Live Debate –I: Microfinance industry experts debate over Inflated Interest Rates

By Asma Azmi
Microfinance Focus, March 3, 2010: The Microfinance Focus group on LinkedIn has spurred a thought-provoking debate on whether the interest rates charged by MFIs are reasonable by any sense or not. Initiated by Dr. Souren Ghosal, an independent banking professional, the debaters came up with insightful realities faced by those who are actually operating in the fields and the countering ideals of Microfinance per se.

Dr. Ghosal, who believes that MFIs are deviating from their original purpose of developing a universal financial accessibility, writes: “I think the core issue is to serve the poor and not to have a luxurious life style at the cost of poor borrower as our age old money-lenders do. If that is not changed what change we bring in to replace moneylender. Money-lenders at least work on their own money and do not ask donors help which MFIs do.”

With MFIs charging interest rates in the range of 18-30%, the industry is witnessing a mushrooming growth resulting in a pointless rat race. Many new players have emerged on the surface to reap the benefits of the new biz. Balasubhramaniam T, the Founder Director of Mudhal Inclusive Growth India Foundation & aptsource.in says: “It is all becoming a matter of routine like getting money from the bank and lending to the clients after adding all our cost and our margins. Due to the above the MFI market is now a virtual Red Ocean where there is too much of competition, most of which is un-healthy. At the other end of the spectrum there are certain areas were at least 40% of poor have not even accessed their first loan because of certain lending policies of the MFIs. The sector currently competes only on product, service and delivery. Several MFIs do not do their home work in terms of products, pricing and only end up as copy cats.”

As against the general belief that the inflated interest rates are because of the internal policies and practices of MFIs,  Hemantha Pamarthy, Managing Director of Hand in Hand Microfinance Limited feels that even external factors play a significant role in here. “Those MFIs who really work for the ‘Social Bottom-line’ would not be really in a position to reduce their interest rates any further as the cost of funds today in the Indian market hovers around 10%. Adding to this, there are establishment, administration and training costs which cannot be wished away. If the MFI remains to be non-profit, promoters and bankers do not take interest in lending or investing substantial funds stating that these are not sustainable and endangers the investment or principal lent. So while scaling up operations, and to access larger funds, whether the organisation likes or not, it is forced to transform into a ‘For Profit’ organisation. The moment it becomes a ‘For Profit’ organisation, it does not attract grants for training needs. Even if some grants do come in, they also can run the risk of being taxed. Most importantly, as the grants given to a ‘For Profit Organisation’ generally do not enjoy any tax benefits, donors do not come forward to give grants to such institutions. Then how can training costs be absorbed without being added to the other costs?”

“Those who are clamouring for interest rate reduction should also understand the costs of support services such as software, that are charged to the MFIs, which many a time could be astronomical. Any rationalised reduction might be thought about, but under today’s circumstances rates between 24-28% are considered as normal. Nevertheless, if really abnormal rates are charged beyond these normal rates, yes, there is a case for asking for reduction.” Making a global comparison he says, “We fare much better in comparison with countries like South Africa where monthly interest rates could start from 30% and taper up-to 60%.”

But against such a proposition Dr. Ghosal feels that MFIs lack transparency and there are several hidden cost and opaque systems and procedures that make these institutions no less usurious than moneylenders. David D Souza, an education management professional is also of the belief that “the so-called market rates are only an excuse for justifying the interest rate. MFIs should calculate the interest rates by activity based costing methods from ‘zero base’ rather than just add tangible and intangible costs to the rates to reach 18 – 24%. The objective must remain as maximising social benefit rather than ‘maximising profit’ as taught in business schools.”

While some participants were in complete denial of any such possibility, few others even suggested way of deflating the rates down. Balasubramaniam proposes cost reduction by eliminating factors which are often taken for granted. Cash handling which is costly as well as risky can be done away with available technologies. Product values can also be enhanced by introducing an optimal loan product disbursed at the appropriate time. David D Souza suggested delivering coupons or even bartering instead of cash as a measure of cost reduction.
The Director of Quest on the Frontier, Arun Diaz on the other hand is of the opinion that the business of MFIs should operate like any other business and should be judged by the results they produce and was in favour of market regulated interest rates sighting the fact that increasing competition would scale up efficiencies and reduce operational costs. Defying the general conception that MFIs are inept beneficiaries of international funds and grants, he stated that “Many MFIs who receive funding from Development agencies in the form of equity do have to generate data on the social impact that they are creating. If there is no appreciable impact then funding is no longer available.” Dr. Satchidanand of GLOBALRISKHUB is also in support of this view saying that “the MFIs are, and should be, pure business entities actively participating in the economy. By being so, they can be strong operators and serve the poor better. I am against mixing up the profit motive with social objective and creating confusion.” Forex Consultant, P Yesuthasen validated the opinion by highlighting the fact that when MFI is run as a social service, people with good intentions and no finance related skills get on the bandwagon and the organisation cannot be run professionally. The result is poor discussions, seminars, consultations, excellent speeches and finally NPAs!

Subramanian Sankaranarayana, Adviser & Senior Management Consultant at Gradatim IT Ventures (India) Ltd who also holds experience as an employee at the Central Bank in India since 1960, handling rural credit and benign sector policies, issues and challenges, rules out any possibility of interest rate reductions. He states: “Running MFI with razor thin margins in high risk areas, according to me, is missionary and executed with empathy, passion and compassion.” Reinforcing the role played by MFIs, he pointed out that MFIs charge several notches below pawnbrokers even today. When mainstream banks turned their back from supporting poor, MFIs, who play powerful social transformation functions as financial and non-financial intermediaries, credit and non-credit dispensers to both urban and rural poor should not be rebuked for a few recalcitrant incidents.
Sighting the example of failed poverty alleviation programs during banking nationalization phase in 70s and 80s, he blames systemic deficiencies and vulnerable tail-end delivery structures for their failures. “Till 1992, the on-set of liberalization phase, interest rate policy of banking sector, was contrived and not free market-determined. Average interest rates as administered by the Regulator with government interest subvention and subsidy schemes worked out anything from 3% to 8% as against 18% for others from mainstream banking sector…!! The low interest rates also had less impacted poor and needy then.”

He stated that interest rate is not the only factor for the woes of the sector and suggested that MFIs should aim for cost reduction, bottom line improvements, technological and infrastructural strength and should ensure outreach, timely delivery, reporting and monitoring.

Comments in Detail

Right Technology could be the Answer

Yours is an excellent start on this exclusive MFI platform created by young, motivated and dynamic professional of sorts, Vikash Kumar of Microfinance Focus.  I genuinely feel that in a market-driven free economy, interest rate reduction chorus does get little response from the right quarters and rightly so. If we address how and why of it, we may elicit some favorable response and deeper insight.

SHGs, NGOs, MFIs, FIIs, private Funders, mainstream banks, State level intervention by way of grants, interestsubvention mechanism, subsidies, etc. do cause sharing of costs to ease interest pains at tail-end beneficiaries. We should more aim at cost reduction and bottom-line improvements of all stake-holders in order to bring down default risks and to sustain viability across the entire supply chain. Improvement in infrastructure including capacity building efforts through fiscal and budgetary support or by developmental-oriented institutions could help viability. Use of right technology will have favorable impact on costs, besides rationalization of work methodologies to ensure outreach and timely delivery, reporting and monitoring.
To cut short at this stage, I do not see any possibility of interest rate reduction. I prefer the route of local savings and cost reduction as also bottom-line improvement exercises. I promise to revisit often your important thread as we go along….

by Subramanian Sankaranarayanan
Adviser & Senior Management Consultant at Gradatim IT Ventures (India) Ltd
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The question to my mind is whether the present level of interest rates can be sustained and if so, for how long and with what consequences to the people, MFI stakeholders and the system.

Satchidananda Dr. S.S.
Founder of GLOBALRISKHUB

Market should regulate the rates

I would prefer to see the market regulate the rates. Currently the market is woefully underserved or served by informal lenders who charge relatively usurious rates of interest. By comparison the rates of MFIs are not usurious.  As more players enter the market and increased competition takes effect, I see scale efficiencies being realized and the operational costs being reduced.  Already the returns available to MFI investors are attracting a number of new players into the market and more should follow.

By Arun Diaz
Director at Quest ontheFrontier

Reduce, Don`t regulate Interest rate

Yes, for sure interest rate needs to be reduced but not through Regulation. MFIs should increase the efficiency level, productivity and increasing fee income. Good numbers of MFIs charge effective interest rate of 18 -24% and sustaining operation. Word of caution: Cost of funds in on the increase. Banks and funding agencies should look at the sector differently

RAMANATHAN ANNAMALAI
Director at School of Management Sri Krishna College Of Engineering and Technology

Insist for transparency

I appreciate the comments but I feel all of us avoiding the core issue. I think that we should first insist for transparency to have a clear view of the load. It looks good to see the MFIs housed in air-conditioned building and holding conferences in 5 star hotels but I am sure no one would like this to happen at the cost of a destitute borrower. There are several hidden cost and opaque systems and procedures that make these institutions no less usurious as moneylenders. I regret that we see all these and just ignore for reasons well known to all of us.
We have to open up and lead these institutions to adopt transparent and benevolent to all their borrowers.  I hope my message is clear and need cool thinking and paradigm change in objective and procedures of working of MFIs.

By Souren ghosal
Independent Banking Professional

Microfinance is Viable as a Business Model

Dear Mr. Ghosal,
What is the core issue? You believe that the service provider should not live a better life than his customer? It’s an open market and some NGOs probably believe as you do and work in relatively modest circumstances but I don’t see them offering much lower rates to their customers.

I am sure that if you chose to start an MFI with such a business model, you would be able to find people willing to support you and then you can show how it should be done.

With kind regards, Arun

Arun Diaz
Director at Quest ontheFrontier

Microfinance Core is to Serve the Poor

Dear Mr. Arun,
I think the core issue is to serve the poor and not to have a luxurious life style at the cost of poor borrower as our age old moneylenders do. If that is not changed what change we bring in to replace moneylender. Moneylenders at-least work on their own money and do not ask donors help which MFIs do. I hope u got my point. Pl. don’t’ take me amiss. I have no grudge for any institution and on their way of life so long they do not exploit poor.

Regards
Dr.S.N.Ghosal

Dilemma of double bottom line

It is always a good wish to ask for interest reduction. But how far is it feasible?  Let us all agree that extending finance, in whatever way or with whatever name we call it, is akin to trading. We source the product/commodity called “Money/Funds” at a price, add our costs, expenses, profits and “Lend”.

The difference is, till recently microfinance had two bottom lines. The “Social Bottomline First” and the real “Profit Bottomline Next”. However, with the proliferation of new “Professional” MFIs, there is a feeling that the “Profit Bottomline” is becoming first and the “Social Bottomline”, if at all existing, next. Well, this is a debatable point.

But in the absence of any perceivable “Social Bottomline” maybe the argument for reducing the interest rates could hold water. But those MFIs who really work for the “Social Bottomline” would not be really in a position to reduce their interest rates any further as the cost of funds today in the Indian market hovers around 10%. Adding to this, the establishment, administration and training costs (this is also a cost that cannot be wished away) how any organisation can work within the 18% is a point to be debated and demonstrated.

If the MFI remains to be non-profit, promoters and bankers do not take interest in lending or investing substantial funds stating that these are not sustainable and endangers the investment or principal lent.

So while scaling up operations, and to access larger funds, whether the organisation likes or not, it is forced to transform into a “For Profit” organisation. The moment it becomes a “For Profit” organisation, it does not attract grants for training needs. Even if some grants do come in, they also can run the risk of being taxed. Most importantly, as the grants given to a “For Profit Organisation” generally do not enjoy any tax benefits, donors do not come forward to give grants to such institutions. Then how can training costs be absorbed without being added to the other costs?

Those who are clamouring for interest rate reduction should also understand the costs of support services such as software, that are charged to the MFIs, which many a time could be, yes, astronomical.

Any rationalised reduction might be thought about, but under today’s circumstances rates between 24-28% are considered as normal. Nevertheless, if really abnormal rates are charged beyond these normal rates, yes, there is a case for asking for reduction.

At the same time, a global comparison also might be in order. We fare much better in comparison with countries like South Africa where monthly interest rates could start from 30% and taper upto 60%, if my information is not wrong.

Best wishes
Hemantha Kumar Pamarthy
(In my individual capacity)

Judge MFIs by Result they Produce

Dear Mr. Ghosal,

If your comments are aimed at the NGOs operating MFIs, I withdraw my objections. I agree that NGOs working with grant funds should be circumspect in how they spend those grants.
However, the business of MFIs should operate like any other business and should be judged by the results they produce. Many MFIs who receive funding from Development agencies in the form of equity do have to generate data on the Social impact that they are creating. If there is no appreciable impact then funding is no longer avaibale.
The interest rate charged as Mr. Pamarthy has pointed out is a function of the cost of funds plus the operating costs plus a “reasonable” margin of profit for the investors who include the development agencies mentioned above.
With kind regards,

Arun

There cannot be free lunch

Dear Friends.Hearty Gretings.
1. As promised I am back. Let us all admit that there cannot be free lunch. Social justice and inclusive growth are functions of the State to be operated through its fiscal outlets and as part of CSR revolving around big public bodies and corporates. Fiscal again is charged back to the same public. But a prudent politico administration, so called welfare state, will have to discriminate the haves and have nots so as to ensure ‘fair’ hit of taxes and distribution of justice. Leaving aside assumptions on variables, which have direct and discrimanatory impact on demand, supply of liquidity funds and costs thereof, little any institution or individual can play philanthropic role beyond a threshold without injuring the basic foundations and economic existence.Cost reduction, not necessarily interest cost reduction, as I stated initially, is necessary. In that direction, globally, some concrete initiatives-MDG is a case in point-by way of ICT connect, provision of infrastructure facilities enabling supply chain links, are all underway, depending on geographies and demographic requirements. In this context and as part of larger financial inclusion approach, I agree with Hemantha segregation of ultimate beneficiaries being targeted under ’social bottomline’ and ‘profit bottomline’. More elaboration is needed. I would come back on this separatetely..

2. As regards comparative study of existing interest rate range, MFIs charge several notches below pawnbrokers even today. Let us admit that mainstream banks have miserably failed or have turned away from direct support. For a few of recalcitrant incidents, why blame the NGOs and MFIs, who play powerful social transformation functions as financial and non-financial intermediaries-credit and non-credit dispensers- both in respect of urban and rural poor.? It’s difficult to imagine the sad demise of golden-egg laying goose once a day. Poverty distribution is not to be our motive.

3. As far as refinancing / funding, direct lending by main stream banking institutions, scope exists but with a risk-reward trade-off and mind-set. Admittedly, the big Corporates appear to get lower interest rates with the use of their business operational muscle power in many geographical jurisdictions, which can be a grouse and starting point for interest rate reduction protests. Cross interest rates subsidisation, which is real in banking sector and other major financial funding entities, again depends on factors beyond the scope of this thread at this stage. Running MFI with razor thin margins in high risk areas, according to me, is missionary and executed with empapathy, passion and compassion. A top functionary of a state-level Federation of MFIs cum NGOs covering a total base of close to 1 million beneficiaries in a ‘SHG intense’ leading State in India, privately confided in me that a very huge financial loss was staring at him in the wake of 2007-08 global crisis.! Federation and the top executive adhere to Governance ethics.  Not a concocted tale please..With love and regards

Prof.S.Subramanian .
Subramanian Sankaranarayanan
Adviser & Senior Management Consultant at Gradatim IT Ventures (India) Ltd

Banks are not reaching to the Poor

Taking a cue from the message of Prof. Subramanian, I wish to touch on two points.

1) Regarding comparison to Money Lenders

Participants, I am sure, will (or will have to) agree that till an alternative method, of disbursing funds even in the middle of the night, in an emergency, could be worked out, the Money lender would be relevant in the financial sector. This is only to highlight the point that more than the rate of interest, it is the access of funds “when needed” is what matters more.

Let us honestly face the question, as to who is able to do it better than the local moneylender? S/he may abuse, kick and charge abnormal rates of interest but it is s/he (moneylender) who is ultimately coming to the rescue, at any given time (at least much more than the instituitions).

Such being the case, the way forward should be in thinking of ways to minimise the lead times in reaching funds/finance “When and where needed” rather than reach “When and where available” and enhancing efficiency.

And as rightly pointed out by the Professor, even today the MFIs are certainly charging lesser rates than the Moneylenders.

2) Banks reaching out to the poor

I am extremely disappointed to note that barring a few banks and those too in patches, not many banks are really reaching out to the poor.

Even today, in the wake of all the din created about total financial inclsuion, many bank branch managers are reluctant to open Accounts for the poor, as that only increases their work but no financial transactions take place.

I also regretfully have to mention that many branch managers of most banks have hardly a clue about microfinance, excepting that they too, like laymen, read about it in newspapers and see in the media.

Till that day when more positive steps to ensure fair and quick and empathetic interventions are undertaken by the Banking and financing system, moneylenders and MFIs would continue to matter, irrespective of low or high interest rates.

Best wishes
Hemantha Kumar Pamarthy
(In Individual Capacity)

Maximising social benefit

The clamour for reducing interest rates by MFIs is just a lot of people jumping on a bandwagon for the sake of it. Most of the arguments, except Hemantha Pamarthy, are off target, I feel. The socalled market rates are only an excuse for justifying the interest rate. MFIs should calculate the interest rates by activity based costing methods from “zero base” rather than just add tangible and intangible costs to the rates to reach 18 – 24%. The objective must remain as “maximising social benefit” rather than “maximising profit” as taught in business schools.

David D Souza
Education Management Professional
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Let’s work for a Common goal of reducing the interest burden

The answer to the question is undoubtedly yes! Yes we need to reduce the interest rate to the microfinance clients. The question here is how?

All the valuable discussions and our effective time should channelized towards this goal.  We normally are used to certain practices, as in our regular day today life, we are accustomed to do certain things without even applying our mind consciously. ( Like driving back home in the night from our work). MFI operations are now becoming so predictable and typical that a set pattern has been created in our the minds.

Its all becoming a matter of routine like getting money from the bank and lend to the clients after adding all our cost and our margins. Due to the above the MFI market is now a virtual red Ocean were there is too much of competition, most of which is un-healthy. At the other end of the spectrum there are certain areas were at least 40% of poor have not even accessed their first loan because of certain lending policies of the MFIs.

The sector currently competes only on product, service and delivery. Several MFIs do not do their home work in terms of products, pricing and only end up as copy cats.

How are we going to break the red ocean of bloody competition.? How are we going to craft the new value curves? I know there are certain factors are taken for granted which can be eliminated.( cash handling – cost and risk is too high, in several places we can eliminate this using technology which are available with them already) Like that we can reduce certain cost and we can enhance certain values, by introducing an optimal loan product disbursed at the appropriate time. ( most of us never bothered about a needy product, we sell our loan product to them ).

Let us discuss the means to create a value curve, put all our energy towards reducing the interest rate to the borrowers at least by 25% from the present lending rate. Everything is possible, if work with one common goal of reducing the interest burden to the microfinance borrowers.
I am sure you will all agree this and contribute your thoughts towards this means….

Balasubramanian T
Microfinance Consultant-Deep knowledge in MFIs. Founder Director Mudhal Inclusive Growth India Foundation &  aptsource.in

Alternatives to delivering cash channel?

Bala mentioned that one of the major cost elements was delivering money or cash handling. Can we consider delivering “coupons” instead? Does anyone have some experiences to share in this regard? Or even “bartering”? Comments will be invaluable.

David D Souza
Education Management Professional

Complex issues and challenges affecting costs across the entire chain,

Very good issue, Dear David..Hearty Greetings

I had direct link and experience as a Central Banker in India since 1960s, handling rural credit and benign priority sector policies, issues and challenges. During bank branch expansionist and banking nationalization phases in India in 70s and 80s, rough, un-imaginative and non-participative handling of rural credit by mainstream banking sector was hampered by politico-administration on the one hand and social factors on the other. Poverty alleviation programs like Integrated Rural Development Programs had experimented, inter-alia, with front-end subsidy, back-end subsidy as also cash component and non-cash / inventory component. In several of studies, I observed that they were failures due to systemic deficiencies as also fragile and vulnerable tail-end delivery structures. Till 1992, the on-set of liberalization phase, Interest rate policy of banking sector, was contrived and not free market-determined. Average interest rates as administered by the Regulator with Govt. interest subvention and subsidy schemes worked out anything from 3% to 8% as against 18% for others from mainstream banking sector…!! The low interest rates also had less impacted poor and needy then.

2. As regards your query, even today, mainly women as home makers, in their part time vocation, do tie up with the nearest vendor for both inventories and marketing of finished products under a package. We do come across small and scattered artifact / handicraft craftsmen like jewellary, dolls, etc. makers tied up with mainstream vendors. Even a few big vendors, public or private bodies, NGOs, and MFIs ensure such tie-ups. The cost saving enables maintenance of supply chain smoothly up to a breaking point based on mutual trust and cost as also revenue-sharing.

3. Incidentally, two posers are yet to be concretely addressed-the one the comparative interest rates wrt pawn brokers and MFIs and the second, reasons / instances for whole-sale criticism of present working of MFIs as financial intermediaries, a laudable role they have alone undertaken to improve the lively hoods of poor and needy. According to me, by and large, both issues favour MFIs; I do not represent any MFI today..!! Linkedin being an international platform, I fear scope exists for obtaining cross section of views on practices in different geographies / jurisdictions..

I am very clear interest rate is not an isolated factor for woes of Micro-finance sector. We are all bringing to the board complex issues and challenges affecting costs across the entire chain, where mainstream banks failed miserably in their direct lending approach. None can dismiss these as non-issues only at peril to the welfare of sector / stake holders concerned and to find comprehensive answer to Dr.Ghosal’s vital poser. I am sure he will not disagree with me on this..!!!!

With love and regards to all

Prof.S.Subramanian
Subramanian Sankaranarayanan
Adviser & Senior Management Consultant at Gradatim IT Ventures (india) Ltd

Hope for the Best

My objective to raise the question of interest rate is not to condemn the institution of MFI but to make it more relevant to the needs of poor artisans and farmers. It is true one cannot ignore the points raised by most of you particularly by Prof.S. Subramanian and Shri Bala but the dire need of the day is easy universal financial accessibility and at affordable price. Governing bodies of MFIs have to focus on these issues and it would not be difficult to achieve the same these days due to paradigm change in technology to outreach the remotest corner and to communicate with adequate privacy all and sundry.

I hope we shall be able to fathom out some feasible strategy to achieve both with transparent tools and processes.
I am anxious to hear from some of our enlightened reactionaries to highlight and educate us on such business strategy that would make MFIs more user friendly and help developing universal financial accessibility (UFA),

Regards
Dr.S.N.Ghosal

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