Al Khair – An interest free microfinance experiment in India
By Tameemuddin Humble
(Mr Tameemuddin Humble is the Secretary of Muslim Empowerment Forum in Gaya, Bihar and can be contacted at tameemhumble(at the rate) Gmail (dot) com ).
AL-Khair Co-operative Credit Society Limited: An Experiment of Interest-Free Microfinance in India
The people need a diverse range of financial services to build assets, meet consumption and protect themselves against risks. The poor need the credit even to meet their basic life-cycle events such as birth, marriage, old age. That is why financial credit is being treated as a human right these days. There are over three billion people living on less than $1 a day and need access to financial services all over the world.
Poor need savings much
The majority of the people are too poor to save for their basic needs. We have to save to avoid “living from hand to mouth”. We regularly face many of life’s worse challenges and live in instability, insecurity, often despair of work and income. The poor obviously are much needy and incapable to meet their objectives as non-poor: health, education, shelter, food, clean water, clothing, child care, old people’s care, safety, transport, stability, to be able to organize their lives and that of their loved ones. This means obviously that they need to be more careful with the little money they depend on for day-to-day life; that they need to plan more and manage better their finance than non-poor people have to.
Informal or semi-formal ways of setting aside money have drawbacks that frustrate the specific financial planning by the poor. Firstly cash money is always at risk in an informal, unstable, insecure, poor environment. There are no controls, no legal address when money goes missing, no real insurance, no regular security control, no safe transport, in an environment where many people need money urgently for life’s basic needs. We need a financial institution legally viable to serve all these purposes. When poor people do not save for a purpose with financial professionals, they will never structurally improve their money management. Hence we find “Al-Khair Co-operative Credit Society Limited” playing an important role especially among the poor promoting saving habit as well as collecting excess liquidity or surplus from the affluent to lend it to the poor people at the low service charge for the last nine years through its five branches mainly in Bihar. The society has recently opened its new branch in Lucknow (U.P.) on 7th December.
Almost 70% of the population in the country doesn’t get benefit from the formal financial services (commercial banks) extended by the government due to unable to fulfill the requirements of those institutions. They mostly do good things for people who can access their services according to their formalities. If anybody happens to lack title to the property, a credit history, or Govt. identification, as most of the poor do, banks are little more than sets of closed doors.
Commercial Banks (CBs)
Commercial Banks (CBs) are like star hotels serving only the affluent class. One who is unable to pay the bill of that star hotels could not sit on the table of that restaurant or hotel. The poor need services according to their affordability. They will have to avail of their services whatever they want from any other simple hotel according to their paying capacity. If the Government makes regulations for star hotels to serve them also then those hotels would open counters at the backside so that both types of customers affluent as well as the low paying could not mix. Obviously the backside counter of that hotel would not welcome the customers in a way the hotel used to welcome at the main counter of that star hotel. Hence the self-respect of the low paying customers can be hurt and they may not want to be served and will not be served by the star hotels. In the same way, the Commercial Banks (CBs) are not serving or could not serve the poor people because of unable in providing savings or deposits in banks according to the CBs’ offerings. Thus the vast majority of the Indian population remains unbanked. The present banking system in India hardly serves 40% (optimistically) of the population, excluding the 60% to participate in the development process of the country meaning thereby almost 65 crore Indians or 14 crore families are unbanked. The credit need of these underprivileged 14 crore families in India is estimated to be Rs. 4, 35,000 crores consisting of consumption and enterprise loans.
That is why Reserve Bank of India Governor D. Subbarao urges bankers to meet the four formidable challenges before CBs: deepening financial inclusion, financing infrastructure, strengthening risk management and improving efficiency. “Commercial banking in India has not penetrated sufficiently to serve the large mass of rural, illiterate and poor people in any meaningful way,” the RBI Governor is saying repeatedly. The intermediation cost in India is still high, largely due to high operating costs, says, Dr. Subbarao. He told the financial institutions in India to reduce the costs and pass on the benefits to both depositors and lenders.
Micro-Finance Institutions (MFIs)
Here we see the role of Micro-finance Institutions (MFIs) in India due to its low operating cost and collateral-free approach. They have gained much importance in the financial inclusion policy of GOI as well as promoting the habit of saving among the poor besides providing credit to them. Two decades ago, the only options for accessing credit and savings services were informal networks and local moneylenders which had been charging interest rates ranging from 36% to 120% in various parts of the country. That all changed with the invention of microfinance — a pro-poor social innovation that has provided access to financial services to millions of people thought to be “unbankable.” It has soared in India in the past few years. It reaches an estimated 70 to 80 million people in India today compared with around 200 million by the CBs. Microfinance is growing faster than banking and, if the experience in other developing countries is mirrored here, microfinance will reach more individuals than the banking sector because of 70% the population in India lives at such a low level which cannot meet the offerings of CBs.
Micro-finance has come on the horizon of the financial sector in India as a breakthrough in the philosophy and practices of poverty eradication, economic empowerment and inclusive growth two decades ago. It was expected that microfinance can help the poor to increase income, build a viable business and reduce their vulnerability to external shocks.
But the corporatization of microfinance has made this sector from boon to curse. Though this sector helped almost 8 crore families in saving Rs.6198.71/ crore as on 31st March 2010. The loans disbursed to them through MFIs during 2009-10 amounts to Rs.14453.30/ crore.
But the lending practices of MFIs have triggered a crisis in India’s $7 billion microfinance sector (now industry) and cast a shadow over the strategy of using tiny loans as a solution to poverty. For the last few years, in fact, MFIs started to “dump loans” on the poor by not even verifying their capacity to repay. And many of these loans go on consumption rather than genuine investments – that just leads to a “debt trap”. Most of the borrowers of some areas in south India particularly of A.P. don’t even know which organizations they borrowed from. They name these companies after they give collections. MFI leaders now acknowledge this as the problem of multiple lending which could be the main reason behind some cases of suicides in Andhra Pradesh.
This problem has started because of a large number of institutions entered the sector, getting the benefit of the “priority sector”, and their capitalization through CBs which led to multiple-lending – too many institutions lending to a single client forcibly. And then MFI workers forced their clients to sell their wedding ornaments so that they could repay their loans. Activists and government officials have blamed the combination of MFI multiple loans and aggressive debt collection tactics for scores of suicides in Andhra Pradesh. Al-Khair’s deposit service not only provides a source of funds to its portfolio but also helps to round out their relationship with clients and reduces the risk of coercive collection behavior by its collectors.
Sources of Fund
Generally, MFIs raise 75-80% of their funds from CBs, 15% from equity and another 10% from other sources like cash securities. Interest rates charged by MFIs vary between18% to 32%. Indian MFIs have raised more than $450 million across 66 deals from private equity investors since 2006.
An analysis of the profits reported by 13 major non-banking finance companies (NBFC) engaged in microfinance has revealed that the profits these firms accumulated through their earnings from interest on loans swelled from Rs 677.3 crore in 2007-08 to Rs 3776.93 crore in 2009-10. In other words, their profits multiplied by 5.5 times over a period of two years.
The controversy over the Microfinance Sector in India
These days Microfinance sector in India is being discussed much in national media since SKS Microfinance, one of the world’s largest microfinance institutions which work in 100,000 villages and has 7.8 million borrowers, made an IPO on July 28, 2010, and raised an estimated Rs.16000 crore in the stock offering. With this step of SKS MF, the corporatization of the MF sector in India takes its final shape.
If the lending becomes a for-profit business, we would end up with the same situation Microfinance was created to stop, that of loan sharking. And that could bring down all the good works of Microfinance. The big question now arises before the MF sector in India–are these MFIs really focusing on the poorest of the poor and with all the profits of the commercial models?
Al-Khair Co-operative Credit Society limited analyzes this situation and diagnoses as unnatural developments in the microfinance sector took place. Lending was meant to the poorest of the poor in the MF sector but now the sector is much concerned about “profit from poor” than poverty alleviation, focusing on capital cycling quickly through loaning only to the commercial clients which generate more cash for the lender. They don’t take a risk in start-ups and finance those ventures which are growing. Earlier MFIs were meant to provide seed capital to the poor to start their income-generating activities. MFIs made loans collateralized and borrowers are seen in terms of return on investment. Instead of providing business training, they seize collateral from defaulters.
Al-Khair Co-operative Credit Society Limited
Al-Khair lends money at low service charge i.e., without interest. It charges Rs.35/, Rs. 730/ and Rs. 1670/ for the loans of Rs. 1000/, 10000/ and Rs. 20,000/ respectively. The rate of service charge does go up for the higher amounts but not more than from 3.5% to 8% on average because Al-Khair levies service charge once even if the time period of borrowing goes beyond one year or whatever. MFIs generally charge interest rates from 24 to 32% in India. SKS MF charges 24%, reducing 2% from earlier 26.7%, after controversy over its collection method and extended its repayment period from 50 weeks to 51 weeks. The earlier percentage break-up of its 26.7% charge was—the cost of funds from CBs 8.5%, salaries 5.4%, administrative cost 3.4%, loan loss provisioning 1.5%, corporate tax 2.8% and profit/investment for expansion 5.1%. The reason of Al-Khair’s low service charge is nothing but its avoidance of commercial borrowings and hence it has nothing to pay in the name of interest and tax. Al-Khair is moderate not only in taking charges on loans but also while lending it sees self-discipline in savings rather than collateral.
Al-Khair feels that suddenly we cannot provide credit to every person on earth but MFIs in India in order to do this they began to access the formal capital markets which are driven solely by financial incentives.
India’s microfinance sector has about $7 billion worth of loans outstanding, with almost $6 billion of that borrowed from banks and now at least 40 banks lend to MFIs. It is because of the conveniences of Indian banks to meet “priority sector lending” targets set by the government. Billions poured into the sector. They borrow from banks at 8-14 percent, but the cost of administering the loans, provisions for bad debts and other costs add another 10-12 percentage points. Amid the crisis in Andhra Pradesh, India’s MFIs have cut their interest rates from about 27 percent to 24 percent but say that is as low as they can go.
Recently in a press conference in Kolkata RBI Governor D. Subbarao said regarding the capping of the interest rate charged by MFIs that there should be some method of bringing MFIs under some sort of discipline. RBI Governor said that any action would only be taken after the Malegam sub-committee on MFIs submits its report in January. RBI constituted a sub-committee to study the Microfinance sector and recommend ways and means on two issues, financial inclusion and social regulation.
Basically there are three areas of MF sector in India that are being questioned upon by the activists and Govt. officials—the rate of interest, lending practices and coercive recovery methods.
Prof. Yunus, the founder of Grameen Bank and father of Microfinance, says, we all have both selfless and selfish parts of ourselves. The selfish part can go and make profits in so many sectors, building businesses, supporting entrepreneurs that are all wonderful. But the selfless part, Dr. Yunus asserts, that is the part that can interact with Microfinance in a way that demonstrates a huge social impact. With this very part, selfless, Al-Khair entered in the MF sector in 2002 and began to serve the neglected populace of Phulwarisharif, a ghetto of Patna in Bihar.
Al-Khair a Boon in India
The term Al-Khair is an Arabic word which means “boon” and true to its name, it has become now a boon to every poor irrespective of caste, creed or religion. It has a membership of 3503 persons comprising 15% female and 43% Hindus as on 31st Oct.2010.
Interest-Free Microfinance as such is not being operated in India but the restrictions in interest-free financial offerings could be circumvented by non-banking financial companies, charitable societies, trusts and co-operative societies. That is why the Al-Khair Co-operative Credit Society got itself registered under the Multi-state Cooperative Society Act.2002 in 2002 and added interest-free products to its repertoire with permission to operate in four states—Bihar, Jharkhand, U.P. and Delhi.
Now the Al-Khair society has Rs. 16, 42,130/-as paid-up share capital with a membership of 3503. The average monthly disbursement and recovery of loans by the society are Rs. 7, 91,676/-and Rs. 7, 20,306/- respectively showing 92.46% recovery rate. The society has total deposit and loan disbursement of Rs.70,749,434/ and Rs.4,95,78,290/ crores respectively till 30th Sep. 2010 through total account holders numbering 7312. At Al-Khair contribution of deposit in loaning is almost 70%. It is close to the portfolio allocation level of the MIX international median of 76.8%. Though the society has been working for the last 8 years, the figures are very humble. But the environment and interest-free practices without seeking capital support from CBs or any other Government financial institution make Al-Khair a unique financial institution in India. Now the financial transaction of the society is being done on its own software.
The society developed interest-free products for its operations. During 8 years of its operations, Al-Khair society has never faced liquidity problems because of its strong liquidity management though it handles both compulsory as well as voluntary savings of clients. Savings could not be a sufficient source of funds for an MFI if any MFI wants to have a large programme and to expand. That is why we find still there are few no. of branches. To keep low operating cost and grow in a natural way keeping the pace of the economic growth of that operated area, Al-Khair manages its savings with utmost care. Without commercial borrowings, Al-Khair has been providing credits to thousands of clients. Therefore Al-Khair gives a very high priority to Liquidity management. Failure in meeting the liquidity and not refunding the savings of even a few clients can jeopardize the reputation of the MFI resulting in problems spiraling into an uncontrollable situation.
Before opening a branch Al-Khair studies the livelihood conditions of the area. The goal is to make sure the practicability of its products.
There are three popular loan products—Demand Loan, Morabaha Loan and Short Term Business Loan(STBL) whose minimum and maximum limits are Rs. 1000/ to 20,000/, Rs. 1000/ to 40,000/ and Rs. 1000/ to 20,000/ respectively. To its sustenance Al-Khair involves itself in income-generating products.
Under the Murabaha loan, Al-Khair buys goods from a dealer and sells on installments to the clients at a fixed mark-up 8-15%. There is also an investment product—Growth Fund, based on the principle of sharing the profits at the ratio of 70:30. 70% Al-Khair gives to the investor. Last year there was a 24% return on the investment. In STBL the profit is shared on a pre-determined basis i.e., 70:30 ratio. 70% of the profit goes to the businessman and 30% to Al-Khair. The most attractive feature of the loaning of Al-Khair is that the loss arises from the business is borne entirely by the society.
Through its products, Al-Khair society has been helping in the financial inclusion of the excluded lot in India with interest-free products since the year 2002. Al-Khair is a pioneer in interest-free microfinance services in India.
Interest-based MF sector in India is in crisis
Interest-based and now corporatized Micro-Finance sector in India is today at crossroads. Either it has to go back to its original policy of poverty eradication through financial inclusion or face collapse in competing with corporates. Vijay Mahajan, president of MFIs Network, said Commercial Bank loans to the sector were drying up and borrowers were refusing to pay. “We are facing collapse”, Mr. Mahajan thinks. Vikram Akula, founder and chairman of SKS Microfinance, also warns that if India’s crisis is not navigated successfully, it will have a chilling effect on the sector around the world. SKS’s listing “broke the dam” of public patience towards India’s commercialized microfinance sector.
If Govt. waives Rs.30,000/crore in outstanding loans of 3 crore clients of MFIs considering suicides of borrowers in A.P. like farmers who had been waived of Rs. 72,000/crore, political pundits may demand it to grab the votes of Aam Aadmi or borrowers, then the present crisis can result in a decline in capital available for MFIs and the repayment rate, thereby slowing down its increasingly significant effect on financial inclusion; at worst it could destroy microfinance altogether, resulting in throwing low-income families back into the arms of moneylenders.
The model of Interest-Free Microfinance which is being practiced by the only institute in India—Al-Khair Cooperative Credit Society Limited could be the only hope for 70% of the population that is thought to be financially excluded and also which holds out the tantalizing prospect for the interest-free MF market with tremendous growth prospects as well as bringing them to the fold of economic growth.
(Mr. Tameemuddin Humble is the Secretary of Muslim Empowerment Forum in Gaya, Bihar and can be contacted at tameemhumble (at the rate) Gmail (dot) com )