Tuesday, May 01, 2007

On Microfinance

Microfinance is touted as the big thing that can alleviate rural poverty. I personally believe, like a lot of others, that it is surely one of the means for the same. It is one of those things which gives us hope. Businessworld has been covering microfinance for a while now and I found a few links. (An interview with the SKS founder, Businessworld - The way ahead). Kudumbashree is one of them which is making waves in this space. There are quite a few others, but some have come under the scanner for unethical practices (Business world - Blood money (must read). For banks, getting a good return from rural areas is quite something, so banks are lending heavily to these MFI's. Their rural lending targets are being met and there is little danger of losing the money.

Did you know the rate of interest charged by microfinance institutions? I checked with my maid who has enrolled in a similar scheme at her native village in Krishnagiri, TN. Rupees 2 per hundred per month, on an average (2% per month, 24% per year - as much as your credit card). You also have to pay a deposit of about 100 or 200 per month for 3-6 months before you are eligible to take a loan from the SHG (self help group). Now it turns out that many of those (like this maid) enrolled here take loans not because they want it, but because they think they might need it. (For a sudden spike in expenditure etc.) My maid takes an "advance" every now and then from us to pay for her SHG. Microfinance and SHGs are different, but in terms of the end users, I think the difference is marginal.

So, even with these kind of rates, why do people still go to MFI's? One, because the alternative, the village money lender typically charges a much larger interest rate. Second, the MFI is a more friendly "social" institution. It is a place that your friends- those who you know on a daily basis - are part of too.

In the end, sure microfinance is here to stay. If it can replace the money lenders great, but I think even if microfinance becomes the money lender of choice, it would have achieved a lot. Also, it should not end up, as credit cards often become, a tool to borrow ever more money. From an interest rate perspective, they really should be different from the credit card companies (at the current rates of lending, they are not very different). The rate of interest ceiling agreement is a good first step and perhaps as penetration increases it could go down still further.

(Cross posted on The Indian Economy blog)

1 comment:

shikhil said...

Microfinance is in my opinion an oppurtunity for both banks and for people at the "bottom of the pyramid." About high rates charged by microfinace:
Interest rates are always charged on the risk profile of the customer and the security provided. A personal loan with no security usually comes at 20%.
The rates quoted by the microfinance are charged after doing calculations based on risk and probability of default.
Also costs associated with managing offices at remote locations etc. are taken into account.
There is no way that the risk associted can be changed. but by intoducing cost cutting measures using IT and by economy of scale better lower rates can be provided. \

Caps on interest rates are just protective regulations. the government should show involvement by helping to increase the efficiency of the Microfinance.

This is the best way to provide sustainable "cheap" credit to the impoverished.

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