Need for regulatory authority on microfinance institutions

Early this month, State Minister of Finance Ranjith Siyambalapitiya remarked that even though there are about 11,000 microfinance institutions operating in Sri Lanka, only five institutions had been registered (the Central Bank website shows only four). In this backdrop, the Government is planning to establish a separate authority to regulate microfinance institutions, highlighting the gravity of the predicament of the affected communities both in terms of politics and economics.

During the Budget Speech, President Wickremesinghe mentioned that the proposed Microfinance and Credit Regulatory Authority Bill will provide more secure legal powers for clients. Nevertheless, Amali Wedagedara – a researcher on agrarian debt and development – in a guest column to Daily FT a few days ago, illustrated a number of shortcomings in the proposed act that deserve the attention of policymakers. Currently, the Microfinance Act No. 6 of 2016 is the main piece of legislation which regulates institutions that carry out microfinance business activities in Sri Lanka.

It is reported that around three million people, particularly the rural, low-income communities, are experiencing various inconveniences from the irresponsible and unethical business activities of unregulated microfinance firms. The loan sharks disguised as microfinance entities have not even spared the country’s indigenous people. Recently, leader of the Sri Lankan indigenous community (the Veddas), Uruwarige Vannilaaththo had urged President Wickremesinghe to take immediate steps against microfinance firms which have swindled numerous people by offering loans at prohibitively high interest rates.

In a letter to the President, the Vedda Chief had mentioned that a number of members of his community had got entangled in loans. He had also pointed out that the contractual agreements for the loans had been drafted in English – a language his community does not comprehend – while claiming that loans had been borrowed without much thought. In certain areas, although the interest rates charged for loans are nominally mentioned in the range of 20% to 30% in the written contracts, the effective interest rates work out to more than 100%.

Majority of the affected individuals from the reckless and predatory lending practices of microfinance firms represent the underprivileged segments of the society, and women and illiterate citizens reflect an outsized portion of the victims. The crisis has caused a huge trauma on the borrowers, sometimes even leading to family breakdowns and husbands physically assaulting their wives who obtained loans at unbearable rates.

Microfinance has long been identified as a mechanism for eradication of poverty, especially in rural areas, by development economists, as it aims to provide financial solutions to low-income groups who are overlooked by the mainstream financial establishments because of their inability to offer sufficient collateral. Proper and regulated microfinance can help the poor to increase income, build viable livelihoods, and reduce their vulnerability to external shocks. It can also be a powerful instrument for self-empowerment by enabling the poor, especially women, to become economic agents of change.

Bangladeshi economist Muhammad Yunus was awarded the Nobel Peace Prize in 2006 for his work to create economic and social development from the bottom through Grameen Bank – a microfinance organisation and community development bank founded in Bangladesh. The bank is considered a successful model for fighting poverty as about six million people have received loans and it is currently operating in 94% of the villages in Bangladesh.

One of the prime reasons why people fall into the traps of predatory lending practices is the lack of financial literacy. The Financial Literacy Survey Sri Lanka – 2021 conducted by the CB found that only 57.9% of adults in Sri Lanka are financially literate. It is high time that steps are taken to make people financially literate beginning from the schools to ensure people do not get deceived by the unrealistic promises associated with the aggressive marketing strategies of microfinance firms.