The past year has seen governments put much passion into beating up microfinance institutions (MFIs). Enraged politicians have punished an industry for the mistakes of a few and recklessly destroyed it in Andhra Pradesh. But informed assessment of the industry has been lacking. Hence Susan Thomas and Renuka Sane’s work on MFIs is important.

A striking finding emerging from their analysis of CMIE statistics concerns how addicted Indians are to borrowing. Two out of every five households had borrowed in 2008. Even amongst the richest, a fifth borrowed; the proportion went up as income went down. Another surprising conclusion concerns the banks: that 40 years after nationalisation and despite the energetic efforts of their owner, the government, to make them lend to the poor, less than a tenth of the poor and the lower middle class got loans from banks.

If all, whether rich and poor, are compulsive borrowers, and if the poor get little out of banks, where do they go for loans? To moneylenders, and let it be stressed, to microfinance institutions (MFIs); these favourite butts of politicians are better friends of the poor than politicians’ beloved banks. But there is an even more important source, namely family and friends. They lend more than twice as much to the poor as moneylenders.

This may sound comforting — Indians so readily help their family and friends. But nothing is known about their lending practices — on what terms they lend, what they charge, what means they use to get their money back, in what forms other than money they extract a return, etc. It is possible that many just lend the money and then forget about it. But that would be a presumption; no one knows how actually generous or exploitative they are. The chorus about microfinance institutions’ exploitation is accompanied by complete silence about the practices of their competitors.

In this market for loans to villagers, MFIs have gained market share, and amongst them, profit-making MFIs have gained ground against profit-shunning MFIs (which are also known as non-government organisations). It is possible that the losers have fuelled the campaign against MFIs. They are not allowed to take deposits, and nothing is known about the sources of their funds. Sane and Thomas suggest that MFIs should be able to securitise their loans and borrow against them.

The main charge against MFIs concerns rough handling of borrowers. The AP legislation is largely directed against this; it prevents MFIs from going anywhere near borrowers to collect their loans. They have to make arrangements with district collectors, and receive collections once a week or less often in government offices. Irrespective of where the money comes from, AP has made MFIs’ lending a branch of government business.

Both Reserve Bank of India and the AP government have jumped into MFI regulation; in Andhra at least, there is one regulator too many. And that is also too few, because MFIs may sell insurance policies, pension policies and other financial products; if they do, they will come under regulators of those products as well. That is why Sane and Thomas think it urgent that a single new regulator should be appointed. But they cannot even imagine that the numerous financial regulators can be combined into one; such things do not happen in India. So they envisage yet another regulator. How to keep him out of the hair of existing regulators? They propose a regulator for just the distributors of financial products. This is not really a new regulator; it would be a joint committee of those existing regulators. But to be effective, it would have to create its own bureaucracy — quite a vast one. So it would take a life of its own.

Sane and Thomas blame MFIs’ strong-arm tactics on their ignorance of their borrowers’ financial status: villagers borrow from a number of sources, pay some off by borrowing from others, eventually run out money and default. The solution they propose is that a credit information bureau must collect data on the debts of every villager. They do not measure the task this bureau would face. It would have to amass data on the debt of some 250 million families. They have no reason to give the information, and cannot be forced to give it to a credit bureau unless moneylenders, families, friends and other lenders make them do so. So Sane and Thomas’s concepts of regulation and credit rating are not as perfect as one would like them to be. But at least they have done some constructive thinking.

(This story was published in Businessworld Issue Dated 04-07-2011)