Microcredit and its vicious cycle
By Sanuj Hathurusinghe-2017-12-24Ceylon Today Features
Central Bank Governor Indrajit Coomaraswamy recently acknowledged that households in war-affected areas in the North are now severely indebted. Speaking with The Hindu, Coomaraswamy said that the indebtedness is mainly due to the substantian microcredit that families have obtained. "What happened is after 30 years of war, people were desperate for consumption and they just used it all up in consumption. Therefore now they are severely indebted," further added Coomaraswamy.
Coomaraswamy thinks an 'enabling environment' might have prevented people from getting indebted to such an extent. Senior Research Professional for Centre for Poverty Analysis (CEPA) K. Romeshun too thinks that it should have been the case. "People are sure to spend these entrepreneurial loans for consumption purposes but that's not the only reason. The economy of the area too is weak as it is slowly recovering from all the damages civil war did. If you go now to Jaffna you might see that the city centre is not that different from a city in Colombo but the same is not the case if you go a little bit further interior. The economy of the area too should support entrepreneurs in order to profit from their ideas which has not yet been the case in the North," says Romeshun.
Prevalent in other areas
The North may have the ongoing post-war recovery as an excuse for the financial woes there but the issue is not limited only to the war-affected areas. Through her research, Chandima Arambepola, a Research Professional at CEPA has found similar problems existing in areas such as Kurunegala, Kegalle, Monaragala, Down South and even in rural areas of the Western Province. In some cases the woman of the house ends up going abroad as a housemaid hoping the commission she gets from the agency will pay off the debt. "The trend was a surprise for us. We probed a little further and found that these women have not only taken microcredit but loans from other informal money lenders as well," added Arambepola.
On paper, it works
Microfinance was made popular by Grameen Bank, Bangladesh. Muhammad Yunus who founded Grameen Bank and pioneered the modern concept of microcredit and microfinance ended up winning the Nobel Prize in 2006 for his efforts through microcredit to 'create economic and social development from below.'
In Sri Lanka, Sarvodaya was one of the pioneers that brought microfinance into rural society. Romeshun explains, in a nutshell, how microfinance works. First a group among the community is formed. They are told of the importance of savings and small amounts of money from each member of the group is collected to create a fund. When there is money, the next step ideally is credit. "Even credit is given in stages. First it is small credit for consumption purposes, say to buy a pair of shoes for your child or books for school. Then you graduate onto something bigger perhaps buying an item of furniture for your house. Only as the third step are people given bigger loans to be entrepreneurs," says Romeshun.
A start up business resulting from the entrepreneurial loan will bloom and when the person needs more credit to improve his or her business, he or she is directed towards banks where bigger loans are available.
"That was the general practice of Sarvodaya. It gave small loans as small as Rs 200 or 300 rupees and then one graduates to Rs 10,000 to 20,000 to 50,000 to 150,000 and then one is told that one is now in a position to go to a bank. There is also the group process. If one fails then the others are expected to pay. The consequent aspect of it is that interest rates are very high. A bank will give you credit at say 12% but microfinance is typically at around 20 to 27%. The cost is much higher because the person comes to you," added Romeshun.
For a beginner, a bank would not give credit to a poor person with only a plan but no collateral. Microfinance helps such people to start a business up, build some reputation and to be somewhat literate in finance, at least to an extent where from there the person can interact with a bank.
Why the muffled
success
The aggressive approach adopted by many finance institutes which are in the business of microfinance is one of the reasons why people are in so much debt. "Samurdhi has a strong presence but people are under the impression that it is only for beneficiaries. If you are cut off from the city you might have to spend a day to get to a Samurdhi office and then another day to bring all the necessary documents. These are people who need money urgently. They would rather go to the person who comes to them and simply sign on an ipad and get a loan quickly," says Arambepola.
"With many financial institutes there is no social mobilization, no vetting process and no scrutiny to see whether the proposal is actually viable. Producing just a proposal, a Grama Niladhari certificate and a letter from your husband is enough to get a micro-loan. People often end up using the loan for consumption purposes rather than for entrepreneurial purposes. With no money generated to pay the loan people tend to get another micro-loan from a different institute and it becomes a vicious cycle," says Romeshun.
People ending up using the loan on consumption purposes don't help matters. If the credit is not making money, the already poor are left with the hard task of paying it back.
Financial illiteracy too plays a major role. A person might not know the exact interest rates of the credit but only the amount he or she has to pay daily, weekly or monthly. On the face, paying a small amount of money as interest weekly or monthly might look do-able but it really becomes next to impossible in a household whose income comes once in every six months from paddy.
The issue is moral
"Legally, every micro finance institute is well within the law. They have all the documents and they are doing nothing wrong. But the issue has a moral aspect to it," says Romeshun.
"There is a stigma attached to it. The debt collector is well-known among the community. These collectors often visit households to collect instalments mostly at odd hours - they have to because those are the times people come back home after work. Invariably it is a man who visits houses and most of the times, it is a woman who is present at home. The collectors demand money and sometimes even scold in filth. When this happens, the whole village gets to know that a certain house hasn't paid," says Arambepola.
What it does is basically shaming people into paying the debt. Granted it is immoral but it proves to be effective. "When you talk to these agents they say that almost 90% do pay on time and it is the rest that they have to visit and collect money from personally," says Romeshun.
Both Romeshun and Arambepola have listened to numerous woes of the affected. Romeshun reveals one such incident where a girl and bunch of others had to stay hidden for hours as the official who came to collect debts just wouldn't leave. Romeshun has heard some stories where shame, guilt and the pressure of debts sometimes have pushed people towards suicide but he is yet to encounter a credible incident of such. Personally, he believes the amount of credit in microfinance is not that large for a person to commit suicide over.
Not for consumption
One of the reasons for the scheme to not work is people not using the micro-loans on start-ups. If a person with no collateral takes a loan with hopes of making money and however ends up consuming the loan, understandably he or she will be in much debt due to higher interest rates of microcredit and simply there not being a way of making money. The success of each business proposal depends on personal attributes and the way a person approaches the business. With that being said, everyone should at least try it and make the loan worth rather than spending it on things a normal household should typically be able to manage with on a regular income.
"Institutes should have a better vetting process to determine the viability of proposals. Most financial institutions don't have a graduation process where they should ideally direct their customers towards banks at some point. Arthavida Foundation still does it but not many," said Romeshun emphasising on the importance of scrutiny before credit.
"If you look at two contradictory statistics one might say that 99% have actually paid back but if you look at the success rate of businesses it is only about 20 to 30%, given the fact that everyone is not an entrepreneur" says Romeshun.
Facts and numbers alone would not give a clear picture. There are ones who pay who will pay even if they have to pawn their valuables to do so. The return rate does not reflect success.
Success is mainly up to the people. At the same time, it doesn't kill for officials to take a more polite and civilized approach in interacting with people.
