There exist policy remedies that, if effectively implemented, can still yield benefits for sectors of the economy through microfinance
During the 1990s, Nepal introduced microfinance institutions (MFIs) such as savings and credit cooperatives as a means to provide credit access to those who were financially excluded. These institutions were initially seen as a solution for lifting people out of poverty by offering loans, savings and insurance options to disadvantaged groups. At first, MFIs showed outcomes. Brought hope for reducing poverty in a country that long aspired for economic growth.
However, over time there has been a shift in the focus of MFIs from their original mission towards profit-making and unsustainable growth. This change has made them more prone to mismanagement and fraudulent practices. Consequently, default rates have reached levels that are unsustainable. People are left with no choice but to express their grievances through street protests. One concerning consequence is the rise in suicides among microcredit borrowers. This tragic trend underscores the toll resulting from imprudent microcredit practices. So, it's high time that the government took steps to reshape the sector in line with its objectives by implementing strong regulations and effective supervision.
According to the Nepal Rastra Bank (NRB), MFIs currently have a loan portfolio exceeding Rs 200 billion and the non-performing loan (NPL) ratio rose to 5 per cent in 2018. The number of MFIs has witnessed growth from six in 1996 to over a hundred in 2012. By 2023 their numbers had multiplied substantially.
This rapid expansion of MFIs has resulted in market saturation and the adoption of aggressive lending practices. For instance, loan officers face rigid targets that compel them to grant loans without conducting assessments of borrowers' repayment capacity.
Conversely, indebtedness has become widespread.Many borrowers, those residing in rural areas, resort to taking out multiple loans from different MFIs to repay existing debts, which ultimately traps them into a cycle of mounting financial obligations they are unable to meet.
A NRB survey conducted in 2017 revealed that 37 per cent of borrowers had loans from at least two MFIs. The absence of credit information sharing between MFIs has facilitated excessive borrowing practices. Credit standards remain inadequate as they fail to consider income streams or repayment capabilities. Furthermore, the lack of financial literacy and understanding of loan terms and conditions makes borrowers susceptible to tactics. Certain MFIs impose interest rates reaching 30 per cent or even more. Additionally, corrupt political protection allows for the continuation of fraudulent lending practices. Inadequate supervision has resulted in relaxed loan disbursement processes and insufficient follow-up, creating opportunities for fraud and mismanagement.
Despite all these unpleasant experiences, economists maintain their belief in
microfinance as one of the practical policy tools for poverty reduction. For instance, a study conducted in Bangladesh revealed that access to microcredit reduced poverty, defined as living under $1 per day. Similarly, an analysis of microfinance in India demonstrated a decrease in poverty rates by 9 per cent between 1999 and 2005. In the context of Nepal, the crucial question arises, how can we reorient this sector back towards its original social objective?
There exist policy remedies that, if effectively implemented, can still yield benefits for sectors of the economy through microfinance. Foremost among them is the need to strengthen financial literacy programmes. MFIs should prioritise programmes to educate their clients about loan terms and conditions, the significance of savings and responsible borrowing practices. Collaboration between governmental organizations and government agencies can facilitate workshops and awareness campaigns in targeted rural areas.
Another important aspect is the regulation of interest rates. The government must establish fair regulations that prevent MFIs from charging high-interest rates. Finding a balance between affordability for borrowers and sustainability for MFIs is key in this regard.
The NRB has the required authority for financial regulation. Indeed, it formulated the Microfinance Development Strategy (2011) to govern the sector and ensure its sustainability and credibility. However, despite regulatory efforts, fraud and mismanagement within the microfinance sector have continued year after year. Weak monitoring and evaluation mechanisms, lack of enforcement and limited resources hinder effective regulation. The NRB should enhance its regulatory oversight to conduct regular inspections and audits of MFIs. Implementing risk-based supervision and employing skilled personnel can help identify potential issues early on. MFIs should be required to publish detailed financial statements and operational reports regularly. This would enhance transparency and help clients and stakeholders make informed decisions.
Establishing a system to protect whistleblowers who report unethical practices within MFIs can be instrumental in detecting and addressing potential fraud and mismanagement.
Providing training and capacity-building programmes to MFIs can help improve their internal governance and risk management practices. The NRB should collaborate with non-governmental organisations, consumer rights groups, and industry associations to gather insights into potential fraud and management issues and develop effective solutions.
The state has a duty to institute stronger consumer protection measures for vulnerable borrowers who are now caught in a debt trap. By addressing the challenges head-on and adopting proactive measures, Nepal can
Revive its microfinance sector and ensure it serves as a potent tool for poverty alleviation and financial empowerment for the destitute in the remote corners of Nepali society.
A version of this article appears in the print on September 08, 2023, of The Himalayan Times.
