The structuring of micro loans matters

Last month, the RBI issued a ‘Consultative Document on Regulation of Microfinance’ inviting comments and suggestions from stakeholders. In the introduction, the RBI states that microfinance “is an economic tool designed to promote financial inclusion which enables the poor and low-income households to come out of poverty, increase their income levels and improve overall living standards. It can facilitate achievement of national policies that target poverty reduction, women empowerment, assistance to vulnerable groups, and improvement in the standards of living.”

RBI Governor Shaktikanta Das developed this idea further while addressing a ‘Financial Inclusion’ summit recently, saying that “the overarching principle is echoed in the Gandhian philosophy: “ Sarvodaya through Antyodaya — Welfare of all through the upliftment of the weakest”. Antyodaya was a major theme of Pandit Deendayal Upadhyaya too, one of the foremost homespun proponents of “poor economics”.

Undoubtedly, the RBI wants to widen and deepen the terms of engagement of the microfinance industry, at relatively cheaper cost and on terms that are transparent.

There are two data points which are relevant to any discussion on how micro credit can help improve livelihoods.

As per the Longitudinal Ageing Study in India (LASI) 2020, which conducted an ‘Investigation of Health, Economic, and Social Well-being of India’s Growing Elderly Population’, the per capita annual income in a rural household is ₹35,893 while it is ₹65,720 in an urban household. This means that the per capita income in the rural areas is definitely below the traditional $2 per day norm (₹150 per day income) while it is just about marginally above the same in urban areas.

In 2017, NABARD had authorised a survey which pointed out that the average monthly income of a rural household was about ₹8,000. A “household” is defined usually as a group of persons who normally live together and take their meals from a common kitchen. We can assume that an average Indian household will have at least five members.

Poverty estimates

Even if we leave out the differences in the outcomes of the two surveys, the most liberal of poverty estimates indicate that close to 100 million people in India live in extreme poverty and at least twice that number on the margins of poverty. So these 300 million people have to be lifted out of poverty for economic growth to have any meaning to them and to their day-to-day lives.

All talk of GDP, GVA, inflation, per capita income, etc., does not mean a thing to them. “What is revolution?”, a character in Pearl S Buck’s Good Earth asks and the classic reply is: “I don’t know what revolution is but it has something to do with food”. We cannot have a better definition of the core issue.

Micro loans are perfect vehicles by which the poor can be supported to improve their livelihoods and increase income levels. The sums of money required are very small, mostly about ₹1-2 lakh or about $1,500-3,000 per person. The Reserve Bank’s heart is in the right place in trying to bring reforms by constantly enhancing coverage and making the micro markets friendly to the beneficiaries. In the beginning of the last decade, following the Andhra micro loans bust, they appointed one of India’s finest chartered accountants, YH Malegam, for a study. His guidelines have proved to be quite useful.

Mode of financing

The latest draft guidelines also are good except with regard to the mode of financing. Even though this may sound like just one aspect, it actually is “the” most important factor in making micro finance a success. More often, tight timelines for repayment have led to defaults or the forced need to give “fresh” loans. The cash cycles of the poor are unpredictable and there may be need to use money for emergencies relating to health, higher education of children and social spends like on marriage,

Structuring of the loan is as important as giving the loan. We have to accept the fact that a household can afford to be indebted to the tune of 12 times its monthly income or equal to its annual income with interest alone being serviced and the money available for use up to the limit perennially. In many urban households, credit cards do this function (in addition to the housing loan, car loan, educational loan, etc).

The principle of credit cards is that, if the minimum amount due is paid, the limit is available for use. Likewise it should only be the monthly interest which will become payable. The households should have the freedom to pay and draw as they please with interest being payable on daily balances. Thus the total load of interest payment even at 10-12 per cent on ₹1 lakh will not exceed ₹1,000 per month. If they have surplus, they may choose to pay back to lower the outstandings. The lenders can take care of the resultant asset-liability issue, if any, in their books.

It is futile to expect even a loan of ₹1 lakh to lead to a disposable surplus of about ₹5,000 to enable a borrower to repay the loan in 24 instalments, approximately. If the loan is in the nature of a revolving credit or a livelihood credit card, that will help improve livelihoods.

The draft guidelines need to accept this major credit principle, as an option. Else, funding the unfunded may run into problems as cash flows for them are uneven and the risk of default will remain elevated.

A broad based lifting of large segments out of poverty and into the next level of standard of living can only come from a targeted/focussed creation of sustainable indebtedness through a revolving credit, based on credit card principles. That is why a livelihood credit card with limits being set based on the need and the ability to service the interest portion will have to be part of the structuring of credit for the microfinance sector to really lift our brothers and sisters out of poverty.

The author is a Chief General Manager with a leading public sector bank