Sri Lanka says access not interest rate matters in micro-finance

April 21, 2009 (LBO) – Low transaction costs and timely delivery is critical for micro-finance to be effective in lifting poor people out of poverty, a senior Sri Lankan central bank official said.

“Experience tells us that micro-finance alone is not enough to eliminate poverty because it only satisfies the funding needs of micro enterprises,” central bank deputy governor W A Wijewardena told an international symposium on microfinance in Colombo.

He said information about the market and consumer needs as well as acceptable business plans were also important for poor entrepreneurs relying on micro-finance.

“Funding is only one aspect. There are a large number of other requirements that need to be met.”

One of the most critical requirements is how to reduce transaction cost, the additional resources which a person has to spend other than that paid to the credit supplier in order to complete the transaction.

These comprise of legal fees, application fees, loan processing fees, taxes, and the opportunity cost for the time spent for pushing the application for a loan through the bureaucracy, Wijewardena said.

High Costs

High transaction costs associated with borrowing from conventional lending agencies might make low-income borrowers prefer the traditional village money-lender who charges exorbitant fees but with whom transaction costs are practically zero

Studies have shown that in lending programmes giving subsidised interest rates to farmers to encourage agriculture, the effective borrowing cost ultimately ends up far higher than even the free market interest rate because of high transaction costs.

The difference was a waste of resources that are not the income of anyone and are known as deadweight losses, Wijewardena said.

“So micro-finance institutions must keep transaction costs at a minimum,” he said.

Timely delivery of micro-finance is also important, such as for most agricultural business, which need funds for crucial expenses on time.

“For example, fertiliser must be applied on the due date for which they need money also on the due date,” Wijewardena said.

“So micro-finance institutions must release loans on the due date. Undue delays could be costly.

“Micro-finance borrowers do not need cheap credit but credit at zero transaction cost and on time,” he said.

Role Model

The informal money-lender provides a role model for micro-finance and instead of fighting them, micro-finance institutions should learn informal management principles from them, he said.

Wijewardena said that in Sri Lanka poverty alleviation has been one of the top-most priorities since independence from colonial rule.

The incidence of poverty has been reduced to 15 percent in 2007 from 28 percent in 2003.

“But this success is not enough,” Wijewardena said.

“In any country if a large number of people remain in poverty it is bound to cause problems for social cohesiveness and social harmony.

“So it is our duty to address the urgent requirements of poverty alleviation in which micro-finance is considered a potent instrument.”

He said micro-finance helps to fill the gap that occurs in other measures taken to alleviate poverty.

Safety Ropes

The usual government strategy in poverty alleviation is the attainment of high economic growth continuously over a long period of time where the benefits are expected to trickle down to the lower levels of society.

But he said that when macro policies are adopted, certain gaps are created in alleviation of poverty as a result of which some sections of society experience a worsening of their position because they are not able to move at the same speed as the growth of the economy.

“The problem is in meeting the needs of the large number of people who fail to perform according to the pace of the market because they have no capacity to do so,” Wijewardena said.

It is up to governments and other non-governmental organisations to have a good approach to take these people through the market mechanism with the ultimate aim of eliminating poverty, he said.

“The normal strategy is the introduction of safety nets to capture them before they make a free fall to the ground.”

These safety nets took different forms, starting with outright grants five decades ago to provide relief to the poor so they can at least fulfil their requirements of food.

But the weakness in such an approach is that there is no incentive for the poor to move out of the safety net because moving out means working hard to make a living, and they end up stagnating at the same level.

“So they are not able to get out of the vicious circle which traps both the aid giver and receiver,” Wijewardena said.

“Experience in poverty alleviation has shown that safety nets in the form of outright grants do not work.

“So safety nets were converted to safety ropes as a means for the poor to hang onto and climb upward.”
This led to the era of micro-finance which acted as a safety rope through which the poor could cross the poverty line.

Lanka Business Online

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