Kuldip Maity

The government’s decision to demonetize two denominations of high value currency notes and to push forth the idea of a cashless economy since November 8, 2016 is indeed a paradigm shift in India’s economic history. Since the platform for ‘Digital India’ was launched, MFIs have been playing a very important role in taking it forward.

Even though the transition was not easy for MFIs, given that majority of their customers are in rural areas, which have traditionally remained under-served by commercial banks, and almost all transactions were done in cash. MFIs, like VFS, have been working towards implementing a system where cashless transactions are encouraged.

While supporting the significant transition to remain in sync with ‘Digital India’ had its roadblocks, MFIs have adopted ways to disburse loans in a cashless manner, and have even been encouraging similar process for repayment. Digital transaction has also emerged beneficial for MFIs as this helps to mitigate risks and bring down operational costs, by cutting down on the system to handle large volumes of cash every day.

A post-demonetization report from Microfinance Institutions Network (MFIN), the umbrella agency for MFIs in India, found that more than 60 percent of micro-lenders have taken up cashless methods to disburse loans, with more than 39 percent of loans disbursed in the financial year 2016-17 was done digitally. The report found that in 2016-17, while 88 percent of total MFI loan disbursements were electronically, 50 percent repayments were via cheques and 33 percent through electronic transfers.

Based on the understanding that the best possible methods for them to go digital, a large number of MFIs have initiated processes and technology of promoting digital technology in their business. For its own purpose, VFS has developed a mobile app to connect the entire organisation, from the topmost stakeholder to the last person working at last mile connectivity. The internal app was inspired by the vision that the digital process will help achieve a much better form of financial inclusion.

Going digital has not just helped MFIs like VFS to provide seamless and faster dissemination of loan, the process has also helped gain better cost benefits. MFIs are also working on using other transaction models, like Aadhaar-enabled payments, mobile wallets and pre-paid cards. A general belief in the microfinance industry is that with increasing use of digital methods and MFIs actively promoting cashless payments, more than 100 million e-transactions could be seen by 2020.

There remains no doubt whatsoever that MFIs have gone where regular banks do not dare to go. Over the years micro-credit lenders have developed an enviable network that connects much of rural India. Given the circumstances, it seems prudent that this network is used to push the government’s mandate of not just financial inclusion but also a cashless economy.

While the government has taken steps to launch Jan Dhan accounts for every Indian and more than 50 percent of India’s population has a bank account to its name, since 2014, only around 12 percent of these account holders made cashless transactions in the past year, finds a World Bank survey from 2017.

Bappaditya Mukhopadhyay, Professor of Economics & Finance at the Great Lakes Institute of Management, states that the agenda of a cashless economy can only be successful when more and more financial activities are done through these accounts, electronically. While the government already makes digital transfers of its subsidies and other payments, unless other transactions, beyond state-backed payments are made on these accounts, the agenda will not reach its full potential.

This is exactly, where MFIs have a role to play and that the government should properly utilise the vast network non-banking financial entities like VFS have developed over time. And the MFI network can be used as a stable platform to encourage cashless transactions in rural areas. While this will also serve the purpose of attaining widespread financial inclusion, the approach will need to be different Despite the presence of bank accounts, there have hardly been cashless transactions in rural areas. This opens up the space for a mechanism where MFI network can be used to promote cashless transactions and they suggest incentivising micro-lenders for that purpose.

MFIs like VFS have a widespread reach in rural areas and are often sole financiers for entire village communities, where most households, as well as local traders, are their clients. If MFIs are incentivised in lieu of utilising their network, micro-lenders can, in turn, develop and maintain a network of cashless transactions. In order to achieve this, the government can come up with any innovative scheme like providing the MFIs with certain percentage of all cashless transactions in its network.

This will give a major boost to the government’s financial agenda, since more than 200 million households across India are connected to microfinance institutes. The MFI rural network is the perfect platform to promote financial inclusion, once the systems and processes for the incentive programme are in place.

Numbers often speak louder than words and this is probably truer when it comes to figures showing how microfinance encouraged social changes in different parts of India. The North-East, which had often been a forgone region in the country, is among those parts that shown significant benefits due to the presence of MFIs.

Several studies have revealed that MFI loans have helped people from the North-Eastern states to not just enhance their family income and annual savings but also to access a better quality of life.

Keeping in mind that majority of MFI loans have gone to women, the Small Industries Development Bank of India (SIDBI) conducted a survey in 2013, where 99 percent respondents were women. Talking to the surveyors, more than 90 percent respondents agreed that their socio-economic and financial conditions have significantly improved since they associated with an MFI.

Even after the survey factored in inflation rate of 8 percent and discounted the annual income figures of respondents by the same percentage, results showed substantial change in family income over the years between the time of survey and the year they received their first loan. The annual savings of respondents not just showed noteworthy improvement, their annual savings also seemed to have improved. Although the results from the North-East were not as glowing as in other parts of the country, given that the region has seen less development, the figure of 28 percent respondents talking of positive results make it an important change. Respondents from the region said that access to toilet facilities at home has increased from 48 to 61 percent, access to TV sets increased from 57 to 72 percent and mobile phones from 67 to 87 percent. Even access to refrigerators showed an increase from 18 to 23 percent.

Further empowering factors have been improved social stature and increased participation in community activities, 88 percent respondents reporting these as bonuses on both counts. Around 32 percent respondents agreed that initiatives taken with MFI loans have provided their children access to better education, 34 percent received access to better healthcare.

Interestingly, even though respondents from the North-East did not report as high on better education access as in some other parts of the country, they were high up on the list when it came to better healthcare access.

Latest figures available from the Bharat Microfinance Report, compiled by Sa-Dhan, the self-regulatory nodal agency for MFIs in India, reveal that MFIs are growing at a substantial pace and building up a solid credit portfolio. Here, it is important to note that the success of MFIs in realizing loan repayments is often better than that of banks. This is a huge feat when one considers the risk factors involved with MFI lending.

Amounts MFIs offer as loans might be miniscule compared to other loan ticket sizes, but these are disbursed with almost no documentation. MFIs, like VFS, lend out money at a much higher risk, since almost all loans are issued to women from rural areas, with no financial collateral or the safety net of a job. Interestingly, this has not been a road block for MFIs to recover disbursed loans. Traditionally the recovery rate has stayed between 97- 100%.

Even though MFIs lend money at a higher interest rates, the associated risks need to be considered and the success of micro-credit needs to be judged based on these parameters. In fact, MFI interest rates are higher because their operating costs are different from those of banks and the last mile penetration is in areas which are highly inaccessible.

Alex Artiach Sounssi, research scholar with University of Exeter in the UK, who studied the microfinance phenomenon in India and elsewhere, observed that MFIs will never be able to match interest rates of banks because lowering rates will make it almost impossible for micro-lenders to recover costs and might even force them to withdraw from the market. This view has been supported by many experts, who believe that this will cut off the present clientele of MFIs from any access to financial services and might even force them to enter a vicious cycle controlled by money-lenders, which has traditionally proven to be a serious socio-economic issue in India.

Sounssi noted that it is imperative for MFIs to cap defaults in repayment at less than 2 percent globally, which, however, in the case of developing countries like India, may be within 10 percent, keeping inflation in mind.

While it might seem strange that MFIs charge higher interest rates, that too, from people without much financial stability, empirical data reveals that MFI clients have better satisfaction and repayment record. In fact, across the globe, low-income clients are not only honouring their debts but are also returning for more loans.