Feature Article of Wednesday, 28 March 2012
Columnist: Acquah, Prosper Kwesi
A Case of Microfinance Institutions
As stated in an earlier article on Ghana’s MASLOC (Microfinance and Small Loan Center), microfinance is “A type of banking service that is provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. Ultimately, the goal of microfinance is to give low income people an opportunity to become self-sufficient by providing a means of saving money, borrowing money and insurance”.
Until recently, the microfinance industry in Ghana has been very informal, unregulated and an industry that can safely be described as free for all – a paradise for “loan sharks”. In July of 2011, the Bank of Ghana, the regulator, came out with operating rules and guidelines for microfinance institutions as a genesis to the regulation of the industry. This document appropriately touched on categorization of the various microfinance institutions (MFIs) in the country and mandated capitalization requirement for each category of MFI. Much as the document has outlined a framework for the industry, it does not go far enough as a regulatory document. The Ghana Association of Microfinance Companies (GAMC) estimates that there are over3000 MFIs currently operating in Ghana with only over 300 of them applying for licensure. The number of MFIs alone points to the fact that the potential for abuse is real and enormous. It is therefore crucial that the regulators acquaint themselves with the operations of these MFIs, the abuses and potential abuses in order to pro-actively regulate the industry effectively before there is any crisis.
If microfinance is aimed at providing financial services and means of livelihood to the unbanked poor and unemployed, then much needs to be done if we are to achieve those aims. If regular commercial (universal) banks in Ghana are charging annual interest rates of between 15% and 30%, it is baffling to know that microfinance companies charge interest rates of between 24% and as high as 240% per annum (2% to 20% per month ). How can people at the bottom of the economic pyramid borrow money at these insanely high interest rates? What businesses do they engage in to make enough profits to pay off the principals and interests on these loans and still earn their daily bread? The Efficient Market Hypothesis (EMH) makes us understand that if such opportunities exist for these lower income people to achieve returns in excess of the kind of interest rates being charged to them by the MFIs those opportunities will not continue to exist for long. Business people and Big Businesses would rush in to take advantage of those opportunities as well if those opportunities really existed. As a result those opportunities will not continue to exist after a short period of time. The truth is that there are practically no opportunities for lower income people and the unemployed to achieve returns in excess of the 240% p.a. being charged by some MFIs.
Microfinance has become a high margin business and not the pro-poor poverty reduction venture that Mohammad Yunus and other pioneers envisioned it to be. All sorts of people including foreigners, NGOs, business organizations and commercial banks are rushing into the microfinance industry to milk the poor before the milk runs dry. Many of those rushing to setup microfinance companies view microfinance as an investment opportunity, with poverty reduction as a secondary goal or not even a goal at all. The microfinance ‘gold rush’ must be watched carefully because the current rate of growth is not sustainable.
International Financial Institutions (IFI) such as BNP Paribas, Deutsche Bank and Citigroup have invested in the microfinance space. These IFIs consider themselves as pioneers in the microfinance industry where they typically provide funding to MFIs in over 50 countries across the world. These banks claim they invest in the industry as their Corporate Social Responsibility (CSR) – great idea in theory. The truth however is that the returns they get from funding MFIs are very juicy, better than returns on most investments in the last five years or so. In a document titled “Microfinance: An emerging investment opportunity; Uniting social investment and financial returns” Deutsche Bank indicated that the RoE (return on equity) from investing in MFIs is higher than that from conventional banks. It is therefore not surprising that Deutsche Bank forecasts that by 2015, 80% of investors in the microfinance industry will be institutional investor with total investment in industry reaching USD 25 billion.
Source: Microfinance: An emerging investment opportunity; Uniting social investment and financial returns by DB
As soon as these funds are disbursed to the MFIs, the IFIs have no control over what interest rates the MFIs charge to the poor and unemployed. This is supported by Deutsche Bank’s claim on its website that it has stopped funding MFIs in India because of the over commercialization of microcredit in that country. This same argument can be made for international NGOs and philanthropies that fund NGOs in the microfinance industry. Their noble intentions to help the poor and unemployed in developing countries are not realized because in many cases the organizations that end up disbursing the funds to the people end up exploiting these poor people and plunging them deeper into poverty.
What is most worrying in Ghana is that the so called Financial NGOs (FNGOs) are equally guilty of these exorbitant interest rates being charged to the poor. Many of these FNGOs get their funding either in the form of grants or concessionary loans at relatively low interest rate (LIBOR + a margin) from international NGOs and the international capital markets. It is worth noting that for the past two years (since January 2010) the 1 Year LIBOR has not exceeded 1.3%, hence it is safe to assume that the cost of funds to these FNGOs has been less than 7% p.a. during the same period. How then can some of these FNGOs charge as high as 48% p.a. interest rates? Are they not supposed to be nonprofit organizations? If it is possible for MASLOC to charge 24% p.a., and The Hunger Project to charge 20% p.a., shouldn’t it be possible for all FNGOs to charge the same or even lower interest rates? I believe by virtue of these organizations being “nonprofit”, they are exempt from paying taxes. Must they continue to be exempt from paying taxes?
The assertion by MFIs that they have higher cost of operation than the commercial banks cannot and should not justify the level of interest rates they charge. Who is watching out for the poor? Are the regulators not watching? Shouldn’t these FNGOs be filing and paying taxes on the profits they make? Do we care? Should we care about what is going on in the microfinance industry? Is it safe to assume that the rather ‘criminal’ interest rates being charge by some of these FNGOs are used to pay the fat salaries of their expatriate staff and local executives? Are the parent organizations and the funding agencies aware of the level of interest charged by these FNGOs? Why is it that many FNGOs I contacted refused to declare their prevailing interest rates? What are they hiding? It is time to name and shame all the FNGOs and other MFIs who are loan sharking the poor.
In my view, apart from the immoral acts of some of these MFIs which is plunging many poor people deeper into poverty, we should be concerned as a nation. The current financial crisis being experienced in the world resulted from irresponsible behaviors of lenders, mortgage brokers and regulators. Brokers found ways to give mortgages to people who in all reality couldn’t afford to services those mortgages over the long term; lenders/banks were happy because they were financing loans in large numbers with the prospects of earning good interest income in the long term; the regulators and credit rating agencies were seemingly oblivious to what was going on only to wake up after the harm had been done. This situation is not any different from what is going on in the microfinance industry in Ghana today. Borrowers are happy because they have relatively easier access to loans regardless of the interest rates; MFIs are happy because they are getting ridiculously high interest revenues and the regulators have been mostly asleep because there hasn’t been a major problem in the industry yet. Some universal banks in the country have also joined in the microfinance bandwagon whereas some others may be struggling with the decision to join.
My prediction for the microfinance industry is that, if regulators do not take pre-emptive steps to bring sanity to the situation going on currently, there will be a crush, a crisis in the future. The question is not if there would be crisis in the industry but rather when the crisis will hit? Unfortunately, when there is a meltdown in the microfinance industry it will affect the entire Ghanaian economy particularly the financial services sector. This is because currently, many commercial/private MFIs take loans from local financial institutions to onward lend to their clients. Hence any meltdown in the microfinance industry will have a direct impact on the banks and other financial services institutions. Also when there is a meltdown in the microfinance industry in Ghana, it will dampen confidence in the entire financial system which will lead to a higher cost of borrowing for other players in the sector, particularly the universal banks. The 2010 microfinance crisis in Andhra Pradesh, India should serve a big lesson to MFIs and regulators. In Andhra Pradesh, millions of borrowers refused to pay back, in part because they owed more than they could realistically pay. When people owe more than they can pay, the only option they are left with normally is to walk away from the loans. In the case of micro-loans, the cost of collection and legal action tend to be more than the amount owed. Besides, there is a moral argument to be made as to whether it is morally prudent to take for instance a “wakye” seller who owes GH? 500 to court for nonpayment of their loans.
The point I am making is that the Bank of Ghana or whoever is in charge must critically regulate the microfinance industry to save us all from a potential future economic meltdown. I propose that regulators impose a ceiling on the interest rates that can be charged by MFIs. The ceiling can be based on a formula that factors in the government monetary policy rate as one of the main variables. It must be noted that the idea of setting an interest rate ceiling is not a new one. The West African Economic and Monetary Union (WAEMU) had in the past proposed 27% p.a. interest rate for MFIs. We must seriously consider adopting some type of ceiling.
I also propose that any consumer protection bill that is put together must include a special protection for consumers of the products of MFIs. The so called FNGOs must be looked at and be made to pay taxes. FNGOs must be made to report their sources and cost of funds quarterly. All MFIs should be made to report their interest rates and all fees to the regulator quarterly. Transparency is key to regulation and self regulation should not be relied upon. One thing is certain; armchair regulation will not work for MFIs. The regulator needs to gear up; recruit more people if need be, to effectively regulate the industry.
The universal banks and other players in the financial services industry must take it upon themselves and advocate for a more stringent regulation of the microfinance industry, else the proverbial ‘bad nuts will spoil the bunch’. The Bank of Ghana and the universal banks must do some introspection and come out with a position statement as to whether it is prudent for universal banks to own and operate microfinance subsidiaries?
So, who cares for the poor? In other words who should care for the poor? The simple answer is that we should all care for the poor. The destiny of the poor is tightly linked to the destiny of the rich and the destinies of all of us. We as a people should not exploit the poor or look on unconcern while the poor are being exploited by a few greedy people and institutions. Exploitation of the poor is the exploitation of everyone else.
By Prosper Kwesi Acquah
Business & Financial Analyst
Member, Volta Advocacy Forum