Posted by : Milan Acharya
As Nepal strives for economic development, microfinance has emerged as a promising tool for financial inclusion and poverty reduction. This concept was first developed by Professor Muhammad Yunus of Bangladesh, who founded the Grameen Bank, Bangladesh, in 1983. Microfinance is a financial revolution that has changed the lives of millions of people around the world by providing small loans, savings accounts, and other financial services to those who are excluded from traditional banking services due to poverty, lack of collateral and restricted physical access to financial market. Microfinance empowers low-income individuals, particularly women, to start or expand small businesses, invest in education, healthcare, and housing, and aims to lift themselves and their families out of poverty. It provides them with the financial means to turn their ideas and aspirations into reality and become financially independent, improving their economic and social well-being.
The initial not-for-profit orientation of microfinance provision, which focused on poverty reduction and development, advocated by Yunus and others, was gradually replaced by a model that emphasized full-cost recovery during the 1990s. This paved the way for a more market-oriented approach that could accommodate and even encourage for-profit microfinance. As a result, the focus of microfinance institutions shifted from social goals to financial sustainability, which led to a proliferation of profit-oriented microfinance institutions. While this approach has led to increased access to credit and formal financial services, it has also raised concerns about the impact on vulnerable communities, as profit-driven institutions may engage in aggressive lending practices and charge high-interest rates.
In recent times, the Microfinance Institutions (MFIs) in Nepal have been criticized for their exorbitant interest rates, which have raised concerns about the relevance of microfinance as a poverty reduction tool. In the past two years, 44 victims of microfinance companies in Kailali and Kanchanpur have reportedly committed suicide, contributing to a total of 78 suicide cases in all nine districts of Sudurpaschim Province alone. This highlights the severity of the issue and raises concerns about the impact of microfinance lending practices to vulnerable communities not only in Sudurpaschim Province but in Nepal as whole. So, what are the major problems that are prevailing in Microfinance system in Nepal?
In Dr. Yunus's view, interest rates on microcredit should ideally be between 10% to 15%, and rates beyond that are considered to be in the "red zone" or danger zone. The high-interest rates charged by MFIs have raised concerns about the relevance of microfinance as a tool for poverty reduction in Nepal. MFIs in Nepal have been found charging up to 30% in loans. While some argue that the rates are necessary for MFIs to cover their operational costs and remain profitable, others argue that they can induce borrowers to fall into debt traps. Many borrowers in Nepal are women who use the loans for small businesses or household expenses. When they are unable to repay the loans due to high-interest rates, they often resort to taking out additional loans to pay off existing debts, creating a vicious cycle of indebtedness. In some cases, courts in South Asia, including Bangladesh, have intervened to regulate interest rates and protect borrowers from usurious practices.
The issue of multiple lending from microfinance exacerbates when borrowers received loans from two or more institutions without proper assessment of their creditworthiness, repayment capacity, and financial parameters. Such borrowers have used the funds to repay loans from other institutions, creating a cycle of rolling debt that increases the risk of loan defaults.
Furthermore, MFIs prioritizing financial returns over borrower welfare has led to controversies related to over-indebtedness and financial distress. Unhealthy competition for loan quantity has neglected loan quality, compromising borrowers' ability to repay loans and improve their financial situations.
Another problem is the lack of financial literacy among the borrowers. Many rural and remote areas of Nepal still rely on informal lending systems that charge high-interest rates (meter interest), and the recent staged protests in Kathmandu also helps in revealing a lack of financial literacy in those areas. Microfinance Institutions (MFIs) though have emerged as a potential solution also to bring people into the formal financial system. However, concerns have been raised about the practices of some MFIs, which may not have operated like it was visioned to. This raises questions about whether the actions of MFIs are actually helping to address the issue of financial exclusion or they are just seeking profits. Many borrowers may not be aware of the terms and conditions of the loans they take, and they may not have the necessary financial management skills to manage their loans effectively. Moreover, people who borrow from MFIs are found using the funds for non-productive purposes such as financing weddings, funerals, or other social events. This is a major concern for MFIs, as it undermines the effectiveness of the microfinance model, which is designed to promote productive activities and income-generating businesses.
The recent issues of borrower harassment and intimidation by microfinance representatives, along with the increased non-performing loan amount, have resulted in several consequences that could compromise the sustainability of microfinance institutions. This has become evident in the current FY 2079/80, as microfinance institutions have experienced a significant surge in the average non-performing loan ratio within the first six months. Out of the 64 MFIs in the country, 60 engage in retail lending, while the remaining four engage in wholesale lending, with the former reaching Rs 391.44 billion, of which 4.68% was recorded as bad debt, and the latter increasing by 3.17% to reach Rs 59.78 billion, with 0.87% of the amount being non-performing. The non-performing loan ratio for the retail lending segment was 2.56% as of mid-July 2022, according to the NRB, which further highlights the urgency of addressing these issues to ensure the long-term viability of microfinance institutions.
Furthermore, the microfinance issue that occurred has brought to light the reports of microfinance representatives using harassment and intimidation tactics to collect loan repayments from borrowers. Unfortunately, this is not a new issue, as similar incidents have been reported in other countries, such as Bangladesh, where microfinance representatives were known to harass and intimidate impoverished individuals. Increased awareness and action could have potentially prevented these situations from occurring.
NRB has updated its guidelines for MFIs to address governance and credit concerns. The new provision mandates that MFIs deposit 50% of proposed dividends exceeding 15% into a general reserve fund, promoting financial stability and reducing the profit-driven nature of MFIs. Additionally, the directive stipulates that a borrower can only receive micro-loans from one MFI under collective guarantee, with or without collateral. Borrowers are prohibited from obtaining loans from both microfinance institutions and other banks/financial institutions, and must declare their loan status to the MFI.
Collaboration between microfinance institutions, the government, and other stakeholders is essential to strengthen regulations and prevent financial instability. The promotion of responsible microfinance practices is necessary to empower individuals and guide MFIs towards success. An effective approach to achieve this goal is to prioritize the conversion of microcredit into viable micro-businesses and enterprises. Additionally, financial literacy programs should be implemented, and reasonable interest rates should be maintained to ensure the long-term sustainability of microfinance programs in Nepal.
Picture Source: The Kathmandu Post