Does Microfinance Need Regulators? Nobel Laureate Yunus Thinks So...Published: December 13, 2007 in India Knowledge@Wharton
Setting up museums isn't exactly what banks think of as their core business. Still, it was hardly surprising to hear Nobel Laureate Muhammad Yunus, founder of Bangladesh-based Grameen Bank, recently exhort Maharashtra, India's most industrialized state, to compete with his homeland to build a poverty museum to mark the end of poverty. "Let's see who eradicates poverty first -- Maharashtra or Bangladesh," he said.
Yunus was in Pune last month to accept the first-ever Sakaal Person of the Year award. Instituted by the western India based Sakaal group of newspapers to recognize individuals who have made a significant contribution to society, the award recognized Yunus for his own pioneering work in microfinance as well as for inspiring others to enter the field. Speaking at the event -- and also in an interview with India Knowledge@Wharton -- Yunus pointed out that while microfinance in India has lots of growth potential, regulatory changes are required and an independent regulator needs to be set up to monitor cases of abuse. Microfinance in India is now a $2 billion business, but it could potentially grow to a size ranging from $10 billion to $30 billion.
Speaking at Pune's prestigious agricultural university before receiving the Sakaal Person of the Year award, his call to action struck a chord in the Western Indian state of Maharashtra which has been plagued by farmer suicides blamed on high debt that they were unable to repay. Coming on the back of complaints that some organizations in the Southern Indian state of Andhra Pradesh were charging usurious rates of interest on money-lending masquerading as microfinance, Yunus spoke about the Grameen model and also called for increased regulation -- administered by a special regulator -- of the microfinance sector in India.
Unconventional solutions to poverty have made Grameen Bank which, has so far loaned $6.5 billion, a highly successful micro-lender. Having started with providing a loan of $27 to a group of impoverished women in the mid 1970s, Yunus has been a pioneer in using microfinance as a tool to lift people in 80,000 villages of Bangladesh out of poverty. Grameen has 7.2 million borrowers, 96% of whom are women, and Yunus says he hopes to eradicate poverty in his homeland by 2030, one small loan at a time, leveraging the entrepreneurial zeal of poor Bangladeshis. "All poor people are entrepreneurs," he says.
For those who might disagree, he has already proven critics wrong with both Grameen Bank -- which today pays out $500 million a yearin loans and has a repayment record that exceeds 98% -- as well as with Grameenphone, a mobile phone provider that serves more than 15 million subscribers and is now the largest corporate taxpayer in Bangladesh.
Create Jobs, Don't Seek Them
Yunus believes that in developing countries, people should stop looking for jobs and start creating them. A poor person should take a small loan and start her own business -- and that will make her big enough to employ others. That has been Grameen Bank's philosophy since its inception. "The way we have designed education encourages students to work hard and study hard to get the best jobs. We need to discuss what to do so that we can go to work for ourselves. Human beings are not slaves so we need not work for someone else as a rule," Yunus notes. Grameen requires all the children of its borrowers to attend school so that they can work towards a better life.
Keith Weigelt, a management professor who teaches microfinance at Wharton, says Yunus is right in his views about education. "When studies are done of successful microfinance initiatives, the findings are that lending money is not enough," he says. "Education is crucial, and it's really lacking." Weigelt adds that most of the educational initiatives focus on managers of microfinance institutions rather than on the borrowers themselves.
According to Yunus, Grameen continuously looks for potential borrowers among those who live in abject poverty, especially women who have no security to offer and in fact have little desire to borrow any money to start a business. "We tell our staff, when you meet the woman who asks, 'What will I do with your money?' you have found your client. You need to persuade her to take out a small loan to start some productive activity -- such as rearing poultry, or something along those lines -- which will elevate her position in society and unshackle her entrepreneurial talents."
Most first-time borrowers at Grameen are women who have never handled money and whose intuitive reaction is, "Why don't you loan the money to my husband?" "When a woman says, 'I don't want money, I don't know how to do business with it,' that's not her voice but the voice of history," says Yunus.
Grameen has expanded dramatically in Bangladesh during the past 30 years, and through the Grameen Foundation, based in Washington, D.C., is also involved with millions of poor people in neighborhoods from South Africa to Chicago. Grameen does not have commercial operations in India, though. In India, microfinance institutions are not allowed to accept deposits, and this forces them to depend on bank refinancing or donor money for expanding their activities. Yunus questions the value of these economic models.
Grameen Foundation is, however, active in India -- it works with some 25 microfinance institutions such as SKS Microfinance whose founder, Vikram Akula, recently won the Ernst & Young Entrepreneur of the Year award. These partner organizations in India have already made loans to 1.7 million families, Grameen estimates. SKS alone has made loans worth $149 million and is said to be among the world's fastest-growing microfinance organizations.
Micro-Credit Ratings International, a Gurgaon-based agency, recently estimated potential demand for micro-credit in India at Rs 480 billion ($12.06 billion). As outstanding microfinance loans in India are estimated at less than a tenth of the potential, the scope is immense. Grameen Foundation estimates the potential for microfinance in India -- which is home to a third of the world's poor -- to be some $30 billion. This latent demand probably accounts for the success of India's largest private sector bank - ICICI Bank -- which already has a portfolio of microfinance loans running into hundreds of millions of dollars. Even international banks such as ABN Amro Bank have multi-million dollar microfinance portfolios in India.
Despite the growth potential, microfinance in India has its share of problems, according to Yunus. "For microfinance to grow steadily, you need a change in regulations by the National Bank for Agriculture and Rural Development (NABARD)," he points out. "The existing regulations are designed with commercial banking in mind, but microfinance requires a dedicated regulator and a relevant set of rules. Commercial banking is like a super tanker whereas microfinance is like a dinghy boat with which you can reach small corners. If you design a dinghy boat with the architecture of a supertanker, it is sure to fail," Yunus says.
The importance of extending the benefits of a developed financial system cannot be stressed enough in India, especially since the country has among the world's highest ratios in terms of savings rate-to-GDP. In the absence of a meaningful social security system, it is critical to ensure that poor people can use the banking system to save some money. Still, according to Pawan Kumar Bansal, minister of state for finance for the government of India, only 10-12 automated teller machines exist per million population in India vs. 50 per million in China and 500 per million in South Korea.
The Reserve Bank of India has tried to introduce no-frills bank accounts which underprivileged sections of society can use. Migrant workers from different parts of India who live in shanties in big cities often find it quite difficult, however, to produce the documents that banks need under the new 'Know your Client' norms. The KYC norms are a fall-out ofa new law called the 'Prevention of Money Laundering Act' passed by India's federal government. The law aims to make India compliant with international norms on money laundering but several sections of the bill have had unintended consequences. In the absence of a national identification such as a social security number, a large percentage of the population cannot produce the many documents required to even open a bank account. Since poor people cannot use the banking system, they often find it difficult to access most other financial products as well.
"You cannot solve the problem of poverty with the institutions and concepts that created the problem in the first place," according to Yunus. Grameen Foundation reckons that 87% of the poorest households in India do not have access to credit. Joydeep Sengupta, who leads the financial services practice in India and Southeast Asia for consulting firm McKinsey, agrees. He estimates that only 47% of the total savings in India are accessed by the financial sector. In a recent study of India's banking system, McKinsey concluded that intermediation costs and financial inclusion are two areas that need attention.
Intermediation cost isthe operating cost involved in mobilizing savings and lending these to borrowers. Financial inclusion means ensuring open and equal access to the financial system to all segments of society. High intermediation costs result in higher cost loans for small borrowers and a lower propensity to offer products for those who wish to save small sums of money. As a result of being excluded from the banking system, small savers have to rely on real assets such as gold, which have an inferior return, or chunky assets like real estate, which they may not be able to afford.
The Grameen Model
Given the small size of microfinance loans and savings, Yunus says microfinance organizations in India should be allowed to both accept savings and grant loans to customers."Conventional banks often ask borrowers if they are worthy of a loan," he says. "At our organization, we ask ourselves, 'Is the bank people worthy?' We look for the poorest borrowers, while commercial banks look for the richest. At Grameen, our philosophy is the less you have, the more you get. If you have nothing, you get the highest priority," he adds.
Grameen in the past depended on donor money to bridge its funding gap. Now it relies on deposits from its poorest customers to provide the resources needed to disburse $500 million a year. "That's the only way to become self sufficient -- as all grants and donations come with some strings attached," Yunus says. Yet to ensure that people do not abuse the system, he says a dedicated regulator for the sector is required.
Wharton's Weigelt says he recognizes that regulation might be necessary to ensure that some microfinance providers do not charge usurious rates of interest. Still, he urges caution. "If a regulator began to introduce rules, you have to wonder if that would drive microfinance institutions out of business," he says. "Now many microfinance institutions are trying to become like banks, and commercial banks are moving into microfinance. As a result, interest rates for micro-credit loans have begun to come down. Moreover, credit agencies are starting to rate the microfinance providers. That, of course, is not the same thing as regulation, but it is a market-based solution."
Yunus points out that Grameen tries to keep its overhead costs low in various ways to ensure that the bank's operations are cost-effective. For example, when a new branch is to be opened, the manager is given an address and told to go there and start collecting deposits and making out loans even before the office is formally set up. "We don't have a lot of money to throw at setting up branches, so it's up to the manager to raise enough resources and business to justify setting up the branch," he says.
While Grameen typically requires its branches to break even within a year of being set up, this has not distracted from its main mission of providing credit to the poorest. "If you are being true to microfinance then there should not be more than 10% difference in the interest rate at which you borrow and that at which you lend." With the involvement of venture capitalists as investors in microfinance firms, Yunus fears that the movement may become like the usurious moneylender it seeks to replace. "The real issue is to evaluate whether people are better off than before rather than recovery rates and statistics," he says.
Indeed, some states in Southern India were forced to enact legislation to control the interest rates charged to borrowers when a few firms masquerading as microfinance specialists started charging interest rates double their borrowing costs or even more. "If maximization of profit is the motive, then the market will not out-compete the money lender," Yunus points out.
Not surprisingly, Grameen doesn't believe in punishing even those who are unable to repay a loan. Such borrowers are not taken to court. "If a loan becomes a non-performing asset, often our staff will work with the borrower to placate their distress and give them another one to start another business and recoup their losses. The loan granted earlier will be converted into a long-term loan allowing the borrower to pay it off smoothly," says Yunus. The bank also has credit insurance that helps pay off loans in case a borrower dies.
Grameen evaluates its 2,500 branches based on a 'five star' rating system which includes conventional metrics -- such as breakeven level of operations and the deposits to loans ratio as well as softer developmental metrics, such as percentage of borrowers' children in school, percentage of borrowers who have crossed the poverty line, proportion of borrowers who have a solid roof over their heads and sleep on a bed. Yunus describes microfinance as a non-loss, non-dividend paying 'social business'. "A charity rupee has one life only, whereas a social business rupee has an endless life as it keeps renewing itself," he says.
So far, Indian microfinance institutions have had a mixed track record as regards the interest rates they charge and fair lending policies. For instance, the south Indian state of Andhra Pradesh closed down some branches of microfinance institutions for charging 'exploitative' rates of interest and adopting forced loan recovery methods that resulted in dozens of borrowers committing suicide. Now several firms that offer microfinance loans in that state charge borrowers there lower rates than they do in other states on the grounds of better penetration of microfinance.
On the other hand, larger microfinance institutions such as SKSoffer interest-free loans for emergencies as well as life insurance to its members. Its affiliate, SKS Education, provides educational services to poor children. Yunus believes that institutions engaged in microfinance should be evaluated on the basis of the number of people they have managed to save from poverty, the number of illiterate families whose children have been educated, and the extent to which loans and savings options have been made accessible to the community.
As for its operations within Bangladesh, Grameen has expanded beyond micro-credit and mobile telephony to a joint venture with Danone to produce fortified yogurt for malnourished children. Grameen is also looking for a joint venture partner to provide drinking water to Bangladeshi citizens affected by arsenic water poisoning. In addition, Grameen is helping set up, stabilize and hand over microfinance organizations in Assam in North East India; sharing its expertise to set up microfinance institutions in the Bronx in New York City; and even working with regional governments in China, such as Sichuan, Inner Mongolia and Hainan, to get microfinance to work in the world's most populous nation.
Clearly, Yunus and Grameen have miles to go before poverty can be regarded as ancient history and consigned to the museum.