By Charitha Ratwatte –

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 Bank’s 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 GA’s approval and with Divisional Secretaries’ (Div Sec) recommendation.

The letter banned weekly collection of instalments. The MFI’s 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 Bank’s 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 Bank’s 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 Lanka’s 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.