Has demonetisation hit micro-finance?

Kirana and tea shops are doing better than businesses that involve discretionary spending

The Micro-finance industry (MFI) is cursed and blessed at the same time. When there were indications that the micro-finance sector is overheating, with high growth rates, multiple lending and oppressive loan recovery practices, the withdrawal of specified bank notes (SBN) hit them. There were reports of stress from Uttar Pradesh and it appeared that there would be a repayment crisis in certain regions, which would have a multiplier effect. This was similar to the events in (the undivided) Andhra Pradesh in 2010.

The providers of micro-finance use standardised models which helps purvey credit aggressively. They do appear to see the struggle of the clients to repay their debt when it grows too large; especially with no attendant growth in livelihoods.

While aggressive growth is a curse on the micro-finance industry, creating a bubble every six or seven years, they are blessed. Blessed, because every time micro-finance is ready to implode, an external explosion blinds it — in 2010 it was the AP government’s law and now it is the withdrawal of SBNs.

Strain but no mass default

Micro-finance thrives on the informal economy and cash. It is India’s sub-prime portfolio with a superior collection (and not necessarily a superior appraisal) mechanism using peer pressure and social shaming.

It is made for people who were left out of the formal financial sector, with weak documentation and inadequate transaction trail. The clients run small businesses, mostly petty shops, and invest in livestock. These businesses thrive on small cash transactions and generate flow to repay the weekly or monthly instalments. Cash lubricates this business.

The withdrawal of SBNs has affected cash flows of the micro-finance clients. This is unlike the crisis faced by the micro finance industry in the past. In the past, including after a devastating cyclone in Bangladesh, we saw that a large number of clients were equally affected resulting in a domino default. In 2010, a majority of the clients had over-borrowed due to the competitive lending and were equally stressed. However, now it appears that the effect of the SBN withdrawal has not affected all the clients equally. Clients who are in the petty business of running tea shops, kirana stores and vegetable vending seem to be doing better than those who are in businesses involving discretionary spending: tailoring, garments, and beauty parlours. While there is strain, there is no mass default. MFIs have reported collections upwards of 60 per cent, a significant number if we were to believe that the informal economy is hit the hardest by SBN withdrawal.

Structure of the Industry

What is important is how this event will affect the basic structure on which micro-finance is built.

The collection methodology of micro-finance depends heavily on group meetings and peer pressure. With some in the group unable to pay, there is pressure on those who can pay, to default.

There is also an increased awareness that any default will go as a black mark in their borrowing history now being recorded in a centralised credit bureau database.

Therefore, more than how it is affecting the micro-finance business now, it would be interesting to see how this move affects the inherent trust built in the group mechanism, with external pressures forcing the members to not behave uniformly as a group.

Adding to this dynamic is the usual external intervention from local politicians and gang leaders. There has been a move to tell the borrowers that they could and should default, as there would be a waiver.

In the season of promises of cleaning up corruption, putting money into accounts, etc, these rumours assume greater credibility, reducing the chances of a recovery.

In Bengaluru, for instance, there were some leaders distributing official looking forms to be submitted with a fee of ₹250, which was supposed to be an application for loan waiver.

How the micro-finance industry deals with this is to be seen. But without doubt, this is an external shock for the micro-finance industry.

Even if the industry faces problems from excessive lending and non-performing loans, the blame can easily be shifted to the Central government, but it will also redefine the interpersonal trust, group dynamics and the basic assumptions on how the micro-finance sector deals with its clients.

The writer is visiting faculty, Centre for Public Policy, IIM Bangalore

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