Life and debt

Tuesday 24th June 2014

Recently in Colombo there was an event at which a
research study entitled Life and Debt was presented. The study was by the Centre for
Poverty Analysis (CEPA), initiated and supported by the Swiss Agency for
Development Cooperation (SDC).
The purpose of the study was to understand whether the Owner-Driven Housing
Assistance (ODHA) scheme, being implemented with donor support in post-conflict
north and east of Sri Lanka, increased indebtedness of beneficiary households and
the implications of such debt on the level of vulnerability of the households to
economic shocks. The study was on a sample of 347 households in the Districts of
Jaffna, Kilinochchi and Mullaitivu.
The research showed that 85% of all households in the sample reported indebtedness
with an average of Rs. 150,871. This included families which had not even begun
construction of their assisted houses. That is indebtedness was not necessarily
connected to building the house. The participants stated that they primarily pawned
their family jewellery to raise the funds for basic living as well as house building and
the transaction was with a commercial bank.
Of the households which have begun construction or completed their assisted houses,
the average debt per family was Rs. 184,754. Two-thirds of the households reported
that the entire debt was due to the need to construct the house. Half of the indebted
households said that they had not paid back any amount of the loan. Of the
households which had begun construction of the assisted houses, 40% said they had
paid back any of the funds borrowed. 70% said that their current level of income was
insufficient to pay back their debts.
Tendency to build bigger houses
The owner-driven housing support scheme has a type plan,
according to the specifications of which the grants are made to
the households. Only 48% of the households which have begun
construction have conformed to these specifications, 23 ft by 21.5
ft. 34% of households reported a length of either 27 or 29 ft.
Some around 30% reported laying foundations longer than 30ft.
Even of those who conformed to the prescribed size, only 11%
have kept to the recommended standard features of a gable roof,
two lockable rooms, doors of basic wood, plastering walls, etc.
Generally the research revealed that male-headed households,
households whose members had higher educational attainments
and where households whose head had an ongoing enterprise
either in agriculture or trading, etc., tended to build bigger house.
The tendency to choose bigger house than indicated by the
specifications was seen as driven by traditional cultural factors
such as the status of the owner of a big house made of brick with
a tile roof.
Housing is seen as an investment for future generations to benefit from. Even in other
parts of the island, it is common to see half-completed houses, into which the
residents have moved in and occupied, and intend to complete the house in
accordance with the financial surplus generated by economic activity. The part which
has been built has been completed using the grant component of a housing scheme or
savings of the family
Marked lack of financial literacy
The important issue emerging from the study is that beneficiaries routinely borrow to
supplementary the grant funds and for survival. This reflects a lack of opportunity for
earning a livelihood. This issue too must be addressed.
Post-conflict, a variety of financial institutions have begun operations in the north east.
Many of these provide small loans, which they label as microfinance or micro credit.
Some of them are virtual hire purchase schemes. Electrical and electronic consumer
items, motorcycles and scooters are made available to consumers on terms which are
not adequately explained.
The study by CEPA has reported that there is marked lack of financial literacy among
the surveyed households. The households are unable to calculate in real terms their
actual level of indebtedness. The hard sell
techniques of some financial institutions and the
ruthless operating systems of their debt collectors
have resulted in anecdotal evidence of stress and
distress caused to families by high indebtedness
and inability to pay instalments, resulting in assets
being repossessed.
Giving micro-credit a bad name
This has given micro credit a bad name. Sri Lanka
has a number of schemes by which small amounts
of money is lent to borrowers. Among them the
traditional Rotating Savings and Credit Associations
(RoSCAs) or cheetu schemes for which there is an
Ordinance regulating them from colonial times.
Pawn broking in terms of the Pawn Broking
Ordinance. Money lenders operating in terms of the
Money Lenders Ordinance. Cooperative banks and
cooperative credit groups operating under the
Cooperative Law. The Divi Neguma Banku Sangam
operating in terms of the Divi Neguma Law, which
inherited the pre-existing Samurdhi Banku Sangam
scheme. Other micro finance institutions that
operate drawing their capital from the Sri Lanka
Savings Bank, the successor to the micro credit
window of the National Development Trust
Fund/Janasaviya Trust Fund. The specialised, development and licensed commercial
banks and finance companies. These are all financial service providers which operate
in the economic environment from which households access funds.
The fact that a large number of beneficiary households of the Owner-Driven Housing
Assistance (ODHA) which was studied claimed that they raised funds to supplement
the grant by pawning their jewellery shows the crying need for a financial instrument
which would supplement the grant under the ODHA.
Ideally this financial instrument should be designed so that it would be accessible by
the diverse providers of financial services in the micro and small sectors described
above. It is essential that beneficiaries should have a choice in where they access the
micro loan from, to supplement the grant under ODHA. Legally and technically in
terms of the law and financial service regulations, it would be possible to design a
financial instrument which would be accessible by RoSCAs, commercial banks,
finance companies, MFIs and cooperatives, among others.
Reputation of MF under attack
The reputation of MF has been under attack recently, especially on the issue of over
borrowing and resultant over indebtedness by MF clients. However a recent
comprehensive study of 3,000 households in eight villages over a 20-year timeframe
released by the World Bank (Dynamic Effects of Microcredit in Bangladesh) has
rehabilitated MF and established that there is no evidence that borrowing from
multiple sources leads to over indebtedness and that MF loans do benefit women
more. In fact the report concludes that access to multiple credit institutions encourage
households to diversify their income earning activities.
Micro finance has been criticised on the ground that most loans are in fact simply used
for consumption, which the World Banks Consultative Group on Poverty (CGAP)
recognises implicitly in its attempts to redefine microfinance in terms of financial
inclusion, ignoring the issue of the micro loan sustainability. This is linked in turn to the
danger of overborrowing and over indebtedness, which was brought home in stark
terms in Andhra Pradesh in India, and by the farmer suicides, which resulted in
politicians and administrators going overboard in attempting to control microfinance
institutions.
But the ODHA beneficiary study clearly shows that beneficiaries are driven by various
factors to expand their house by raising funds from diverse sources and it would be
sensible to accept this as a given and design the financial product, a flexible micro
loan scheme which could be delivered by a variety of financial service providers to
beneficiaries of ODHA
Batticaloa developments
Probably arising from these concerns, of access to micro credit increasing
indebtedness and creating social stress, the District Secretary (DS) of the Batticaloa
District in the Eastern Province of Sri Lanka, summoned a meeting of Micro Finance
Institutions (MFI) operating in the District on 1 April. A representative of the Central
Bank was also present.
Representatives of MFIs present at the meeting say that the DS declared that Non
Government Organisations which do not have permission from the Central Bank shall
not implement MF programs. The DS also is reported to have stated that a
Registration Certificate of a company shall not be treated as license for the provision
MF services.
On 4 April the Director Planning, Batticaloa District Secretariat issued a series of
guidelines under reference BT/DPS/FFP/Micro 2014 by which, among other things,
the maximum rate of interest for micro credit activity was fixed at 12% per annum.
Further the letter stated that MFIs have to work with the GAs approval and with
Divisional Secretaries (Div Sec) recommendation.
The letter banned weekly collection of instalments. The MFIs were advised to avoid
duplication of beneficiaries. Each and every MF loan should be recommended by the
Div Sec. The MFI should be registered under Central Banks Guidance. Individual
house visits to collect loan instalments or to evaluate loan application are not allowed.
All NGOs in MFI activities should get special permission for MF activities. MF loans for
consumption were prohibited.
It is nowhere stated under what legal authority the Government Agent/District
Secretary has issued these orders. The Lanka Microfinance Practitioners Association
(LMFPA), the apex organisation, took this issue up with the authorities in the Ministry
of Economic Development and it was suggested that a meeting be held to discuss the
matter with the District Secretary, Batticaloa.
Newspapers reported the crisis faced by both lenders and borrowers in the Batticaloa
District by the sudden imposition of these draconian rules, most of which have no legal
basis. Subsequently it is reported that micro finance institutions have been permitted
to resume lending and collecting instalments in Batticaloa under certain conditions,
after the LMFPA met the DS. But the legal basis for the District Secretary to impose
such regulations is not known.
This situation has come about currently in Sri Lanka today due to the fact MF seems a
lucrative profit centre, among financial service providers, there being no regulatory
mechanism in place. All financial service providers ranging from licensed commercial
banks, finance companies, non government organisations, cooperatives, money
lenders, pawn brokers, cheetu schemes (Rotating Savings and Credit Associations),
registered voluntary social service organisations, registered societies, government
programs, etc. are all promoting themselves as providers of MF to the poor and the
marginalised.
Long history of microfinance
Sri Lanka has a very long history of microfinance. The first cooperative rural bank took
in savings deposits and gave out its first small loan, what is today fashionably referred
to as micro credit, in the early 1900s at Menikhinna, in the Kandy District. The
Government has from time to time promoted microfinance, for example through the
Central Banks Isuru Project, the Janasaviya Trust Fund (JTF) and its successor, the
National Development Trust Fund (NDTF). The Sri Lanka Savings Bank now has a
special window for wholesale lending to microfinance institutions, using the NDTF loan
repayment funds, after the latter was wound up.
The current incarnation is Divi Neguma; the Act defines Microfinance as: A type of
banking service that is provided to employed or low income individuals or groups, who
would otherwise have no other means of gaining financial services. This is the only
legal definition available in an enacted law. The definition is far from satisfactory.
For example, the unemployed are not eligible for microfinance? One recent estimate
put the number of MFIs at 16,400. Microfinance has an important role to play in
gender empowerment in Sri Lanka as it is estimated that over 70% of depositors and
borrowers are women. Women-headed households in the ODHA, which have
borrowed to supplement the grant provided, would come within this category
Central Bank stance
While the Central Bank of Sri Lanka is the primary regulating authority for banking and
financial services, the Commissioner of Cooperative Development at the national level
and his provincial counterparts, the Registrar of Companies, the regulators under the
laws governing RoSCAs (cheetu), money lenders, pawn brokers and all other legally
recognised providers of financial services have designated regulators, under which the
institutions under their purview have been set up.
The Central Bank, recently under the caption Microfinance Institutions, has stated:
The CBSL was involved in preparing legislation for the regulation of microfinance
institutions. There are several categories of microfinance institutions that are
registered under various laws, but are not regulated or supervised according to
prudential criteria. Hence, to safeguard the interest of depositors and customers and
also to strengthen the governance and service delivery of these entities, it was
decided to bring them under a common regulatory umbrella.
Microfinance Bill
In terms of a Microfinance Bill, hereinafter referred to as Draft Bill No. 03 on
microfinance announced recently as having been approved by Cabinet, the Monetary
Board of the CBSL is the regulator for MFIs. This is a welcome step. In Sri Lanka
although there is no legal definition as to what specifically falls with the definition of
microfinance (except in the Divi Neguma Act), the Draft Bill No. 03 provides a
definition, differing from the Divi Neguma definition. In Part II section 10(2) of the draft
law it is stated that microfinance business is the acceptance of deposits and
providing financial accommodation any form and other financial services mainly to low
income persons and micro enterprises.
At the briefing of the press on the meeting of the Cabinet of Ministers which approved
the Draft No. 03, MFI Bill, it was stated that a three-tier system was being adopted in
Sri Lanka, certain MFIs directly by the Monetary Board, others through officials like the
Commissioners of Cooperative Development and a third category by registered
auditors acting on behalf of the CBSL.
MFIs in Sri Lanka for decades received subsidised funding from the Janasaviya Trust
Fund and its successors, the National Development Trust Fund and the Sri Lanka
Savings Bank. With the ongoing consolidation of the financial services sector, the
future of this MFI window of the SLSB is not known.
The discussion on the first and second draft bills on MFIs in Sri Lanka has resulted in
the Draft Bill No. 03 being a great improvement on its predecessors. The CBSL itself
has admitted that several categories of microfinance institutions are registered under
various laws, but are not regulated or supervised according to prudential criteria.
Need for prudential regulation
Whatever the controversies, at a global intellectual or at operational level, in places
like Batticaloa District, the fact remains that microfinance is a financial instrument,
which almost all financial service providers, in Sri Lanka are presently utilising. The
Central Bank itself has recognised the need for prudential regulation.
Give the rampant scandals in the financial sector of late; leaving the microfinance
sector unregulated is a high risk strategy, which, if at all, compounds the dangers,
which micro savers and micro borrowers face. As has been pointed out, this sector is
not a new development but has a long history, going back to the 1900s. The continued
lack of prudential regulation is a betrayal of the legal and moral obligation of the
regulator of which cognisance must be taken at the highest level, including the Higher
Judiciary, which has to ensure the rule of law.
The findings of the CEPA study of the ODHA scheme in north east Sri Lanka, makes a
strong case for:
1. The need for development of livelihood earning opportunities
2. The need to improve financial literacy among beneficiaries
3. The need to design and introduce of a soft loan micro credit scheme for ODHA
beneficiaries to supplement the grant.
This financial product should be by design and intent flexible enough for beneficiaries
to select which type of micro financial service provider they would choose to access
this product, from the variety of micro financial service providers operating in Sri
Lanka.
Over-reliance on pawn broking
The seemingly over-reliance on pawn broking causes huge distress to families as gold
jewellery are considered heirlooms, including the Thali among the Tamil community
and there is great reluctance to pawn it.
Another study in the past also reported that up to 40% of funds for land preparation
and mobilisation for rice farming in Sri Lankas rice bowl of Anuradhapura,
Polonnaruwa and Ampara is generated by pawn broking. This shows the utter failure
of the financial system to design a financial product to service the needs of rural
agriculturalists despite the lip service to rural banking from time immemorial!
The ODHA study strengthens the fact that the most accessible and simple method for
a poor family to raise cash is to pawn their jewellery. No wonder that almost all
financial service providers are in the pawn broking business! Presently they are in
crisis due to fall in the value of gold and the resultant reluctance of borrowers to
redeem their gold, pawn brokers are sitting on gold mountains! This reinforces the
case for a flexible micro loan scheme to supplement the grant in future and current
ODHA schemes.
(The writer is a lawyer, who has over 30 years of experience as a CEO in both State
and private sectors. He retired from the office of Secretary, Ministry of Finance and
currently is the Managing Director of the Sri Lanka Business Development Centre.)