MFIs: Digital and Physical Micro-lending

ECONOMY/ GOVERNANCE

Topic:

• GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment 
• GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

MFIs: Digital and Physical Micro-lending

Context: Micro-lending is in the news again for the wrong reasons – first is related to Assam and the second is related to Digital Micro Lending.

What is microfinance?

• Microfinance is a basis of financial services for entrepreneurs and small businesses deficient in contact with banking and associated services. 
• The two key systems for the release of financial services to such customers include ‘relationship-based banking’ for individual entrepreneurs and small businesses along with ‘group-based models’ where several entrepreneurs come together to apply for loans and other services as a group. 
• The interest rates charged by microfinance institutes (MFIs) are lower than those charged by normal banks.
• Usually, their area of operations of extending small loans are rural areas and among low-income people in urban areas.
• The model had its genesis as a poverty alleviation tool, focused on economic and social upliftment of the marginalised sections through lending of small amounts of money without any collateral to women for income-generating activities
• Lack of security and high operating costs are some of the major limitations faced by the banks while providing loans to poor people. These limitations led to the development of microfinance in India as an alternative to provide loans to the poor with an aim to create financial inclusion and equality.
• MFIs act as supplements to Banks as they not only offer micro credit but they also provide other financial services like savings, insurance, remittance and non-financial services like individual counseling, training and support to start own business etc.

Salient Features of Microfinance

• Borrowers are from the low income group
• Loans are of small amount – micro loans
• Short duration loans
• Loans are offered without collaterals
• High frequency of repayment
• Loans are generally taken for income generation purpose

Microfinance in India

• SEWA Cooperative Bank was initiated in 1974 in Ahmedabad, Gujarat, by Ela Bhatt which is now one of the first modern-day microfinance institutions of the country. 
• MFIs in India exist as NGOs (registered as societies or trusts), Section 25 companies and Non-Banking Financial Companies (NBFCs). 

• The National Bank for Agriculture and Rural Development (NABARD) offered financial services to the unbanked people, especially women and later decided to experiment with a very different model, which is now popularly known as Self-help Groups (SHGs). 

• Commercial Banks, Regional Rural Banks (RRBs), cooperative societies and other large lenders have played an important role in providing refinance facility to MFIs. 
• Banks have also leveraged the Self-Help Group (SHGs) channel to provide direct credit to group borrowers.

Do You Know?

• MFI loan portfolio has reached Rs 2.31 lakh crore at the end of FY2020, touching the lives of 5.89 crore customers.
•  Some of the MFIs, that qualify certain criteria and are non-deposit taking entities, come under RBI wings for Non-Banking Financial Company (NBFC) Regulation and supervision. These “Last Mile Financiers” are known as NBFC MFI.
• The objective of covering them under RBI was to make these NBFC MFIs healthy and accountable. 

What is the issue of MFI in Assam?

• Assam government passed a bill which barred micro-finance institutions (MFIs) from lending to vulnerable sections of society. It was a response to a backlash against MFIs. 
• A large number of borrowers working in tea plantations had taken loans from MFIs. RBI noted that the economic slowdown in tea plantations and anti-Citizenship (Amendment) Act disruptions led to rise in the delinquencies. 
• MFIs started sending collectors for recoveries to the borrowers, leading first to the backlash and then the political response in terms of the bill.
• In 2010, the Andhra Pradesh government also passed similar legislation like the one in Assam against MFIs leading to a crisis in the industry. 
• Though the scale of lending is lesser in Assam and is unlikely to drive MFIs to a crisis, finance is not about scale alone but interconnectedness of the players.

What is the issue with Digital Micro-lending?

• Digital lending platforms have mushroomed and there are criticisms of high interest rates, hidden charges, unacceptable recovery methods and misuse of data of borrowers.
• RBI expressed caution against digital lending platforms and constituted a working group to study both regulated and unregulated digital lending so that an appropriate regulatory approach can be put in place.
• Fintechs will soon be criticised for being Shylocks and loan sharks. Pre-2008 crisis, financiers were the cynosure of all eyes and post-crisis they were branded as devils of the game. 

Way Ahead

• In 1870s, a similar backlash emerged in Poona and Ahmednagar districts of the Bombay presidency. The agriculture boom in the early 1860s led farmers to take loans from moneylenders. As the boom went bust, farmers were unable to pay these loans. The moneylenders took away land placed as collateral, fuelling protests and riots.
• Government responded by passing the Deccan Agricultural Relief Act in 1879 that barred the arrest of the agriculturist-debtor and saved his immovable property from attachment and sale, unless specifically pledged. However, this and other related legislations enacted did not have the desired impact.
• Therefore, government of the day must learn from the previous incidents before passing laws that restrict the working of MFIs. One should go for an honest review of the entire issue by engaging with all the stakeholders involved in this sector.

Connecting the dots:

• Challenges with MFI and need for Social Impact Monitoring: Click here