A campaign of sorts has begun against microfinance businesses. A group of people are claiming that microfinance companies are using intimidating practices in loan collection. In fact, a similar campaign is going against the entire banking sector. Campaigners are accusing the banking industry - from Class ‘A’ commercial banks to class ‘D’ microfinance companies (MFCs) - as well as saving and credit cooperatives of behaving like loan sharks. While such accusations may be guided by vested interests, the banking sector, including MFCs and the regulatory authority, Nepal Rastra Bank (NRB), must take notice and take corrective action to address these concerns.
Looking at the ongoing allegations and data published by the NRB, it is evident that the microfinance business is deviating from its intended track. However, the blame cannot be solely placed on the MFCs. The primary purpose of MFCs is to assist poor or economically disadvantaged individuals and families in escaping the poverty cycle. That keeps them totally different from other banks and financial institutions (BFIs). But the system that has evolved and is in place now does not differentiate much between MFCs and other BFIs.
If the ongoing allegations are true, MFCs are not abiding by the principles of group lending (i.e., lending against group guarantee) and ensuring that borrowers are sufficiently literate in financial and microbusiness practices before lending. Moreover, the actually deprived or poor people are still out of the reach of MFCs. As per an NRB report from mid-October 2022, 23% of MFC branches are concentrated in Lumbini Province, whereas only 4% of branches are in Karnali Province which lags significantly behind in poverty indicators compared to other provinces. This alarming trend should have prompted the regulator to take corrective measures.
Another allegation is that multiple MFCs are lending to the same individual or family, leading them to fall into a debt trap. This is indicative of a regulatory failure as much as it is a lapse on the part of the MFCs. MFCs are also criticised for charging high-interest rates. Much has been discussed about the issue. While campaigners argue that such high rates exploit the poor, MFCs claim that they cannot lend at a rate lower than the cost of their funds plus the administrative margins.
The reality is that high-interest rate is not an issue if lending truly benefits the poor. Certain businesses yield high profits, ranging in the thousands of percentages of the initial capital outlay, but people other than the really poor are unwilling to undertake them. Examples include businesses typically run by so-called low-caste and economically-disadvantaged individuals such as village barbers and ironsmiths. Another example is the fruit and vegetable trade, where individuals purchase goods from wholesalers and sell them door-to-door, often making a profit even with a 100% interest rate. These individuals require a small initial loan, which they can turn over hundreds of times in a year.
Therefore, the issue facing the truly disadvantaged is easy access to loans, rather than interest rates. If the interest rates are to be lowered as demanded by campaigners, arrangements must be made for MFCs to obtain funds at comparably low rates. This again underscores the role of the NRB which can receive assistance from the government in this.
Microfinance should be treated as a distinct category of banking, separate from other forms of financial institutions. At present, MFCs are under pressure to generate profits, which leads them to pursue large and collateral-based loans. According to the aforementioned NRB report, 18-19% of outstanding loans of MFCs are secured by collateral. True microfinancing is genuinely expensive. The loan size per client is small, but the number of clients is vast, necessitating a significantly higher personnel cost per million of rupees lent compared to commercial banking. As a result, the potential for substantial profits in this industry is low. Therefore, there must be distinct metrics in place to monitor and evaluate MFCs.