Since the demonetization in November 2016, at-risk portfolios have steadily increased. These increases have presented a number of problems for microfinance institutions that serve the informal cash economy.
In November 2016, the Indian government declared that 500 and 1000 rupee notes would no longer be acceptable legal tender. The demonetization was meant to curb illicit activity and pull funds from the shadow economy, but its ramifications went much farther. Those who had relatively easy access to banks were able to turn their notes in for legal tender or deposit their cash in bank account, sometimes standing in line for hours. For those who did not have easy access to banking, however, long lines were the least of their worries.
The rural poor in India operate in cash. With 86 percent of the country’s cash suddenly illegal, micro-businesses were hit hard. The institutions that support these micro-businesses, microfinance lending institutions, began to falter alongside their clients.
The Indian microfinance sector is a strong example of successful financial inclusion. In 2010, when SKS Microfinance went public, the company attracted more interest than expected and was oversubscribed 13-fold. Though the industry has had its ups and downs since then, by 2016 microfinance in India was valued at 8.2 billion and serving 40 million people. The industry also boasted a high number of female clients – between 70 and 80 percent – and a 95 percent repayment rate.
Since the demonetization, at-risk portfolios have steadily increased. These increases present possibly cataclysmic problems for some financial institutions, microfinance institutions included. In September 2016, only 1.32 percent of holdings were considered at-risk. By February 2017 that number had jumped to 23.69 percent. Microfinance borrowers operate in cash. They receive compensation in cash, borrow in cash and they pay their loans back in cash. The cash shortage that accompanied the 2016 demonetization impacted their ability to pay their debts (see related post The impact of Demonetization on Microfinance Borrowers). In turn, this impacted the viability of the entire industry.
Dwindling collection rates are at the heart of this rise in at-risk portfolios. Some microfinance institutions saw their repayment rate drop to 10 or 20 percent in the weeks following demonetization. Though levels have recovered somewhat, they have not returned to pre-demonetization levels.
Low collection rates were also fueled by misunderstanding and misguided local activism. Rumors about debt forgiveness and altered policies of repayment spread like wildfire. Local activists took to the streets against repayment schemes. Amidst the confusion of demonetization, it was easy for borrowers to believe that changes had also been made to the structure of microfinance lending institutions.
In some areas, local politicians further confused matters by asking customers to delay or stop payments to their microfinance lenders. On aggregate, this advice leads to higher interest rates and creates problems for the entire organization, including other borrowers. The only way to combat this issue is through proper communication with customers and the political class. Politicians, as well as borrowers, need to be informed about microfinance policies, regulations, and limitations.
One of the benefits often cited of India’s demonetization policy is a move into mobile banking. Indeed, mobile transactions have increased by 33 percent since the policy was announced. The merits and problems associated with mobile money have been discussed ad nauseam and both sides make good points. That said, microfinance borrowers tend to be older (see Microfinance Borrower Profiles) and less comfortable with technology. It is not uncommon for rural people forced into mobile banking to simply hand their phones and passcodes to vendors instead of using the technology themselves. Until we can solve the technical and educational problems associated with mobile banking, abruptly pressing its usage among this group can have unfortunate short term ramifications.
Despite these challenges, microfinance in India is moving forward. Madura Microfinance, for example, is uses both Training & Socio-Political survey to understand and tackle the miscommunication surrounding issues like debt and repayment. Microfinance institutions are social organizations working for the benefit of society at large and it is to the benefit of all that this role is maintained and properly explained. Identifying how demonetization has impacted our customers, and helping them to navigate the new financial climate is paramount to microfinance success.