ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

A+| A| A-

Rural Credit in 20th Century India

This overview of rural credit in 20th century India finds a remarkable continuity in the problems faced by the poor throughout the period. These include dependence on usurious moneylenders and the operation of a deeply exploitative grid of interlocked, imperfect markets. We articulate the theoretical and historical case for nationalisation of banks and provide evidence of its positive impact on rural credit and development. Certain excesses led to the reforms of the 1990s, which did increase bank profitability but at the cost of the poor and backward regions. While the microfinance institution model is unsustainable, the self-help group-bank linkage approach of MF can make a positive impact on security and empowerment of the disadvantaged. Much more than MF is, however, needed to overcome the problems that have persisted over the last 100 years.

Special articles

Rural Credit in 20th Century India

Overview of History and Perspectives

T

Economic and Political WeeklyApril 14, 20071352Moneylenders’ power was reinforced through the grain loansthey made to poor proprietors, tenants and labourers.1Rates ofinterest were generally higher for the poorer cultivators, partlybecause they made greater resort to grain loans but also reflectingtheir generally more vulnerable position [ibid, Vol II, p 403].Creditors sought to exploit this vulnerability by cheating invarious ways, for it was they who kept the accounts (if any),conducted the grain measurements and had a more accurateknowledge of prices. The 1935 report on agricultural indebted-ness provides instances of moneylenders who kept accounts butnever revealed them to debtors, to whom they never providedreceipts either. They recorded higher rates of interest on thepro-notes than theyactually charged. The amount repaid wasgenerally not deducted while calculating future interest dues, norwere the principal and interest separately accounted. If repaymentwas not made in instalments previously agreed to, a higher“penal” interest rate was charged.Another oppressive nexus involved the purchaser of crops, whoin several cases was also a moneylender. In such cases, the debtorhad to sell his produce at a pre-arranged time, usually the immediatepost-harvest period, at a price, which was lowered to take accountof the interest on the loan.2Such producers, who lacked therequisite storage and transport facilities to take advantage of pricevariations, both inter-spatial and inter-temporal, were forced tosell off the ground, as it were, immediately after the harvest.3Finally, the fact that they had to buy back grain in the peak priceperiod made them even more inextricably trapped in debt forthey had to borrow in order to buy.Tenants, who formed a very significant proportion of theworking population in the colonial period, were the worst affectedbecause for them an extra source of exploitation was added –the rent-relationship. Rent payments were generally fixed for theimmediately post-harvest period. This was particularly tough ontenants who paid rent in cash. Tenants were not allowed to liftthe crop off the ground until the rent had been paid. Since leaseswere usually renewed every year, pressure on tenants to pay rentwas intense. In case rent was not paid in time, high rates of interestwere charged on the unpaid amount. When land was leasedfollowing a mortgage, the rent charged was equivalent to theinterest [MPBEC Report 1930, Vol I, p 47].The colonial administration was aware of this problem andmade several, if somewhat feeble, attempts to grapple with it.The first was the enactment of the Deccan Agricultural Debtors’Relief Act (1879) that authorised courts to stop charging usuriousinterest rates and sales of land as a result. Similar land alienationacts were passed in Punjab, united provinces and central prov-inces and Berar [Chandavarkar 1984:799]. The late 19th centuryalso saw land mortgage banks being set up. Low interest loanswere provided after the Land Improvement Loans Act of 1883(for long-term loans) and the Agriculturists Loan Act of 1884(for current needs). But these loans remained extremely sparseand ineffective. The success of the cooperative movement inEurope prompted the passage of the Cooperative Credit SocietiesAct in India in 1904. Real government encouragement of co-operatives started with the more comprehensive CooperativeSocieties Act of 1912. After the 1915 Maclagan Committee onCooperation, provincial cooperative banks were established inalmost all major provinces by 1930.4But unlike Europe, coop-eratives in India found it very hard to get going. The sharp socio-economic divisions in rural India appeared to overwhelm the veryidea of “cooperation”. The cooperative credit societies were“run in most cases by rich landlords and moneylenders”[Baker1984: 229]. These societies were embroiled in local powerpolitics and were a source of rural patronage and influence. Inthe words of a witness testifying before the Royal Commissionon Agriculture (RCA), in these societies “outcaste men will notget a loan unless they promise to sell their labour to the casteman who is a member of the panchayat at a lower rate than whathe can get in the market” [RCA Report 1929, Vol III, p 410].The witness went on to describe his experience at an annualgeneral meeting of a cooperative credit society where “the directorsat on one side of the street and the outcaste sat on the other”(loc cit). In a study of rural credit in western India (1875-1930),Catanach (1970) finds that cooperatives only became an additionto the dealings of the rural moneylender, not an alternative to him.The Usurious Loans Act, passed in 1918, sought to apply the‘damdupat’ principle (interest never exceeding principal) to debts.The CBEC estimated in 1929 that the accumulated burden ofinherited rural indebtedness in India was Rs 900 crore. The steepfall in agricultural prices during the Great Depression openedthe floodgates of legal suits for attachment of lands of borrowers.The official response was a spate of debt conciliation acts between1933 and 1936 by the governments of the central province andBerar, Punjab, Assam, Bengal and Madras. But in his classicenquiry into rural indebtedness in 1941, B V NarayanswamiNaidu concluded, “after existing for about seven years, the debtconciliation boards were abolished as not having been of anyconsiderable practical utility” [Naidu 1946: 52]. The complicatedadministrative machinery involved in these boards and the factthat they had no coercive powers explains their poor performance.The Punjab Regulation of Accounts Act (1930) and the DebtorsProtection Act of 1935 provided for compulsory licensing andregistration of moneylenders and proper recording of transactionsand accounts. However, these Acts proved “by and large, a deadletter...not least because of the understandable reluctance ofdebtors to bring moneylenders, often their sole source of creditmto court” [Chandavarkar 1984: 800]. Ironically, the MadrasAgriculturist Debt Relief Act (1938) suffered for the oppositereason when several powerful creditors petitioned the courtsquestioning it [Naidu 1946: 52-53].It is clear that the strength of the debt mechanisms remainedlargely unimpaired by the activities of the colonial state.5Thisis why the statement by one of colonial Punjab’s legendaryadministrator-scholars Malcolm Darling (1925) that “the Indianpeasant is born in debt, lives in debt and dies in debt” has becomea classic of Indian economic history. This condition resulted froman interlocking of a number of imperfect markets (land, input,output, labour and land-lease markets) with the credit market,which itself was characterised by deep imperfections. Themoneylender was not merely a source of credit; he often combinedthe roles of crop buyer, labour employer and land lessor. “Real”rates of interest were then not just the “rate” charged. They werealso hidden in the lower price paid for produce sold, exploitativewage rates and rents charged for land leased. This interlockedgrid worked in tandem with the oppressive caste system as apowerful nexus of exploitation, which became the basis for thepauperisation of the peasantry in the colonial period. The balanceof power was terribly skewed against the poorer, “lower” castefarmers, who faced a cumulative and cascading spiral of expro-priation. In such a situation, productive investments were vir-tually impossible to visualise for the vast majority of India’speasants. Worse, even basic consumption needs were hard to
Economic and Political WeeklyApril 14, 20071353meet, with an external ecological crisis such as a drought beingenough to tilt the balance and endanger survival itself, especiallywhen the state provided little or no social security.1947-1969: Focus on CooperativesThe historic all India rural credit survey (AIRCS) carried outin 1954 confirmed that formal credit institutions provided lessthan 9 per cent of rural credit needs in India (Table 3). Money-lenders, traders and rich landlords accounted for more than 75per cent of rural credit. Cooperative credit societies had alreadybeen in existence for 50 years but their share in rural credit wasstill less than 5 per cent. The 1945 Cooperative Planning Com-mittee had discerned early signs of sickness in India’s cooperativemovement, finding that a large number of cooperatives were“saddled with the problem of frozen assets because of heavyoverdues in repayment” [GoI 2005: 8]. Even so, in the 1950sand 1960s, the way forward was seen to lie in cooperative creditsocieties. These cooperatives were to take the lead in the Inte-grated Scheme of Rural Credit suggested by the AIRCS. Theshare of cooperatives in rural credit did rise to cross 20 per centin 1971. Today, India’s cooperative credit structure (CCS), withover 13 crore members (including six crore borrowers), consti-tutes one of the largest rural financial systems in the world. Theover one lakh primary agriculture credit societies (PACS) can,in many ways, be regarded as the veritable bedrock of India’srural economy. The CCS has 50 per cent more clients thancommercial banks and regional rural banks (RRBs) put together.Directly or indirectly, it covers nearly half of India’s totalpopulation [GoI 2005: 15]. The CCS services farm input dis-tribution, crop production, processing and marketing as alsodairying, weaving and textiles.However, the CCS has never realised the enormous potentialopened up by its vast outreach. According to the task force onrevival of rural cooperative credit institutions, this owes mainlyto a “deep impairment of governance” [GoI 2005: 18]. Whilethey were originally visualised as member-driven, democratic,self-governing, self-reliant institutions, cooperatives have, overthe years, constantly looked up to the state for several basicfunctions. The task force describes in detail how state govern-ments have become the dominant shareholders, managers, regu-lators, supervisors and auditors of the CCS. The concept ofmutuality (with savings and credit functions going together), thatprovided strength to cooperatives all over the world, has beenmissing in India. This “borrower-driven” system is beset withconflict of interest and has led to regulatory arbitrage, recurrentlosses, deposit erosion, poor portfolio quality and a loss ofcompetitive edge for the cooperatives [GoI 2005, Ch III].Domination by richer elements in the rural elite that characterisedcooperatives in the colonial period continues to be an abidingfeature of these institutions even after independence.61969-1991: Nationalisation of BanksIn 1951, the AIRCS found that the share of banks in rural creditwas less than 1 per cent.7Even through the 1950s and 1960s, therole of private commercial banks in rural credit remained minimaland indirect. The AIRCS itself had wanted the involvement ofthese banks in agricultural marketing and processing but notdirectly in farm output. Rural branches of commercial banks werefew and far between despite a 1954 Reserve Bank of India (RBI)directive for them to open at least one branch in unbanked ruraland semi-rural areas for every branch opened in previouslybanked areas [Meyer and Nagarajan 2000: 172]. The ImperialBank of India8was nationalised in 1955 and the new State Bankof India (SBI)9was asked to open 400 branches in semi-urbanareas and start agricultural lending, even if at a loss. Even so,right up to 1971, the share of banks in rural credit was no morethan 2.4 per cent and most of these loans were given to plantations.Their main activity was to finance agro-processing firms andpurchase bonds floated by land development banks. Until the endof the 1960s, the overwhelming share in commercial bank creditwas that of industry (62 per cent) and trade and commerce (26percent). Within industry, the distribution of credit was skewed infavour of large borrowers [Sen and Vaidya 1997]. It has alsobeen alleged that “advances by private banks were diverted tosister companies of the banks or to companies in which theirdirectors had an interest” [Chandrashekhar and Ray 2005: 12].10Thus, cooperatives remained dominated by the rural elite andbanks continued to have an urban bias throughout the 20 yearsafter independence.In trying to understand the case for nationalisation, it is usefulto remember that government control over banking was the normin most low-income countries in the four decades after the firstworld war [Burgess and Pande 2002: 3]. Similar state-led ruralfinance programmes were spread across the developing worldin the post-colonial period. State control over banking to act asan engine of structural change and the attack on poverty waspart of the orthodoxy of development economics at that time[Besley 1995]. Even though they lament it, La Porta et al (2002),assemble data on government ownership of banks around theworld, which show that such ownership is large and pervasive.In the average country, more than 40 per cent of the equity of10 largest banks remained in government hands even as recentlyas 1995.11Theoretical Case in Development EconomicsPerhaps the first intellectual case for nationalisation of com-mercial banks in India was made in a public lecture deliveredby K N Raj in 1965 [Raj 1974]. Raj felt that “there are importantreasons why banking enterprises seeking to maximise their profitswould not venture out into areas and sectors of activity to whichhigh priority needs to be attached from a larger social andeconomic point of view” [Raj 1974: 308]. Thus, rural credit wasnot merely a commodity that needed to reach the poor to freethem from usurious moneylenders, it could also be seen as a publicgood critical to the development of a backward agrarian economylike India, especially as Indian agriculture moved decisively intothe green revolution phase, where private investments by richerfarmers needed massive credit support.Private banks operating in an imperfect credit market wouldonly aggravate already existing imperfections. Keynes and Kaleckihad already provided the theoretical foundations of this view inthe 1930s. As Kalecki put it, “the most important prerequisitefor becoming an entrepreneur is the ownership of capital…firmsbelow a certain size have no access whatsoever to the capitalmarket…a state of business democracy where anybody endowedwith entrepreneurial ability can obtain capital for starting abusiness venture is, to put it mildly, unrealistic” [Kalecki 1954:91-95]. In General Theory, Keynes expresses the problem a littledifferently. He distinguishes “two types of risk that affect the
Economic and Political WeeklyApril 14, 20071354volume of investment” [Keynes 1935: 144]. The borrower’s riskarises because she is unsure whether her business venture willprovide the expected yield. She would want a low rate of interest,especially if her venture is a risky one. But the same situationcreates the “lender’s risk” of default by the borrower (voluntary,what Keynes terms “moral hazard” or involuntary, due to poorreturns on investment). This necessitates that the lender chargea rate of interest high enough to induce him to lend. Keynesexpresses the resulting social dilemma somewhat poetically: “thehope of a very favourable outcome, which may balance the riskin the mind of the borrower, is not available to solace the lender”[ibid: 145].Applying the insights of Keynes and Kalecki to a deeplyunequal agrarian economy like India, Raj argues that “the verybasis of profit-making in banking activity sets limits in under-developed economies to the enterprise it can display” [ibid: 309].There are high information and transaction costs of dealing withmany small borrowers that act as a major disincentive.12 Alsobecause profitability of banks is greater, the higher is “theproportion of their earning assets to the idle cash reserves theyhave to hold” [ibid: 309], servicing illiterate customers, who insiston payments in cash on the spot means higher idle cash reservesof banks and lower profitability. Raj showed that mere legislationand control had not led to an “optimal allocation of investibleresources” [ibid: 307]. Nationalisation of large banks was theonly way forward. Raj was aware that “the bureaucratic elementin decision-making may introduce considerable rigidity” but hehastened to add that in “large private banks, the element ofimpersonality with all the rigidity it introduces, is almost as greatas in the case of state owned banks, except in case of favouredcustomers known to the bank…The larger private banks are noless impervious to the needs of small customers who have nosecurity to offer” [ibid: 311].ObjectivesFourteen of India’s largest scheduled commercial banks werenationalised in 1969.13 The RBI had acquired a more direct andactive role in deciding banking policies. The preamble to theBanking Companies (Acquisition and Transfer of Undertakings)Act, 1969 that empowered the state to nationalise commercialbanks speaks of “a larger social purpose” and the need to “subservenational priorities and objectives such as rapid growth of agri-culture, small industries and exports, raising of employmentlevels, encouragement of new entrepreneurs and development ofbackward areas”.14The 1961 Census showed that nearly 50 per cent of India’stowns and almost none of its villages had bank branches. In 1969,the National Credit Council, set up to guide the branch expansionprogramme, found that not even 1 per cent of India’s villageswere served by commercial banks. It also noted that whileindustry accounted for a mere 15 per cent of national income,its share in commercial bank credit was nearly 67 per cent. Onthe other hand, agriculture that contributed to 50 per cent of GDPvirtually got nothing from banks.Nationalisation was aimed at redressing these inequities. Theidea was to reduce the average population served by a bankbranch and to reduce disparities in this across states. Accord-ingtothe1949 Banking Companies Act, banks needed a licencefrom the RBI if they wanted to open a new branch.15This policywasaresult of the perceived need to control the mushroomingof banks andwidespread bank failures during the war period.16Under the act, the RBI closed down, merged and consolidatedmany unprofitable banks. As a result, there was a decline in thenumber of banks from 566 in 1951 to 85 in 1969 [Sen and Vaidya1997: 13]. The 1969 law sought to dramatically change course.After nationalisation, branch expansion was deliberatelyskewed towards previously unbanked or under-banked ruraland semi-urban areas.Reaching Out to Unbanked AreasThe RBI created a comprehensive list of unbanked locationsin India that it circulated every few years to all banks. In 1970,the RBI formulated its first “socially coercive” licensingcriterion-based on this data. For every new branch in an alreadybanked area (with one or more branches), each bank would haveto open at least three branches in unbanked rural or semi-urbanareas.17 The RBI directed that all semi-urban locations wouldhave to be covered by the end of 1970. In 1977, the RBI furtherupped the ante – the banked-unbanked license ratio was raisedto 1:4. In 1976, the regional rural banks (RRBs) were created.The RRB act states that RRBs were set up to develop the ruraleconomy by providing “credit and other facilities, particularlyto small and marginal farmers, agricultural labourers, artisansand small entrepreneurs” [Misra 2006: 111].18Table 1 records that the RBI policy of “social coercion” throughlicensing and targets was a success in forcing banks to openbranches in hitherto unbanked locations. The number of ruralbranches of banks (including RRBs)19increased from a mere1443 in 1969 to around 35,000 in the early 1990s. Most of thisincrease was in unbanked areas. The number of banked locationsin this period rose from around 1,000 to over 25,000. The shareof rural branches went up from 18 to 58 per cent during the sameperiod. Between 1961 and 2000, the average population servedby a bank branch fell from around 1,40,000 to just under 15,000.There is strong convergence in this figure across states after 1977and by 1990 all Indian states were below the national target of17,000. This reflects the fact that bank building intensity wasmuch greater in states with a higher proportion of rural unbankedTable 1: Growth of Rural Banking in India, 1969-2006YearNumber ofCreditDepositsCredit-Bank OfficesOutstandingDepositRatio(Per Cent)RuralPerCentRuralPer CentRuralPer CentRuralAllof Total(Rsof Total(Rsof TotalAreasCrore)Crore)1969144317.61153.33066.337.671.91972527436.02574.65406.547.767.21975711235.56086.011718.551.973.519781253442.515308.4266410.157.469.119811945351.2360011.9593913.460.668.119842554152.9658913.5960313.468.668.319873058556.21112715.31752714.763.561.019903486758.21735214.22860915.560.766.019933536056.32290614.14141015.055.358.919963298151.22901211.46131314.447.359.819993284049.34209111.010269714.741.054.820023244347.86668210.215942314.241.858.420053208246.91099769.521310412.251.664.920063057244.51758168.422604910.856.372.5Source:RBI:Banking Services: Basic Statistical Returns, various issues;Quarterly Statistics on Deposits and Credit of Scheduled CommercialBanks: March 2006.
Economic and Political WeeklyApril 14, 20071355locations in 1969. Bank branches in unbanked locations reallyexploded after the 1:4 licensing rule of 1977. That the rule wasstrictly enforced is clear from the fact that between 1977 and1990, 80 per cent of all new branches opened were in unbankedlocations [Burgess and Pande 2002].20Another major impetus to rural credit was provided by theestablishment of the National Bank for Agriculture and RuralDevelopment (NABARD) through an Act of Parliament in 1982.21NABARD was set up as an apex development bank with amandate for facilitating credit flow for agriculture, ruralindustries andall other allied economic activities in rural areas.Over the last 25 years, refinance disbursement by NABARD tocommercial banks, state cooperative banks, state cooperativeagriculture and rural development banks, RRBs and other eligiblefinancial institutions has aggregated over Rs 8,600 crore.In order to ensure that rural deposits were not used to justincrease urban credit, the RBI directed that each rural and semi-urban bank branch had to maintain a credit-deposit ratio of atleast 60 per cent. Table 1 shows that between 1969 and 1987,rural credit as a proportion of total credit outstanding went upfrom 3 to 15 per cent. Rural deposits as a share of total depositswent up from around 6 to over 15 per cent. The credit-depositratio went up from under 40 per cent in 1969 to nearly 70 percent in 1984 and remained over 60 per cent until the early 1990s.Priority Sector LendingOther than directing credit to hitherto unbanked geographicalregions, the RBI also sought to influence the sectoral orientationof bank lending. In 1972, the definition of certain “priority”sectors was formalised. These included agriculture and alliedactivities and small-scale and cottage industries. A target of 33per cent lending to the priority sector was set in 1975 (to beachieved by March 1979). In 1979, the target was raised to 40per cent (to be achieved by 1985). In 1980, sub-targets were set:16 per cent of lending was to go to agriculture and 10 per centhad to be targeted at “weaker sections”.22As Table 2 shows, theshare of priority sector advances in total credit of scheduledcommercial banks went up from 14 per cent in 1969 to around40 per cent by the end of the 1980s. The share of agriculturehad reached 19 per cent by 1985 and remained around that figureuntil 1990 [Chavan 2005:118]. The number of agricultural loanaccounts increased from around 1 million in the early 1970s tonearly 30 million by the early 1990s [Narayana 2000: 10]. Withinagriculture, 42 per cent of the credit went to small and marginalfarmers [Burgess and Pande 2002: 2].Ceiling on Interest RatesPerhaps the most important measure of social coercion de-ployed by the RBI was to affix ceilings for every size-class ofloans for the various priority sectors. Differential rates of interestwere introduced in early 1972. The scheme for providing cheapercredit to weaker sections was started in 1974. For this a ceilingof 4 per cent per annum was fixed. Banks had to provide 1 percent of their total loans within the priority sector at this rate.In 1978, the RBI directed commercial banks and RRBs to chargea flat rate of 9 per cent on all priority sector loans, irrespectiveof size. Down payments were not to be mandatory for small ruralborrowers. It was clearly recognised that cost of credit, ratherthan access, was the key constraint facing the rural poor. Afterall, the local moneylenders were all over the place but the waythey operated created more problems for the vulnerable ruralpopulation.Decline of MoneylendersSomething fairly dramatic happened in the 20 years followingbank nationalisation. The share of “exploitative” sources (pro-fessional moneylenders, landlords and agriculturist moneylend-ers) in rural credit fell from an average of over 75 per cent in1951-1961 to less than 25 per cent in 1991. The share of formalsector lending more than doubled between 1971 and 1991.Economic Development ImpactsA study of 85 randomly selected districts by Binswanger etal (1993) shows that bank branch expansion accelerated the paceof private investment in agriculture in the 1970s. A 10 per centincrease in bank branches raised investment in animals andpumpsets by 4-8 per cent. The demand for fertiliser was alsofound to be highly correlated with bank expansion. Burgess andPande (2002) devise an extremely sophisticated econometricmodel23 to study the economic impact of this explosive growthin rural banking during the period 1970-92. They find that bankTable 2: Share of Priority Sector Advances in Total Credit ofScheduled Commercial Banks, 1969-2005(Per cent)YearShare196914.0197221.0197525.0197828.6198135.6198438.1198742.9199040.7199334.4199632.8199935.3200234.8200536.7Source: RBI: Banking Services: Basic Statistical Returns, various issuesTable 3: Share of Rural Household Debt by Source,India, 1951-1991(Per cent)Credit Agency19511961197119811991Cooperatives andcommercial banks5.710.324.458.658.8Government and otherformal sources3.15.57.34.67.5All institutional agencies8.815.831.763.266.3Professional and agriculturistmoneylenders68.662.036.116.117.5Traders7.28.43.12.2Landlords7.68.64.04.0Relatives and friends14.46.413.111.24.6Other sources8.20.82.12.42.3All non-institutional agencies91.284.068.336.830.6Source not specified0.00.20.00.03.1Total100100100100100Note:In 1951, landlords and traders are lumped together within “othersources”.Source:All-India Rural Credit Survey for 1951, All-India Debt and InvestmentSurvey for the other years.
Economic and Political WeeklyApril 14, 20071356branch expansion into both banked and unbanked areas has asignificant positive impact on the growth of non-agriculturaloutput. They also find that expansion of banking into unbankedlocations contributed to the growth of the small business sector.This led to an increase in the share of non-agricultural labourin the total workforce and also a rise in the real wages ofagricultural labour. Most significantly, they find that expansion ofbanks into unbanked areas reduces aggregate poverty and therural-urban poverty difference. It is also found to reduce aggregateinequality in the economy. Burgess and Pande conclude that theseresults are precisely due to the “social coercive” elements of India’sbanking experiment – “namely expansion into unbanked loca-tions and priority sector lending” [Burgess and Pande 2002: 17].IRDP Disaster: Underbelly of NationalisationWhile the positive social and economic impacts of nationalisationare evident, the experiment is also a lesson in the disaster thatmindless bureaucratic programmes can become. The IntegratedRural Development Programme (IRDP) is a grim reminder ofhow mechanically trying to meet targets can completely under-mine the very integrity of a veritable social revolution, that acounter-revolution can be set into motion. Arguably India’sworst-ever development programme, the IRDP aimed at providingincome-generating assets to the rural poor through the provisionof cheap bank credit. Initiated in 1978 as a pilot project, the IRDPwas rapidly expanded to cover all rural blocks by 1980. It becamethe lynchpin of India’s anti-poverty effort in the 1980s. It peakedto cover over 4 million households by 1987.Several independent evaluation studies based on micro-surveysacross 11 states showed substantial mis-classification of bene-ficiaries under the IRDP, with better-off families being selected[Rath 1985]. Little support was provided for skill formation,access to inputs, markets and necessary infrastructure. In the caseof cattle loans, for example, a majority of cattle owners reportedthat they had either sold off the animals bought with the loanor that these animals were dead. Cattle loans were financedwithout adequate attention to other details of fodder availability,marketing of milk, etc [Shah et al 1998: 311]. As Dreze (1990)has pointed out, the IRDP promoted a very deep dependence oncorrupt government officials at every stage. It was principallyan instrument for powerful local bosses to opportunisticallydistribute their largesse. There was no attempt made to ascertainwhether the loan being provided would truly lead to the creationof a viable long-term asset. No attempt was made to work outthe necessary forward and backward linkages to ensure that theloan was a success. Little information was collected on theintended beneficiary. In chasing targets of high credit supply,what we may term as the “quality of lending” was completelyundermined. Working for the poor does not mean indiscrimi-nately thrusting money down their throats. Unfortunately, IRDPdid precisely that.The abiding legacy of the programme for India’s poor has beenthat millions24have become bank defaulters for no fault of theirown. Today, they find it impossible to rejoin the formal credit sector.The IRDP alone accounted for 40 per cent of the losses incurredby commercial banks in rural lending in 1988 [RBI 1995]. Thefinal nail in the coffin was the official loan waiver of 1989, whichdestroyed whatever semblance of credit discipline there was.25By the end of the 1980s, great concern began to be expressedabout the low capital base, low profitability, high non-performingassets and inefficiency of public sector banks. They were seenas being burdened with huge arrears, since their earnings wereinvariably lower than their loan losses and transaction costs. Theyrequired continual refinancing and recapitalisation by apexinstitutions. Loan recovery was regarded as an especially seriousproblem. Loans collected as a percentage of total amount duewas between 50 and 60 per cent throughout the 1980s and early1990s. Of the 196 RRBs, 173 reported losses in 1993. A 1993survey of rural households showed that only 12 per cent ofborrowers made regular repayments. Of those who took loansfor buying assets, 16 per cent never bought the asset, 50 per centhad sold the asset and 27 per cent said that their asset had beenstolen or had died [Meyer and Nagarajan 2000: 179-81]. A studyin Orissa found that loans were disbursed without assessing thefeasibility, viability and entrepreneurial experience of borrowers[Rajasekhar and Vyasalu 1993]. An RBI study of 300 ruralfinancial institutions across the country in 1984-85 found thatthey were unable to cover their costs [Satish and Swaminathan1988]. The study argued that break-even nominal interest rateswere 27 per cent, 28 per cent and 34 per cent for commercialbanks, cooperatives and RRBs respectively. Low interest rates,high transaction costs and low loan recovery rates were depress-ing bank profits.It must also be recognised that the expansion of the formalcredit sector, even in the period of social banking, showed a greatimbalance, being concentrated in the hands of the rich and thealready developed regions. The poor still depended on the informalsector in a big way.26Narasimham Committee 1991:Reforms and Their FalloutIt is against this backdrop that the RBI set up a Committeeon the Financial System in 1991 (chaired by M Narasimham).The Narasimham Committee placed its report centrally withinthe broader process of “liberalisation” of the Indian economy.It wanted to move towards “a vibrant and competitive financialsystem to sustain the ongoing reform in the structural aspectsof the real economy”. It took a clear view against using the creditsystem for redistributive objectives and argued that “directedcredit programmes should be phased out”. It wanted the branchlicensing policy to be revoked and interest rates to be deregulated.Future branch expansion was to depend on “need, businesspotential and financial viability of location”. In order that bankscould compete globally, it wanted major changes in capitaladequacy norms and a new institutional structure that was market-driven and based on profitability as the prime criterion. It alsowanted a larger role for private Indian and foreign banks.It can be clearly seen from Table 1 that after peaking to over35,000 in 1993, the number of rural bank branch offices steadilydeclined thereafter, coming down to around 30,000 in 2006. Theshare of these offices in total bank branches peaked in 1990 (58per cent) and steadily declined thereafter to under 45 per centin 2006. As we saw above, especially between 1977 and 1990,branch expansion exploded in unbanked regions, while decliningin already banked locations. After 1990, exactly the oppositestarted to happen. Mergers and swapping of rural branches, ratherthan expansion, became the norm. The number of RRBs that roseto 196 by 1990 had fallen to 104 by 2006 [RBI 2007]. A concertedeffortwas made to reduce the total number of loan accounts. Theysteadily fell from the peak figure of 659 lakh in 1991 to 524 lakh
Economic and Political WeeklyApril 14, 20071357in 2001, before increasing once again. Private banks have increasedtheir share in both credit and deposits from around 4percentin each in 1990 to around 18-19 per cent in each in 2005.The profitability of public sector banks has improved followingliberalisation. Total non-performing assets (NPAs) of publicsector banks as a proportion of total advances have declined [RBI,2006, Appendix Table III.26]. But the share of rural credit hasfallen continuously from the peak of 15.3 per cent in 1987 to8.4 per cent in 2006. The share of rural deposits has also fallensteadily from its peak of 15.5 per cent in 1990 to 10.8 per centin 2006 (Table 1). The sharp rise in rural credit in 2004-06 willhopefully lead to a trend reversal in these shares. The rural credit-deposit ratio of commercial banks fell from a peak of nearly 69per cent in 1984 to just 41 per cent by the end of the 1990s.It has also risen sharply in the last two years. But it remains wellbelow the levels in the 1980s. The incremental credit-depositratios have fallen even more sharply – for rural bank branchesfrom over 60 per cent in the 1980s to under 35 per cent in the1990s; for semi-urban branches, from nearly 49 per cent in the1980s to 30 per cent in the 1990s [Shetty 2005: 56-57].This decline in credit-deposit ratios has been the worst in thealready underdeveloped regions (Table 4). The intensity of bankinghad historically been the lowest in these regions but they bene-fitted greatly from the social banking period of the 1970s and 1980s.However, the post-reform period has once again set them back.Chandrashekhar and Ray (2005: 19) show that public sectorbanks have increasingly opted for investment in risk-free returnsof government securities, their share in total earning assets risingfrom 26 to 33 per cent during the 1990s. This trend has beenreversed in the 21st century.27But there is no doubt that theenforcement of stringent prudential norms, capital adequacystipulations, setting up of the Board for Financial Supervision(BFS) and pressure to reduce NPAs have made banks so risk-averse that they have reduced their exposure to private loans witheven a modest risk of non-recovery [Sarkar and Agarwal 1996].The rise in interest rates in 2006-07 has been seen as showingan “utter disregard for the development needs” of the Indianeconomy, with “adverse repercussions for medium and smallborrowers”, while rendering “in a nonchalant manner, largeproportions of bank credit to cash-rich corporates at below primelending rates” [EPW Research Foundation 2007: 621].Even in terms of sectoral direction of credit, the trends do notenthuse. The share of agriculture in total bank credit has fallenfrom 19 per cent in 1990 to under 11 per cent in March 2005.While Table 2 shows that priority sector lending remained ashigh as 37 per cent even in 2005, we must also note that thereform period led to a widening of the definition of the prioritysector in several ways that dilute the focus on agriculture andthe weaker sections [Chandrashekhar and Ray 2005: 20-24]. Theworst affected have been the poor. Sahu and Rajasekhar (2005,Table 11) show that the share of marginal farmers in disbursementof short and long-term loans by scheduled commercial banks(SCBs) declined by 6 per cent between 1991 and 2000. Theyalso show that the share of agricultural loans of less than Rs 25,000in total SCB credit fell dramatically in the 1990s [ibid, Table6].As the RBI itself said, “Direct finance to small and marginalfarmers (with land holdings up to two hectares) has been slowingTable 4: Region-wise Changes in Credit-Deposit Ratios,1981-2001(Per cent)Region198119912001Eastern545037Central (MP&UP)475033North-eastern435028Source: Shetty (2005: 58).Table 5: Trend Growth Rates of Scheduled Commercial Banks’ Direct Finance to Farmers (Short-term and Long-term Loans)(Per cent)Up to 2.5 Acre2.5 to 5 AcreAbove 5 AcreTotalAccountsAmountAccountsAmountAccountsAmountAccountsAmountLoans outstanding:1980s8.6119.3311.8021.487.4116.969.1718.391990s-3.697.65-1.588.95-0.928.05-2.278.17Loans Disbursed:1980s7.5118.3811.4521.557.2117.518.5118.611990s2.1611.845.7215.888.5516.314.9515.01Note:Trend growth rates are based on semi-logarithmic functions.Source:Report on Currencyand Finance 2000-01 (Table 3.15).Table 6: Share of Institutional Agencies in Outstanding CashDebt, Major States and All-India, 1971-2002(Per cent)1971 (NSS1981 (NSS1991 (NSS2002 (NSS26th Round)37th Round)48th Round)59th Round)Andhra Pradesh14413427Bihar*11477337Gujarat47707567Haryana26767350Karnataka30787867Kerala44799281Madhya Pradesh*32667359Orissa30818074Punjab36747956Rajasthan9414034Tamil Nadu22445847Uttar Pradesh23556956West Bengal31668268All-India29616457Note:2002 data for Bihar and MP exaggerate the decline after 1991 as theyrefer to the divided states after separation of Jharkhand andChhattisgarh, both of which have a comparatively much higher shareof institutional agencies.Source:NSSO (2005b, report 501, Statement 7, p 27).Table 7: Share of Debt Provided by Institutional Sources, 2003,All-India(Per cent)SizeClassofLandPossessedShare of Debt Provided by Institutional(ha)Sources (Per Cent)< 0.0122.60.01-0.4043.30.41-1.0052.81.01-2.0057.62.01-4.0065.14.01-10.0068.8>10.0067.6All Sizes57.7Source: NSSO (2005a, Report 498,Table 3, p 125).
Economic and Political WeeklyApril 14, 20071358down in recent years. The average growth in loans outstandingto marginal farmers has decelerated sharply during the 1990s ascompared with the growth recorded in the 1980s” [RBI 2002,para 3.48]. The evidence is summarised in Table 5.The RBI report goes on to reveal that direct finance to smallfarmers by banks fell from 15 per cent in the 1980s to 11 per centin the 1990s. Within this, there is a shift in favour of short-termadvances which the report views as “a matter of some concern,as it is likely to further accentuate the declining private sectorcapital formation in agriculture” (ibid). We know that both percapita foodgrain production and availability in India were lowerin 2000-03 than their pre-green revolution (1960-63) levels. Thedecline has been the sharpest in the 1990s. A major reason forthe slowdown in agriculture is the precipitous fall in publicinvestment in agriculture [GoI 2006]. The drying up rural creditis one integral element in this larger story.The single most disturbing feature of the post-reform periodis the return of the rural moneylender. A comparison of the shareof institutional agencies in outstanding cash debt in 1991 (NSS48th round) with that in 2002 (NSS 59th round) provides tellingevidence in this regard (Table 6). In all states, there was a dramaticrise in reliance on formal sources after nationalisation. But thistrend was reversed after 1991.The 59th round of the national example survey (NSS) showsthat the poorer you are, the more dependent you would tend tobe on exploitative sources of credit, something that was true evenin the colonial period (Table 7).It is clear that in the period of banking reforms, in the relentlesspursuit of profits, rural banks have forgotten what theirprimarymandate was and continues to be. The post-IRDPpendulum has swung too far in the opposite direction. While thereis no denying that IRDP represented a mindless, reckless disbursalof funds, the correction has now gone too far. The exploitativesector is back. The wheel has turned full circle over the last100years.Microfinance PhaseIt is into this vacuum created by the withdrawal of the statein rural credit that microfinance has entered. Both the NABARDand RBI define microfinance as the “provision of thrift, creditand other financial services and products of very small amountsto the poor enabling them to raise their income levels and improveliving standards” [NABARD 2000; RBI 1999]. Two broadapproaches characterise the microfinance sector in India – self-help group (SHG)-bank linkage and microfinance institutions.The SBL is the larger model and is unique to India but theinternationally more established MFI model is the one thatappears to be the increasingly favoured route.28The SBLapproach dates from the NABARD initiated pilot of 500 SHGsin 1992. NABARD has had a key role to play in initiating andnurturing India’s unique SBL programme. It was largely respon-sible for the RBI including Linkage Banking as a mainstreamactivity of banks under “priority sector” lending in 1996.NABARD’s work with its partner NGOs (Myrada, Pradan andDhan) also led to the government according “national priority”to the programme in the union budget of 1999. Beginning as apilot in 1992 with 500 SHGs, by March 2006, over 22 lakh SHGshad been provided with bank loans. They covered over 3crorehouseholds and had disbursed Rs 11,398 crore to theirmembers[NABARD 2006].29In comparison, the loans outstandingof162 MFIs in India were estimated to be around Rs 1,600 crorein March 2006 [Ghate 2006].The microfinance sector is still small in India but it is growingat an astonishing rate. While in 2001, the proportion of rural bankcredit disbursed through SHGs was less than 1 per cent, this figurehad risen to over 6 per cent the next four years.Microfinance has several strengths. Even during the socialbanking phase, it is undeniable that bureaucratic functioning andhaughty attitude of officials made banks highly unapproachablefor the rural poor. Going into a bank branch has always beena forbidding experience for village people, especially women.The requirement of collateral, as also the fact that credit wouldonly be provided for productive purposes, made it harder for thepoor to access bank loans. Banks do not provide credit even forhealth and education that can hardly be described as “consump-tion”. With the advent of reforms, access has fallen further. Insuch a context, microfinance offers a new ray of hope for therural poor. It makes finance accessible and available for con-sumption needs. Freedom from the need for collateral is the othergreat attraction of microfinance. These are the common featuresof the SBL and MFI models. But there are significant differencesin the two approaches, which have very serious implications forthe poor as also for the banking sector.SHG-Bank LinkageThe SBL approach involves the formation of SHGs (mainlyof women). These women regularly save money that is placedin a local (generally public sector) bank account. Many studieshave shown that creation of a safe avenue for savings (on whichinterest is earned) is an attractive feature of SHGs, whichhasledtosignificant promotion of savings [NABARD 2002;Hashemi et al 1996; Rajasekhar 2000]. The SHG has a set ofbye-laws devised and agreed by the members themselves.Theseinclude rules for monthly savings, lending procedures,periodicity and timing of meetings, penalties for default, etc.Meticulous accounts and records are maintained. The SHG itselffunctions like a small bank. The group lends money to itsmembers. After a certain period (six months to a year) of dis-ciplined functioning, it becomes entitled to a loan from the bankwhere it has an account.A number of studies document the positive economic impactof SHGs on indicators such as average value of assets perhousehold, average net income per household, employment andborrowing for income generation activities [Puhazhendi andSatyasai 2000; Puhazhendi and Badatya 2002; Harper et al1998].30 It has been shown that SHGs help inculcate the bankingTable 8: Size of the SHG Microfinance Sector in IndiaYearTotal Rural CreditCumulativeCredit(2)/(1) Per Centof ScheduledDisbursedCommercial Banksthrough SHGs(Rs Crore)(Rs Crore)(1)(2)2001544314810.8820026668210261.5420037715320492.6620048502139044.59200510997668966.272006175816113986.48Sources:Ghate (2006) for (2); RBI, Basic Statistical Returns, 2001-05 andQuarterly Statistics on Deposits and Credit of Scheduled CommercialBanks: March 2006 for (1).
Economic and Political WeeklyApril 14, 20071359habit in rural women [Varman 2005]. The running of an SHGis also a great lesson in governance. It teaches the value ofdiscipline, both procedural and financial. Well-run SHGs aresubject to external audits that enforce prudence. It broadens thehorizons and expands the capabilities of its members who haveto interact with the outside world, including banks, governmentdepartments and NGOs. Since most SHGs are women’s groups,the potential for women’s empowerment is huge. There isoverwhelming evidence that women-run SHGs are the bestmanaged with women showing much greater sense of respon-sibility as also a commitment to human development objectivessuch as health and education of their families [Pitt and Khandker1998]. There are reports of SHG office bearers being elected topanchayats and becoming more effective leaders in panchayatraj institutions.31In a word, it is not merely finance but empow-erment that is potentially achieved in good SHGs.32The problem with the SBL is that it is largely a government“pushed” model and has, therefore, suffered from all the infir-mities of any bureaucratic programme, run in a mindless, target-driven sort of way. All manner of government officials have beenasked to form SHGs, including anganwadi workers and forestguards. These people have badly failed to do their own jobsproperly. To expect them to undertake a task requiring muchenergy, motivation and creativity is absurd. As a result, theimpressive figures of the fast growth of the SBL model hide alot of poor quality work [Basu and Srivastava 2005: 1754]. Thishas had the impact of destroying the credibility of the SBL modelin the eyes of key stakeholders, including potential womenmembers, as also bankers.The other side of the problem is the attitude of bankers towardsSHGs – partly because of bad experiences of poorly run SHGsbut also owing to the bureaucratic insensitivity that characterisesbanking in India (both public and private). Bankers fail to recognisethe enormous self-interest banks have in the success of the SBLmodel – that there can perhaps be no better path to financialsustainability, which also helps banks fulfil their social respon-sibility, other than lending to SHGs. Banks can effect hugereductions in the information costs of lending to the poor whenthey go through SHGs by avoiding the usual adverse selectionand moral hazard problems [SPS 2006]. There is much merit inthe criticism that SHGs should not be seen as alternatives to publicsector banks [Swaminathan 2007]. It is clear that SHGs canflourish only when linked to these banks. But it also needs tobe recognised that these banks will not survive the new com-petitive environment of the banking industry unless they strengthentheir bonds with SHGs and their Federations.The real power of the SBL model lies in the enormous econo-mies of scale that are created by the power of SHG federations(each of 150-200 SHGs): for example in bulk purchase of inputs(seeds, fertilisers etc) and marketing of outputs (crops, vege-tables, milk, non-timber forest products, etc). They also providelarger loans for housing and health facilities to their membersby tying up with large service or loan providers. A variety ofinsurance services are also made available, including life, health,livestock and weather insurance [Vasimalai and Narender 2007].A study of four large SHG federations (including India’s oldestone) with a total of over 18,000 members in Andhra Pradeshand Tamil Nadu, shows that federations help make SHGsfinancially viable by reducing transaction and promotional costsas also default rates, provide them economies of scale, createvalue added services and build local human capital [Nair 2001].It has also been shown how doing business with SHG federationscan help public sector bank branches in remote rural areas becomeviable entities [SPS 2006].A number of studies have tried to assess the impact ofmicrofinance interventions on women’s empowerment.33 Whilethepotential for a positive impact is recognised, it is also clear thata great deal depends on the orientation and capacity of the agencyfacilitating the formation of groups. Since gender issues touchan epicentre of conflict in society, those engaged in formingwomen’s groups better be prepared, both intellectually andpolitically, to tackle challenges that lie on this path [Mayoux2002].Where groups are mere conduits for the lending andrecoveryof money (as in MFIs, see below) or when lendingistoindividuals, empowerment impacts are the least[Kabeer2005:4713].34SHGs do involve high transaction costs [Swaminathan 2007].Armendáriz and Morduch (2000) and Murray and Lynch (2003)argue that SHG group meetings are a costly affair for the poor.There is no question that there is investment of time and moneyinthis process. But if we recognise that “governance” and not justfinance is a major “deficit” in rural India, then we must viewthis as an investment in empowerment of women and the poor,which is not too high a price for the state to bear. NABARD’s“promotional” costs for SHGs, if well spent, can be an invaluableand a reasonable investment for achieving this socially desirablegoal. In any case, SHGs need support only for the initialyears,afterwhich they become financially self-sustainingentities[SPS 2006].35There is some critique of SHGs charging high rates of interestto their members [Chavan and Ramakumar 2005]. But we mustremember that SHGs (unlike MFIs) are member-run mini-banks.What they charge is also what they earn. The money remainswith them. Of course, as we shall argue, there is a need for interestrate caps in microfinance but it is useful to remember that themoney earned on interest by an SHG accrues to itself.Microfinance InstitutionsThe newly emerging (and internationally more established)MFI model is a different ball-game altogether. Here the sponsoris a profit-oriented venture capitalist, who sees the rural creditmarket as a fresh business opportunity. The MFI apparentlybrings great professionalism, innovation and technology to itsenterprise. It also ventures to provide loans that banks do not.But MFIs form no groups that are engaged in governance func-tions a la SHGs. Even when they operate through NGOs, MFIsare primarily concerned with lending and recovering (mostlyevery week) what they lend to cohorts of people, at times at veryhigh rates of interest. The recent suicide episode in AndhraPradesh [Ghate 2007] is a grim reminder of the possible extremeconsequences of MFI lending. Since profits are the overwhelmingconsideration for an MFI, there is enormous pressure to lend atall costs (“dumping money on borrowers” as Ghate calls it).36And concomitantly to recover. Added to this is the requirementof MFIs of a security deposit as cash collateral. As also highrates of interest, inevitable because of high transaction costsand a relatively low scale of operations. Another dubiouspractice of many MFIs is that they chargeborrowers intereston the entire remaining period as well, even if they were to returna loan early. This could become a killing penalty with longremaining periods. There is also a greatlack of transparency,
Economic and Political WeeklyApril 14, 20071360especially in “start-up”MFIs,about such practices [Ghate 2007].Join this to the fact that borrowers are often illiterate people,without adequate information on the terms of the loan, andwe get a potentially explosive situation, which in a vulnerablecontextsuch as Andhra Pradesh (already riddled with suicides)was bound to explode. Finally, the really poor do tend to beimplicitly or deliberately excluded as they are unable to bear thepressure of recovery [Ciravegna 2005; Scully 2004; Marr 2004;Simanowitz 2002].People are reported to have had to borrow from moneylendersin order to repay MFIs. Other borrowers have “absconded”,migrated or at times tragically committed suicide. This is linkedto abusive collection practices that MFIs sometimes resort to.“Abusive” is a well-defined technical term with strict usage inthe literature [CGAP 2004]. It includes “(i) adjusting overduesagainst the security deposit, (ii) holding the weekly meeting infront of the defaulter’s house, (iii) MFI staff sitting in front ofthe defaulter’s house, (iv) offensive language used by groupleaders or staff, (v) putting up a loan overdue notice in front ofa defaulter’s house” [Ghate 2006: 66]. Also mentioned are instancesof recovery of large individual loans by encashing signed blankcheques, legal action to enforce blank promissory notes andphysical force used by group leaders. There is huge pressure onall members because of joint liability. No one gets another loanuntil all repayments are made.A major demand of MFIs is that they should be allowed toraise interest rates in an unfettered manner. “No regulation cancontrol supply and price simultaneously. So if more credit hasto flow to farmers, the price (interest rate) must be deregulated”[Mahajan 2004: 33].37The enactment of anti-usury laws is saidto have led to a reduction in supply of credit and rise in interestrates. Our earlier discussion and data clearly show that this issimply not true. There was a massive expansion in the supplyof credit to the poor in the social banking era. And this was atlow rates of interest. It is only in the reform era that the supplyof institutional credit has contracted and the usurious money-lender has made a comeback.The suggestion that it is not the price of credit but itssupplythat is thereal problem, appears ludicrous in a socio-historical context where usurious moneylending has been at theheart of relations of power, which made credit easily availableto the poor but at a “price” that they just could not afford.However,todaytherearecalls, even in official documents, forthe poor to pay if they wanttogetoutofpoverty. The RBI’smicrocredit special cell proclaims:past experience shows that dollops of sympathy in the form ofsubsidy and reduced rate of interest have not helped matters much.Microcredit has to be commercialised where all patrons –Microfinance providers, intermediaries, NGOs, facilitators and theultimate clients – must get compensated appropriately... The cellbelieves that freedom from poverty is not for free. The poor arewilling and capable to pay the cost [RBI 1999: 12, italics added].There are many presumptions implicit in this view that needto be questioned: (i) that social banking was a mistake (ignoringthe real achievements of the period listed earlier); (ii) thatsocialbanking wasall about “dollops of sympathy” (overlookingthe theoretical basis on which it was grounded and continuesto operate in large parts of the world); (iii) that all “patrons”need“appropriate compensation” (it is clear that the goal hasshifted away from eradication of poverty as a moral obligationof the welfare state towards those in whose name it rules andthrough whose votes it derives its own legitimacy); and (iv) that“freedom from poverty” is nigh, now that profit-oriented MFIsare here.What Microfinance Can Do and What It CannotIt is the last proposition to which we now turn. It must beunderstood that microfinance by itself is no magic bullet – notfor poverty eradication, livelihood creation, empowerment ofwomen or the poor. As for MFIs, a paradox militates against theirvery survival. Given their relatively low scale of operations, theimperative of profits forces MFIs to demand that they be allowedto charge high interest rates. But such rates will only attract thosewith high-risk (and potentially high return) investments. Saferinvestors (with lower but more certain returns) will not borrowat such high rates. The consequent danger of default will be muchgreater for MFIs, which will negatively impact their profits and/or create unbearable pressure on borrowers with tragedies likethe Andhra Pradesh suicides as extreme possibilities. As Stiglitz(1993) has shown, market failures are even more pervasive infinancial than in other markets. This is the theoretical foundationfor the need for intermediation in these markets [Diamond 1984],because “information provision is a natural monopoly” [Sen andVaidya 1997: 5]. A recent international survey of MFIs concludesthat “due to the trend of commercialisation of the sector, financialsustainability is becoming more and more important at the expenseof using credit to help overcome poverty” [Hermes and Lensink2007]. Research also shows that increased competition amongMFIs may benefit wealthier borrowers but it lowers welfare levelsfor the poor [McIntosh et al 2005]. Are MFIs in India not indanger of repeating the 1940s’ and 1950s’ story of mushroomingprivate banks and rampant bank failures?38It is clear that in India, with one of the largest public sector bankingnetworks in the world, it is best for microfinance to build on theSHG-bank linkage model [Basu and Srivastava 2005: 1752-53].But even the SBL programme has a very specific place thatmust be clearly delineated – distress cash requirements,includingthosefor food; loans for health-related crises; easingthe hold of the moneylender-trader nexus; a secure and attractiveavenue for the poor to save and insurance. SHG federations canbe a powerful avenue for macroeconomic activities such aspurchase of inputs and sale of outputs at scale. They can becomea source of long-term, high volume “macrofinance” for activitieslike low-cost housing. These are new “civic institutions” [Vasimalaiand Narender 2007] or “community-based organisations” [SPS2006], involved not just with finance but also with humandevelopment issues such as education, health, sanitation, childnutrition and drinking water. Running SHGs and SHG federa-tions can be a unique empowerment experience for women. Thesefederations are also potentially powerful regional economic entitiesthat generate large-scale demand for a variety of goods andservices in rural areas, provided by both private and publicplayers.39But it must clearly be understood that poverty eradication inIndia’s backward regions is impossible without a critical mini-mum dose of public investments – in natural resource regenera-tion, sustainable agriculture and a whole range of nature-basedlivelihoods as also infrastructure – that create the enablingenvironment for private investments to flourish. One of the worstdirections the SBL programme has taken is its obsession withthe setting up of microenterprises, which has often been attempted
Economic and Political WeeklyApril 14, 20071361as mindlessly as the IRDP was. By itself microfinance can achievelittle even in this direction. Many allied inputs are required –forward and backward linkages (input-market support), appro-priate skills and technologies as well as finance for fixed assetsand working capital [Dichter 2004; Mahajan 2005]. Withoutworking out this entire package, microcredit can easily become“macrodebt”, pushing the poor into traps they find very hard toescape. It is truly ironic that the very same people who sing paeansof globalisation are promoting microenterprises as the answerto world poverty without waiting to reflect on how they expectthese microenterprises to withstand the unbearable pressures ofglobal competition.40ConclusionIn the fifth Henry Simons lecture delivered at the Law School,University of Chicago, James Tobin (1981 Nobel laureate ineconomics), spoke of “specific egalitarianism”, which he definedas “non-market egalitarian distributions of commodities essentialto life and citizenship”. As Tobin said, “In some instances, notablyeducation and medical care, a specific egalitarian distributiontoday may be essential for improving the distribution of humancapital and earning capacity tomorrow” [Tobin 1970: 276-77].In our view, rural credit fits very precisely into Tobin’s proposalfor “limiting the domain of inequality”, for lack of access to ruralcredit has certainly been one of the factors depressing growthin agriculture in the 1990s, which is today regarded as the maindrag on the Indian economy. More importantly, it has snowballedinto a veritable agrarian crisis, with thousands of farmers takingtheir own lives, and many others (in over 25 per cent of India’sdistricts) taking to the gun.In a penetrating analysis of rural finance, Bhaduri (2006) arguesthat the administrative costs of lending are bound to be high inrural areas. For one, the loan per borrower is typically low. Theseasonality of agriculture demands that loans be providedprecisely intime. And the sparse distribution of population,especially in dryland tribal areas, raises the cost of servicing,as also monitoring of loans. Moneylenders are able to cut costspartly because they are better informed about their clients. Butmost importantly since the profitability of lending depends “toa large extent on the vulnerability and weak bargaining positionof the borrower, it is likely that the lender would develop a sortof vested interest in the poverty of the borrower, that is in keepingthe latter sufficiently poor to be vulnerable” [Bhaduri 2006: 165].Bhaduri explains how private moneylending to the poor turns outto be so profitable, even as public sector banks find the same activitydifficult to sustain.41The mechanism is precisely the interlockedmarkets we described in the colonial period. The only collateralrural borrowers can offer is future labour service, future harvestor the right to use already encumbered land. The lender is ina powerful position to undervalue these not easily marketablecollaterals. This transfers the risk of default from the lender tothe borrower. Monitoring is no longer an issue as the borroweris far more worried about losing the collateral than the lenderis. And there is great incentive for charging usurious rates ofinterest because default will only mean that the lender grabstheasset offered as collateral. The moneylender could even besaid to prefer default to repayment. This is an extraordinarilyingenious but utterly exploitative relationship, which hassustained itself over centuries in India. It is deeply distressingto note that the government is even considering that it could “bringinmoneylenders” [Reddy 2006: 8] to solve the problem of ruralcredit.There cannot conceivably be a bigger disaster than that,especially when thousands of farmers are already being drivento suicide.The life of rural Indians in our period of study has beenvulnerable to shock, both ecological and market-induced. Thisvulnerability has grown in the post-World Trade Organisation(WTO) period [see especially, GoI 2007, chapter 7]. Rural creditis one of the cushions against such shocks. Rural incomes beingseasonal, credit is needed to smoothen out the asymmetry betweenthe flow of earnings and cyclicity of expenditure. Even 60 yearsafter independence, rural Indians have no guarantee of state-provided education and health. The public distribution and socialsecurity systems are wrecked by inefficiency and corruption.Social obligations, too, cast a heavy load on the rural populace.Each of the basic needs of health, education, food and socialsecurity, apart from the working capital and long-term investmentrequirements of rural livelihoods create a major demand forcredit. The formal banking system could provide some productivecredit requirements but it has suffered greatly from a lack ofprofessionalism and accountability in its functioning. The“consumption” needs of the poor also could not be met bythebankingsystem. In their responsiveness to the demands forequity, banks reflect the biases of a deeply divided society. Thus,the usurious moneylender holds sway in a context of imperfectand interlocked markets that operate as a strangulating nexus ofexploitation. After a brief period of 20 years where the mon-eylenders beat a tentative retreat, the period of reform after 1990has brought them back to the fore, especially for the rural poor.It is true that even in the period of social banking, rural elitesdisproportionately cornered the benefits of formal credit. Butinstead of addressing this problem, the reform period has onlyaggravated the inter-regional and inter-class inequities inruralfinance.Seeing unregulated MFIs as a solution can be a potentialdisaster. It has been rightly argued that “dilution of entry normsfor MFIs combined with a weak monitoring infrastructure carriesrisks of [poor, illiterate] consumers getting ripped off” [Srivastava2005: 3628]. There may be some grounds for raising interest ratesto promote cost coverage but they must, in all events, be keptwell below the rates charged by usurious moneylenders. It wouldnot be difficult to calculate breakeven rates and specify thesefor loan-size and borrower categories for all lenders (whetherbanks or MFIs).42Those unable to adhere would be automaticallyeliminated by competition. On the other hand, the programmeof linking SHGs with banks holds out great promise in providingneeds of the rural poor, in a manner that is financially and sociallyempowering for them. However, this must not be seen as a stand-alone, magic bullet. To meet the requirements of finance in ruralIndia, what we require is a package of changes that includes:(i) A massive increase in public investment in natural resourceregeneration (especially in rainfed India), ecologically sustainable,low cost, low risk agriculture and all forms of rural infrastructure;(ii) Market support for crops grown in rainfed areas, such ascotton, pulses and oilseeds (which have become especiallyvulnerable in the post-WTO period) [see GoI 2007, chapter 7for a detailed policy package];(iii) Reforms of public sector banking (including RRBs) aimedat strengthening capacity to deliver high quality credit. Thisincludes debureaucratisation of procedures and personnel and theinfusion of professional staff. The latter should be able to guide
EPW
Economic and Political WeeklyApril 14, 20071363repayment can become an additional burden on women. Kannabiran’s(2005) extremely negative about SHGs’ role in women’s empowermentneeds to be balanced with careful reading of Vasimalai and Narender(2007) and Fernandez (2007).34On the other hand, success poses its own challenges as evidenced in theattempted political capture of SHG federations in Tamil Nadu and AndhraPradesh.35The key issue is whether we value sustainability of microfinance overall other considerations. Fernandez (2007) strongly questions this tendency,correctly in our view.36A strange repetition of the sorry IRDP episode for completely differentreasons (that was the coercion of a mindless bureaucracy, this is theeconomic coercion of the greed for profits).37Raj, building on Keynes, had shown 40 years ago, that “monetary authoritieshave always considered it necessary to fix both” [Raj 1974: 303]. Aswe see it, there is no way you can increase supply of “genuine credit”(as against money, which becomes vicious debt) to the poor, withoutlowering its price.38Let us also not forget the negative experience of financial liberalisationin the southern Cone countries in the 1970s and 1980s, that is in sharpcontrast to the success achieved by the relatively “repressed” financialmarkets of Japan, Korea and Taiwan [Sen and Vaidya 1997].39The Kudumbashree programme of the government of Kerala with itsfederations of community development societies throws up many learningsin this regard (www.kudumbashree. org).40We may recommend to them a reading of Schumpeter’s (1942) “perennialgale of creative destruction”, if not Volume III of Marx’s Capital foran understanding of the process of “concentration and centralisationof capital”.41The recent rigorous models of imperfect credit markets and collectivepoverty traps developed by Banerjee (2001) contain an interesting discussionon similar lines.42Ghate (2006) estimates this to be 21-24 per cent. We strongly endorsethe stand of the union ministries of rural development and women andchild that the new microfinance bill must include interest rate caps.ReferencesAll India Debt and Investment Survey, various issues.Armendáriz De Aghion, B and J Morduch (2000): ‘Microfinance BeyondGroup Lending’, Economics of Transition, Vol 8, No 2.Baker, C J (1984): The Tamilnad Countryside, Oxford University Press.Banerjee, A (2001): Contracting Constraints, Credit Markets and EconomicDevelopment, Working Paper 02-17, Department of Economics,Massachusetts Institute of Technology.Basu, P and P Srivastava (2005): ‘Exploring Possibilities: Microfinance andRural Credit Access for the Poor in India’, Economic and Political Weekly,April 23.Besley, T (1995): ‘Saving, Credit and Insurance’ in J Behrman andTNSrinivasan (eds), Handbook of Development Economics, Vol IIIa,North Holland, Amsterdam.Bhaduri, A (2006): ‘Provision of Rural Financial Services’ in Employmentand Development: Essays from an Unorthodox Perspective, OxfordUniversity Press.Binswanger, H P, S R Khandker and M R Rosenzweig (1993): ‘How Infrastructureand Financial Institutions Affect Agricultural Output and Investment inIndia’,Journal of Development Economics, Vol 41, pp 337-66.Bose, S (2005): ‘Regional Rural Banks: The Past and Present Debate’, MacroScan,URL: http://www.macroscan.com/fet/jul05/fet200705RRB_Debate.htm.Burgess, R and R Pande (2002): Do Rural Banks Matter? Evidence fromthe Indian Social Banking Experiment.Catanach, I J (1970): Rural Credit in Western India, 1875-1930, Berkeley.CGAP (2004): Interest Rate Ceilings and Microfinance: The Story So Far,Occasional Paper, Washington.Chandavarkar, A (1984): ‘Money and Credit, 1858-1947’ in D Kumar (ed),Cambridge Economic History of India, Vol II, 1757-1970.Chandrashekhar, C P and S K Ray (2005): ‘Financial Sector Reform andthe Transformation of Banking’ in V K Ramachandran and M Swaminathan(eds).Chavan, P (2005): ‘How ‘Inclusive’ Are Banks under Financial Liberalisation?’,Economic and Political Weekly, October 22.Chavan, P and R Ramakumar (2005): ‘Interest Rates on Micro-Credit’ inV K Ramachandran and M Swaminathan (eds).Ciravegna, D (2005): The Role of Microcredit in Modern Economy: The Caseof Italy, www.flacso.or.cr/fileadmin/documentos/FLACSO/auCiravegna2.DOCDandekar, V M and F K Wadia (1989): ‘Development of InstitutionalFinancefor Agriculture in India’, Journal of Indian School of PoliticalEconomy, 1,2.Darling, M L (1925): The Punjab Peasant in Prosperity and Debt, OxfordUniversity Press.Diamond, D (1984): ‘Financial Intermediation and Delegated Monitoring’,Review of Economics Studies, Vol 51, pp 393-414.Dichter, T (2004): Remarks to the Microfinance Club of New York.Drechsler, W (2005): ‘The Rise and Demise of the New Public Management’,Post-Autistic Economics Review, http://www.paecon.net/PAEReview/issue33, September.Dreze, J (1990): ‘Poverty in India and the IRDP Delusion’, Economic andPolitical Weekly, Vol XXV, No 39, September 29.EPW Research Foundation (2007): ‘Need for Calibrated Policy in InterestRates and Credit’, Economic and Political Weekly, February 24.Fernandez, A P (2007): ‘Sanghamithra – An MFI with a Difference: AreSHGs Only Financial Intermediaries?’, Economic and Political Weekly,Vol XLII, No 13.Fisher, T and M S Sriram (2002): Beyond Micro-Credit: Putting DevelopmentBack into Micro-Finance, Vistaar, New Delhi.Ghate, P (2006): Microfinance in India: A State of the Sector Report, 2006,CARE and Ford Foundation, New Delhi.– (2007): ‘Consumer Protection in Indian Microfinance: Lessons from AndhraPradesh and the Microfinance Bill’, Economic and Political Weekly,VolXLII, No 13.Goetz, A M and R S Gupta (1996): ‘Who Takes the Credit? Gender, Power,and Control over Loan Use in Rural Credit Programmes in Bangladesh’,World Development, Vol 24, No1.Government of India (2005): Report of the Task Force on Revival of CooperativeCredit Institutions, Ministry of Finance.– (2006): From Hariyali to Neeranchal: Report of the Technical Committeeon Watershed Programmes in India, Ministry of Rural Development.– (2007): Report of the Working Group on Rainfed Areas for the 11th FiveYear Plan, Planning Commission.Haque, T and S Verma (1988): ‘Regional and Class Disparities in the Flowof Agricultural Credit in India’, Indian Journal of Agricultural Economics,Vol 43, No 3.Harper, M, E Esipisu, A K Mohanty and D S Rao (1998): The NewMiddlewomen – Profitable Banking Through On-Lending Groups,Oxfordand IBH.Hermes, N and R Lensink (2007): ‘Impact of Microfinance: A CriticalSurvey’,Economic and Political Weekly, Vo XLII, No 6, February 10.Kabeer, N (2005): ‘Is Microfinance a ‘Magic Bullet’ for Women’sEmpowerment?’,Economic and Political Weekly, October 29.Kalecki, M (1954): Theory of Economic Dynamics.Kannabiran, V (2005): ‘Marketing Self-Help, Managing Poverty’, Economicand Political Weekly, August 20.Keynes, J M (1927): A Treatise on Money, Vol II.– (1935): The General Theory of Employment, Interest and Money.– (1971): Indian Currency and Finance, Collected Writings, Vol I.Khandker, S R (2005): ‘Microfinance and Poverty: Evidence UsingPanel Data from Bangladesh’, The World Bank Economic Review,Vol 19, No2.Krishnaswamy, K S, K Krishnamurthy and P D Sharma (1987): ImprovingDomestic Resource Mobilisation through Financial Development: India,Asian Development Bank, Manila.La Porta, R, F L de Silanes and A Shleifer (2002): ‘Government Ownershipof Banks’, Journal of Finance, February.Mahajan, V (2004): ‘Deregulating Rural Credit’, Seminar, September.– (2005): ‘From Microcredit to Livelihood Finance’, Economic and PoliticalWeekly, October 8.Marr, A (2004): ‘A Challenge to the Orthodoxy Concerning Microfinanceand Poverty Reduction’, Journal of Microfinance, Vol 5, No 2.Marx, K (1976): Capital,Vol III, Penguin.Mayoux, L (2002): Women’s Empowerment or Feminisation of Debt? Towardsa New Agenda in African Micro-Finance, Department for InternationalDevelopment, London.

To read the full text Login

Get instant access

New 3 Month Subscription
to Digital Archives at

₹826for India

$50for overseas users

Comments

(-) Hide

EPW looks forward to your comments. Please note that comments are moderated as per our comments policy. They may take some time to appear. A comment, if suitable, may be selected for publication in the Letters pages of EPW.

Back to Top