demonstrating that the poor are responsible creditors and that they pay back on time. After decades of subsidised government agricultural loan programmes which generally failed to ensure minimal repayments, here was a client group that effectively practised credit discipline. This institutional insistence on carefully managing delinquency resulted in the possibility of millions receiving access to finance. And of course this is not always without difficulty and this is not to say that some MFIs do not engage in coercive practices to ensure repayments.

In Andhra Pradesh in India, a great drama is being played out where coercive practices in certain instances of some MFIs have led to a widespread attack on MFIs generally. While this masks the real reason for the conflict, an intense turf battle between government-led Self Help Groups versus private MFIs, it draws out the need for MFIs to engage in responsible finance. The focus of the public discourse, if we are serious about the needs of the poor, has to shift from interest rate caps and vilification of the sector as coercive, to one on client protection. New ideas need to be developed to ensure transparency on interest rates and all charges, financial education so that poor people understand the choices they face and so that they can make informed decisions, better and more ethical staff-client interface and mechanisms for clients to seek redress against grievances.

There also needs to be greater understanding of when and why coercion occurs. Why does the contract between the MFI and the client break up? Is it because MFIs are “blood thirsty” and hence force clients into contracts they cannot deliver on? Is there something systemic about the model so that credit expansion has to occur for institutional sustainability? Are the methodologies for client screening inadequate? Careful research is required to ensure we have a better understanding of the dynamics of “coercion” to ensure client protection. And to determine how best to manage the inherent tensions between zero tolerance on delinquency and real repayment problems that clients may face.

Multiple loans and over indebtedness
An endemic feature of the Bangladesh microfinance landscape is the “overlapping” phenomenon -- people belonging to multiple MFIs and therefore drawing on multiple loans. Now accessing financial services from multiple providers by itself is harmless; in fact, it may very well signify that clients are effectively using their knowledge to seek out the best products from the best providers. So many of the wealthy have multiple savings accounts, a car loan from one company and a mortgage from another and a school loan from yet another. Or it may also be that the loan size of any one MFI is insufficient to meet their credit requirements. Hence the strategy to pool loans from multiple providers. But overlapping can be symptomatic of two problems.

Many critics suggest that clients borrow from one MFI to pay off another in a circuitous survival strategy. Even a cursory examination would however indicate the fallacy of this argument. What is true of moneylender credit (where large lump sum repayments are made) is not true of microfinance. Most MFIs collect small weekly repayments. Such repayment records are copiously maintained and delinquency carefully tracked. A greater than 30-day non-repayment generally raises alarm bells. Hence, unless clients are borrowing small amounts from MFIs each month to pay off other MFIs, they would soon be identified as delinquent. So unless MFI records are deliberately tampered with, the likelihood of borrowing from one MFI to pay off another would be rare. What, however, can and does happen is borrowing from an MFI to repay a non-formal loan or diverting loans for other uses.

The second problem, the one on increased indebtedness, is the really serious issue. It is likely that multiple loans could lead to indebtedness and worsening client conditions, especially in a milieu of credit-led microfinance. While no large-scale study has yet identified this as pervasive, it is of serious concern. Any individual MFI, of necessity, will screen clients to ensure their earnings justify the loans being sanctioned. But such screening is based on partial information since they are not privy to credit information of other MFIs. Hence the heightened risk of collective loan size far outstripping borrower repayment capacity. What is required therefore is what credit agencies the world over use -- a credit information bureau that maintains records of not just loans and credit history but also earnings and repayment capacities of individuals. But this requires sharing of client information that many MFIs are yet to buy in to. It is time that MFIs in Bangladesh weigh the advantages of a credit bureau against the real threat of a systemic crisis stemming from mass defaults due to high indebtedness.


Portfolio quality and repayment problems
There had been a rapid expansion of micro-finance clients in the mid to late 2000s by the big three MFIs (Grameen, BRAC and ASA). From a little over 2 million clients in 2000, Grameen went up to 7 million clients in late 2000. BRAC and ASA also increased their client size to over 6 million. While this raises the question of overlapping (discussed earlier) it has also raised the spectre of repayment problems and poor portfolio quality. David Roodman estimated, based on Grameen data, that the delinquency rate (greater than 30 days) for Grameen was around 3.5% in December 2009. While this is not high compared to rates in other countries, the sharp increase from 1.7% in December 2008 raises troubling questions. Are we heading towards a credit bubble that may burst? Pakistan (and especially Kashf Foundation) faced serious delinquency problems, with portfolio at risk (greater than 30 days) beyond 60%, a couple of years ago, fuelled by fast expansion and the loosening of the interface between staff and clients. How reliable is the data MFIs provide on portfolio quality? To what extent does loan rescheduling occur at the branch level to mask the real state of portfolio quality? Who's monitoring this information?

Microfinance Regulatory Authority
The Microfinance Regulatory Authority (MRA) can easily become the bane of MFIs. It needs to ensure that it does not become an adversarial and bureaucratically controlling agency. Yes, the MRA ultimately needs to regulate the sector and hold MFIs accountable, but it needs also to gain confidence and buy-in of MFIs and assist in building the sector. For one, there is no way that it can develop the capacity to effectively regulate the 550 MFIs that are part of its current portfolio. It needs to form two tiers of regulation. The first should include the top 10 or 20 MFIs, which probably covers 95% of the sector. These should be very carefully tracked since they can adversely affect the health of the system. The rest should be tracked separately through routine mechanisms. The MRA should staff the first group with the most experienced professionals. The MRA should also help some of the leading MFIs transform into prudentially regulated MFI banks that can come under the tax net as do regular commercial banks. The MRA needs to push for greater transparency on interest rates and charges that are levied by MFIs rather than micromanaging interest rate caps. It needs to serve as a diagnostic centre and carefully track sectoral performance to protect it from systemic instability.

What's ahead for microfinance in Bangladesh?
Bangladesh is faced with the dual problem of selling microfinance as the answer to all poverty troubles on the one hand, and the public and political posturing to colour MFIs as greedy moneylenders on the other. It is time that practitioners, policy makers, academics and regulators stop making broad and overly simplistic statements and begin to deliberate on the real issues surrounding financial inclusion. What is required is consensus around three sets of priorities.

Instrument issues:
* Eliminating interest rate caps and protecting clients, not through controlling interest rates but through consumer protection services, financial education and greater transparency on charges levied by MFIs.
* Driving down interest rates, first through reducing cost of funds of MFIs -- by allowing them to keep a reasonable margin that can be reinvested, thereby increasing their equity; second, through reducing transaction costs -- by facilitating the adoption of technology to improve efficiency; and third through reducing credit risk -- by setting up a microfinance credit bureau.
* Continuing focus on sustainability, particularly in light of soaring transaction costs due to inflation and increased risk due to increasing incidences of natural calamities.
* Diverting government subsidy away from conventional microfinance to research and development, product development and testing, and reaching those in extreme poverty and those living in difficult to reach areas.

Analytical issues:
* Understanding better the financial lives of the poor and putting serious effort in diversifying financial products for the poor, which would include, but not remain limited to, remittance, insurance and pensions in addition to savings and credit.
* Conducting an intensive study on indebtedness through an analysis of the household economy to understand cash flows, investment and consumption needs and microenterprise and asset accumulation. Identifying indicators that can assess household level debt capacity and signal potential systemic problems.
* Assessing the microfinance delivery model to determine when coercive practices occur and how to balance the imperatives of the institution (repayment) with those of the client.
* Addressing issues of the ultra poor who are often left out of conventional microfinance.

Confidence building issues:
What has emerged in recent years is a serious gap in our understanding of the financial lives of the poor and what microfinance can realistically deliver to meet their needs. Passions on different sides have fuelled antagonisms and polarisation that are often not based on any serious analysis of evidence. Confidence building measures are therefore urgently required. Dialogues and discussions need to take place. MFIs need to listen to the political opposition. Microfinance critics need to appreciate the gains on the ground over the last three decades. These are turbulent times for the sector. We need to develop a common strategic vision forward. Or else we seriously risk hurting the sector and severely limiting the choices poor people have in accessing finance.

Syed M Hashemi is Director, BRAC Development Institute.

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