Are MFIs loan sharks or necessary financial institutions?

Unscrupulous microfinance companies driven by profit are causing fear and distress in rural areas of Nepal, with victims being coerced into selling their properties or resorting to suicide.

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Dil Kumari Karki, a resident of Rautahat, found herself in a difficult financial situation when she took a loan from a local loan shark at a high interest rate. In order to secure the loan of Rs 450,000, Karki was forced to provide a blank cheque to the loan shark. However, to her surprise, the loan shark filled the cheque for an amount of Rs 4.5 million. This left Karki in a precarious position, as the loan shark began to harass and threaten her, even going as far as to show up at her house late at night and demand the full amount.

Desperate to find a way out of this situation, Karki turned to microfinance companies for help. However, the employees of these companies proved to be no better than the loan shark. Despite paying regular installments of the money she borrowed from the microfinance, the principal amount never seemed to decrease, and the employees of the microfinance companies began to harass Karki as well, often showing up at her home late at night to demand more money. Despite her best efforts to repay the loans and escape the clutches of these unscrupulous lenders, Karki’s situation only worsened.

The constant harassment and the financial pressure proved to be too much for her 12-year-old daughter, who tragically took her own life.

Shyam Kumari Chaudhary from Devipura in Siraha had to sell off her house and land after severe torture from a microfinance company. “I only received Rs 85,000 when I took out a loan of Rs 100,000. The microfinance deducted Rs 15,000 as a service charge at the beginning. Even though I paid 13 installments of Rs 10,000 rupees each month, the principal amount did not decrease. When they demanded more money, I had to sell my land,” she said.

The story of Punam Kumari Mahato from Siraha is no different. She borrowed money from a microfinance company to start a small business. But during the Madhesh Movement, her business was disrupted, and she was unable to pay the installments regularly. “The employees of the microfinance company came to my house every day and harassed me until I borrowed money from a loan shark at a high interest rate to repay the debt I owed to the microfinance. I lost all my assets in the process,” she shared.

These are just a few real-life stories among numerous horrifying cases that show how microfinance institutions (MFIs) have transformed from being the ‘financial institutions of the poor’ to organizations that are wreaking havoc on the lives of the poor across the country.

With the cases of debt defaults increasing sharply across the country due to the ongoing economic slowdown, borrowers of MFIs have been staging protests against such financial institutions in Kathmandu. High interest rates, exorbitant service charges, hassles in the repayment process, and harassment of borrowers by MFI employees have been pointed out as the major issues in this respect.

According to Rebati Prasad Nepal, Executive Director of Nepal Rastra Bank (NRB), there is a chain of problems that have led to the current situation in microfinance companies. “The chain, I mean, is tangled between loan sharks, cooperative institutions and MFIs, and problems like these will not be possible to untangle at once,” he said adding that NRB is studying the root cause behind the problems in the microfinance companies.

Central bank officials say that protesting against microfinance companies is not a solution to the problem and borrowers cannot use such programs as an excuse to evade the repayment of loans.

The Problems in MFI Lending
Till recently, microfinance companies were allowed to issue collateral-free loans of up to Rs 1.5 million and were also allowed to charge up to 15 percent interest rates and levy 1.5 percent in service charge from the borrowers.
However, MFIs are charging more than 25 percent interest rate and service charge, according to people who have claimed they’ve been victimized by the lending practices of such financial institutions.

According to Nepal, another problem is that any individual can borrow up to Rs 1.5 million from many MFIs as borrowing is possible without collateral. “Currently, microfinance companies are profit-oriented. Without studying if borrowers have taken loans from any other financial institution, they lend without collateral. This is where the problem lies,” said Nepal. “They lend money easily and use harsh tactics to recover debts.”

The other problem is the massive investments in the stock market and real estate sector. As it is easier for borrowers to get loans from multiple MFIs without collaterals, a massive amount of money has gone to unproductive sectors. With the economy in recession and the central bank tightening investment in those sectors, the return on such investments has drastically declined over the past year causing both borrowers and MFIs to feel the real pressure.

Likewise, unhealthy competition between MFIs is threatening the financial discipline in the rural parts of Nepal. Currently, there are 64 MFIs, and the duplications in the working area and clients have created severe problems.

According to Bharat Singh Thapa, Assistant Prof. of Microfinance at Tribhuvan University, MFIs have started working against the norms. “Their duty is to form social capital, but their focus has been seen centered on profit making,” he said.

When asked why microfinance companies resort to harsh tactics in debt recovery, Jagat Pokharel, President of Microfinance Association Nepal said, the central bank has the authority to take action against those harassing the borrowers. “But staging protests will not resolve problems. Also, it is high time to rework the investment models of MFIs.” According to him, MFIs should identify potential productive areas, so that investment would boost production and there is also a good return. “Also, it will help to set a fixed interest rate,” he said.

Similarly, Janardan Panta, CEO of Nirdhan Utthan Laghubitta said that if the loan is not invested in the productive sector, there might not be a return. “The microfinance companies should look for a small margin of profit and invest in productive sectors. Just this step would help.”

NRB’s Stringent Measures
The unchecked growth of MFIs has led to severe problems, prompting the central bank to introduce stringent measures for these class ‘D’ financial institutions.
Amending the Unified Directives on Microfinance Financial Institutions, 2078, the central bank has tightened the noose around MFIs, including their lending practices. Under the new arrangements, those who have borrowed from commercial banks, development banks, or finance companies will not be eligible for loans from microfinance companies. Additionally, borrowers can only receive loans from one MFI at a time, with each financial institution disbursing loans without exceeding the credit limit as per the provision.

Furthermore, borrowers must self-declare that they have not borrowed money from other banks or financial institutions when taking a loan from an MFI. The borrower’s loan information will be used to confirm whether or not they have taken a loan from other banks or financial institutions. However, borrowers with existing loans must adhere to their previous installment payment schedules.

To ensure the protection of customers, the central bank has set a minimum interest rate for deposit savings, which must be fixed at least 50 percent of the maximum interest rate of loans provided by microfinance institutions. The guidelines have also amended the funding arrangements of MFIs, requiring institutions proposing an annual dividend distribution of more than 15 percent to deposit 50 percent of the proposed dividend in the general reserve fund.

Similarly, the provisions relating to the Client Protection Fund have also been amended, requiring organizations distributing dividends of more than 15 percent annually to set aside at least 35 percent of the proposed dividend above that in the bank customer protection fund. Finally, the social responsibility regulations of MFIs have been updated, with companies proposing to distribute dividends of more than 15 percent annually required to set aside an amount equal to 10 percent of the proposed dividend above 15 percent for corporate social responsibility.

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