The State of the Sector: A Discussion with Prabhu Ghate
By Rati Tripathi | Rati is a research associate at the CMF. She coordinates CMF's field experiments on credit product design and impact evaluations as well as research studies on microfinance sector wide and policy issues.

Prabhu Ghate is an independent researcher, journalist, and consultant. He was in the Indian Administrative Service (IAS) in Uttar Pradesh, and a Senior Economist at the Asian Development Bank (ADB) where he authored Informal Finance: Some Findings from Asia. He has a PhD in public policy from Princeton University.

Q: You have worked on the issue of informal finance for many years with the ADB. Many people think "MFI" is just a fancy name for a moneylender. What is your view regarding the relative positioning of the MFI and the moneylender?
A: It is very unfair to regard MFIs as moneylenders for two main reasons. For one thing, they offer credit at much better terms. Secondly, there are very good reasons why many MFIs pick a credit minimalist approach. Doing finance is a full time complicated job and there is a lot to be said about just doing that well and letting others do other stuff (and in no way am I implying that finance is the only thing needed).

Q: Do you think that MFIs should become a permanent part of our landscape or should we really be concentrating on strengthening our existing formal financial channels—regional rural banks (RRB), cooperatives, public sector banks? What changes would be required in formal channels to make them cater to the poor?
A: MFIs are to be seen as the last mile—the connecting link to the rest of the financial sector. They've developed technology that banks do not have. If banks get into the business of organising groups and all, they won't be able to do it effectively. The private banks are not doing direct microfinance. Banks are doing bulk financing of MFIs and doing the Partnership Model but no bank is doing direct retail finance. They are not retailing microfinance because of the Prime Lending Rate restrictions (on small loans less than Rs.2 lakh in value). The way they get around it in the ICICI Partnership model is that the interest rates on the lending contracts which is in fact below the PLR is not the final interest rate charged to the borrower. The MFI keeps the difference to cover its own costs. If the PLR restriction were removed and if public opinion could countenance the banks charging cost recovery rates, then they could easily make 20% rate loans and pay service fees to the MFI out of that. Until then I see NBFC and NGO-MFI always being around.

Q: You spent seven months last year working on the state of the sector report for CARE INDIA for which you traveled around the country taking a pulse of the people and work on the ground. What was your take home from that whole process?
A: It was a tremendously satisfying experience and a continuous learning process for me. I was very inspired by action on the ground. Despite all the problems and shortcomings, here was something very very good happening because of civil society. Microfinance is a civil society movement, and a development movement, and a financial movement in that order. It was very encouraging to see so many people coming together from all different backgrounds. In a broader sense—and to borrow a term from Ajay Nair's paper on the SHG-Bank linkage movement—microfinance is a "co-production" between NGOs, bankers, venture capitalists, trainers, accountants etc.

Q: You have agreed to write the report again. What is your take on the theme this year and why?
A: Well, this year we are going to try to build up a basic team of people to do the report every year. One person can't keep doing it every year and it certainly shouldn't be a monograph. It needs to be much broader based so we are trying to rope in more people. We are also trying to cover topics that got left out last year such as impact assessments, urban microfinance, and community based microfinance such as cooperatives and SHG federations. The three core chapters will be the first three chapters—an overview and two chapters to bring people up to date on the SHG and MFI channels. We have not picked any single theme this year. Instead the idea is to complement the first report so that between the first two years, we would have covered most of the important aspects of the sector. We will cover emerging topics like remittances and insurance every two to three years. We also hope to provide up to date statistical information on the sector in every report.

Q: Looking back, what do you think have been the consequences of the March 2006 skirmish between MFIs and state government in Andhra Pradesh over interest rates and unethical practices, and what will be the consequences longer term? Is the crisis over or not? Is such a crisis likely to happen in other states to the same extent?
A: I think the AP crisis has led to many more positive outcomes than any negative impact it might have been at the time. For example, it expedited the microfinance bill. It also led to first the interim and now final code of conduct drawn up by Sa-Dhan. More generally, it lead to much greater awareness and appreciation of the need for the quality of lending administration in terms of transparency in dealing with borrowers, borrower satisfaction and greater borrower understanding of lender practices.

I think people are now more aware of the need to try to achieve these things. I do think the crisis is over in the sense that there was no contagion effect beyond Krishna district. Although there is a mixed picture on the extent to which recoveries have improved in Krishna district. Another positive outcome is that all four big Andhra MFIs are accelerating their expansion outside Andhra to underserved areas.

Q: Large corporations such as Reliance and Bharti are looking at microfinance—existing MFIs or setting up new ones—as an avenue to penetrate the rural market both to seek suppliers and customers for their products. In development jargon we would call this the perfect combination of bottom of the pyramid and livelihood promotion approach. How do you react to this news?
A: I think this is an excellent idea. I presume the model they have at the back of their minds is the Grameen one. Perhaps they are planning to assist MFIs to finance larger loans that may be required. I'd like to see more details.

Q: The Ministry of Finance promises to table the NABARD Amendment Act in order to create a single microfinance regulator in this Parliament session. Meanwhile, the Rangarajan Committee on Financial Inclusion is likely to recommend the creation of a new category of NBFCs called MF-NBFC defined as companies providing thrift, credit, insurance, remittances, and other financial services up to a specified amount to the rural and urban poor. They propose such companies should be exempt from state moneylender acts and should be able to receive foreign debt and equity investment from venture capital and mutual funds. Do you think both these proposals adequately fill the present regulatory vacuum? What else do you think should be included in a regulatory framework for mf?
A: I'm very glad to hear the Committee is thinking of recommending creation of MF-NBFCs because the microfinance bill excludes NBFCs. It is very important to allow NBFCs to mobilise thrift. Regulations are far too stringent to allow that because these are regulations are common to all NBFCs and not just microfinance NBFCs. For various reasons, savings are extremely important to MFIs and borrowers. I do hope that one of these things happens—either the bill is amended to include NBFCs or the RBI should create a new category. NBFCs can already receive foreign debt and equity investments and are already exempt from state moneylender acts. Remittances are missing from the bill but other financial services could be included later. I think the microfinance bill is a great step forward in proposing to allow thrift. The microfinance bills talks about not allowing demand deposits. They seem to imply there is a prudential risk because there could be a run which could create cash management problems for the MFI. But people need to be aware that for the poor especially, the liquidity of savings is very important and the one of the purposes of savings is to have cash available for emergencies. One unfortunate aspect of the bill is that it brings cooperatives into its fold and it is unfortunate because it will now require cooperatives to apply for a certificate of registration to take thrift whereas they already do this under existing regulation. This is a step backward for cooperatives. You can argue that NABARD is more likely to regulate them than the existing set up of Registrars but it is going to be a huge task. There are several thousand cooperatives and for NABARD to have to grant certificates of registration to all of them and to monitor all of them is unfair. Some cooperatives are functioning very well. It would be a pity for them to be hamstrung now by having to seek approval. After all cooperatives are mutual institutions which is the justification for allowing them to mobilise thrift from their members unlike societies and trusts. But if the bill were to delete cooperatives then they would miss out on the benefits of effective regulation. Some of the positive aspects of the bill is that it is going to provide for much better reporting, lay down auditing requirements, performance benchmarks and gather data. So all those things are very useful for the sector as a whole and I would like to see everything included whether it is being done by cooperatives or trusts or whoever. The bill should be careful not to affect existing saving activities of cooperatives.

Q: What do you see as the most important challenges the industry will have to face in the next few years? What should MFIs, policy makers and sector-wide players focus on in your view.
A: In the CARE report I highlighted what I think is the most important challenge in the sector. We must create greater awareness of the importance of allowing MFIs to charge cost recovering interest rates. Soon after the report was released, the Finance Minister was quoted in the Hyderabad edition of the Times of India acknowledging this point explicitly talking about MFIs being allowed to do so in other countries. We need that view to filter down to the state level and to the public generally. To that extent, that is still a challenge. But I would now put the main challenge to be capacity building. The need to enhance capacity is a huge complicated task that has to be done by a whole different set of actors. That is the main task for the sector. The sector needs to induct a huge number of professionals at a senior and management level to handle work like MIS, accounts, financial analysis etc. Field level staff can be trained in-house. MicroSave has stepped into capacity building but we need more.

Q: What do you feel are the most important questions that still have not been answered by researchers working on microfinance in India or elsewhere in the world?
A: I think the biggest need is for researchers who are willing to spend a long time in villages and do the kind of detailed work that economic anthropologists do. We need to study the integrated economic system of the household—consumption, production, cash flows. Most of the questions of interest to the sector now can only be answered by careful in-depth field studies. We want to look at questions of equity or loan distribution within SHGs, how do they handle loan disbursement and collection, what is the loan usage, questions of accountability and repayment rates within SHGs. All this can only be answered by people who adopt the methods of economic anthropologists using participant observation and immersion in the field over periods of time. Only this kind of research is going to enable us to understand the economics of the household. How profitable are microfinance clients? How do they manage to sustain the high interest rates we charge them? Would they be able to survive when wage employment becomes more widely available? Are they engaged in so-called inferior activities because the opportunity costs of their labour are virtually nil? We need to understand the behavioural aspects and dynamic workings of joint liability groups and self help groups. In the long run, microfinance as we know it should put itself out of business. That is how you would define success.