By Ashok V. Desai
[The author is an independent columnist. This article is a reproduction of his column from The Telegraph]
The Reserve Bank of India is an exceptionally clean and efficient organization. It discourages contact between its staff and outsiders in the belief that personal contacts are an essential component of corruption. That could make it unfriendly to outsiders. But it promises quick response to letters, and almost invariably gives it. It minimizes discretion by making clear rules. Its rulebook runs into thousands of pages; but the result is that everyone knows or can find out rules, and everyone gets equal treatment. In brief, the RBI is an admirable institution; if the Central and state governments ran half as well as it, Indian lives would be much improved.
But, as can happen with rule-bound institutions, it is extremely compartmentalized; it does not see the interconnections between the various areas it oversees. And it has strong preconceptions. In particular, it dogmatically protects the interests of banks, and of government banks in particular, and is consequently biased against change and innovation. How much damage this blinkered approach can do is illustrated by the report prepared for its directors by a sub-committee to study issues and concerns in the microfinancial institutions sector.
To begin with, the committee’s terms of reference were so narrowly defined that it considered only MFIs and defined them as only lending institutions; it consequently ignores the larger purpose, which is to extend financial services to the villages and the poor. Contrast this with the Raghuram Rajan Committee of the Planning Commission, which is never mentioned by the RBI. It said that the poor have three kinds of financial needs: credit, security, and earning from savings.
It would save costs if the needs were fulfilled by the same institutions; for that, financial institutions need to be diversified. The RBI’s model of the institutions as extensions of banks is ill-suited to the needs. There is plenty of evidence of its weakness, for example cooperative credit societies and rural banks.
The Rajan Committee pointed out that microfinance organizations needed to raise money from somewhere. The answer was obvious to the MFI committee: the money would come from the banks. But there is an even more obvious answer that it strenuously avoided: the money can come from their clients. In other words, the MFIs would be much more viable if they could take deposits — if they were banks themselves. And the need is not for a dozen or two; to reach 700 million people in half a million villages, thousands of banks would be needed. The RBI hates this idea, and relates how experiments with small and rural banks have failed. If banks are to be made failure-proof, they must start with huge capital; the RBI would not think of anything less than Rs 300 crore. They would have to have promoters with deep pockets; and since there are not so many of them around, only a handful of new bank licences can be given.
But if the Rajan Committee is right, the fault did not lie with their smallness. Cooperatives failed because they were used only to channel credit from state governments; they came under the control of local politicians who gave themselves loans and forgot to repay. This was, for example, the story of the Maharashtra sugar cooperatives, but it will never be mentioned in any official document because the politicians who ruined the cooperatives were the pillars of the Congress. The record of state-sponsored credit institutions is at least as bad as that of private ones.
The MFI committee wants the MFIs to confine themselves to lending to the deserving poor, and wants to place a ceiling on the interest rates they charge. Both proposals are designed to make MFIs less profitable and therefore more susceptible to failure. Interest rates charged by moneylenders go to very high levels. That is what creates a business opportunity for MFIs. They can charge high rates and still lend more cheaply than moneylenders. But the rates are not high just because moneylenders are crooks and exploit their borrowers. Costs of giving small loans to a large number of borrowers in villages are high; so are the risks. They will affect MFIs as much as they do moneylenders, and MFIs will have to charge high rates if they are to survive and to put something by for expansion. Hence it is a thoroughly bad idea to control their interest rates, or their margins — and it is impossible to control both together, as the committee’s chairman, Yezdi Malegam, a chartered accountant, should know.
More generally, the MFI committee wants to confine MFIs to lending to the deserving poor, and for that purpose, to collect considerable information about their income, their borrowings and so on. One wonders which world the committee is living in. A villager may do some agricultural labour while it is available. She may go and work on some public works if any are going on. She may go to the next town and do some domestic work. The poor find work wherever they can, and travel for it. The MFI committee wants MFIs to pursue the poor and compile a record of how much they are earning, how much they have borrowed and from whom, and so on. It expects the itinerant poor to cooperate with the MFIs and give them all the information from day to day. This is unrealistic; if MFIs keep collecting such detailed information, they will be able to lend to very few.
But then, the MFI committee does not expect them to lend to the poor. It wants every poor person to join a “self-help group”, borrow through it, and repay through it. It wants the MFI to sit in the courtyard of the village council and wait for SHGs to come and transact business; it would prohibit anyone from an MFI to ever go near an individual’s home. It has a closely defined, structured model in view: banks would finance a very small number of MFIs, MFIs would deal only with SHGs, and all SHGs would be attached to and sponsored by the establishment of the village. This would be very convenient for the RBI; it would simply reproduce its current model of bank regulation and extend it to villages.
It seems to me that the Malegam report has been designed to enable the RBI to keep close control of rural credit and to keep its hands clean. It is simply not concerned with creating competition, bringing down the costs of financial services, or taking to villages the variety of financial services that townsmen are used to or with encouraging innovation. As I have said, I have a high opinion of the RBI’s competence. I also think that the government has created too many financial regulators, chiefly to create jobs for its favourite bureaucrats, and that we could do with fewer. But it could not make a bigger mistake than allow the RBI to regulate MFIs; that would be the way to deal rural financial development a death blow. In fact, the RBI’s recent attitudes make me wonder if it has lost the plot. Maybe it should rethink its entire model of regulation.