The Sri Lankan economy benefits tremendously from its Microfinance sector which fulfills the financial needs of the country’s low income segments in a secure and convenient manner. Amongst many evidence available such as various research findings, thousands of successful entrepreneurs emerging and growing through microfinance, the figure bellow exhibits how the poverty level of the microfinance clients are reduced when microfinance clients move from one loans cycle to the next.
As the industry dedicated for helping low income people to move out of poverty towards prosperity, microfinance industry welcomes the government’s efforts to revise the present loan interest rates downward to the benefit of the borrowers, and support development of micro enterprises. However, there are number of practical difficulties for MFIs in achieving this objective and therefore, as the President of the representative body of Microfinance Practioners in Sri Lanka, it is my obligation to bring to the spotlight some of the challenges facing the industry at present especially in the post-pandemic context where many financial institutions have come under pressure to be ‘flexible’ with clients who are, understandably, affected by the economic downturn owing to complete lockdown of country & economy fortwo to three months.
MFIs provide loans to micro enterprises whosefinancial requirements are low by amount. The average loan size provided by MFIs is about Rs. 50,000. Despite loan amounts being relatively small, cost to service the same is often relatively higher when compared with commercial banks/finance companies which provide large loans.
The cost of funds of the MFIs is also high. They pay market rates of interest when borrowing from banks or international lenders. As such, almost 17% of the interest income of MFI is spent for paying interest cost of borrowed funds. These MFIs are highly geared having an average of 50% equity funds for which only 2% of the interest income is given as return through MFI’s profit which is highly inadequate. Therefore, making arrangements for assuring low cost funds for MFIs would result in lowering the end borrower interest rates.MFIs are not allowed to take public deposits and therefore, current drop in deposit rates in the market has no much help for MFIs.
The initiative by the Secretory to the HE President together with Government banks and LMFPA will contribute in achieving government’s objectives to reduced loan interest rates.In most of the countries in South Asia, there is a government managed fund contributed by international Agencies such as the World Bank and ADB for on lending to MFIs at low cost. Sri Lanka also had National Development Trust Fund (NDTF) in the past lending at 7% interest rate to MFIs which on lend to end borrowers at 15%. As this fund is still available with the Sri Lanka Savings Bank same type of low cost funding could be arranged to MFIs which could be provided as low interest loans to end borrowers.
The above figures also show that 10% of the interest income of the MFIs is paid to the Government as taxes by MFIs. The taxes applicable for MFIs are also same as for banks and other financial institutions (Cooperate TAX at 24% and FVAT at 15%). Financial VAT (FVAT) has to be paid irrespective of whether a MFI makes a profit or not. The tax on profits has also to be paid irrespective of profits are made or not due to large portion of disallowable expenses but it is not as burdensome as FVAT. Many countries in South Asia has concessionary tax arrangements for MFIs where it is 0% in Bangladesh. Therefore, removal of FVAT for MFIs and reducing cooperate income tax rate would significantly bring the benefits to majority of low income people while the impact on Government income would not be significantly effected as the turnover and profits of microfinance industry is much lower and insignificant.
Another factor that compels higher interest rate is the risk involved in the microfinance loans. At present the country’s Average Risk Ratio measure PAR (30 days) of Microfinance Sector stands at 41% high from 1-2% in 2018; the dramatic change is resultant of Government’s ad hoc decision in 2018 to write off loans in 12 districts subject to certain criteria.
This led to not just the entitled borrowers but many others defaulting their loans willfully causing Microfinance Sector to suffer severely while the credit culture nurtured through decades of service to the poor was damaged.
The microfinance sector again suffered last year during the turbulent period following the Easter Sunday Attack. Due to the impact of the bomb attack on business, many borrowers were unable to pay their loans compelling the MFIs to forego their incomes.In 2020, Covid-19 pandemic which brought the entire country and the world into a standstill had its toll on MFIs too.
The losses had to be absorbed by MFIs. Almost 13% of the interest income had to be allocatedas provisions for the loans losses in 2019 which is now further increased due to the impact of the pandemic. We believe few years will take MFIs to recover from this loss and reestablish a reduced cost structure for loan losses.
MFIs typically lend to rural, low income customers – the very purpose of these loans is to provide them easy access to credit as livelihood support as well as for their other financial needs. Owing to this, Microfinance sector has a mutual guarantee system in contrast to needing collaterals or high-income-earning guarantors as in Commercial Banks and other Financial Institutions. Besides offering rural households the necessary funds this exercise of vouching for one another also serves to build up social capital in communities.
One of the main reasons why MFIs cannot afford to slash interest rates willy-nilly is because the companies absorb high service& operational costs. In the typical scenario MFIs reach out to the customers to lend as well as for recoveringtheir loans, providing financial services at door step of the poor. Door to door services reduces the costs to the borrower in transacting their loans. For providing such service, the MFIs have to develop especially skilled set of employees. Human resource and administration costsof a MFI is therefore rises close to 58% while the same cost in banks is around 27%. One should understand that those rural people have to spend a day out of their work if they come to the town to pay a loan installment which is a net savings to microfinance clients due to door step service of MFIs.
However, MFIs also has to be more innovative to cut down their costs by being innovative and increased use of technology etc without taking much time for adaptation in order to contribute in reducing on lending interest rates. It is noteworthy to mention hear that MFIs has created over 22,000 employments opportunities contributing to the employment generation in the country.
If microfinance institutions are to bring down their interest rates, the State will have to intervene to relieve MFIs of the colossal tax burden. Additionally, MFIs can tremendously benefit from low-cost funding and technical assistance ideally from international donor organizations like ADB or JICA. Aggressive pursuing of such possibilities will serve to invigorate the economy by empowering the middle & low income segments especially at this juncture.
Further regulating the lending ecosystem of the country is another area that must be looked into with sense of urgency. We have met some customers, who, had resorted to borrowing from theinformal sector at 220% interest rate partly due to their poor financial illiteracy and desperation. In recent times, a breed of lenders in the market with ‘microfinance’ branding who are who are no different to traditional money lender apart from their appearance and approaches are immerged.
If MFIs find it difficult to operate due to unbearable interest income loss it paves the way to such illicit money lenders to exploit the poor and low income people at their will.
