Micro-finance and Leasing: Today’s Loan Sharks

21 June by Ahilan Kadirgamar

It has taken the Central Bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

ECB : http://www.bankofengland.co.uk/Pages/home.aspx
many years to see what some of us have been pointing to since the war ended – that people in the north and east are in a massive debt trap.

When I set out to research rural incomes in Jaffna five years ago, it was evident that debt had become a central economic problem. In most villages in the north and east, any discussion about the rural economy would quickly get to the problem of crippling indebtedness. After years of indifference and denial by the state, last month, the Central Bank has finally acknowledged the issue prevalent in the war-torn districts.

Debt in the post-war north and east has had many phases, starting with loans linked to resuming agriculture, pawning, self-employment programmes and housing construction. The state’s vision of reconstruction – that a population devastated by war for decades could resume its economic life through loans – was severely flawed to start with. The result was not just the disruption of livelihoods and diminishing avenues for employment, but also continued dispossession. They lost even the few assets that remained with them after the war, and were pushed to abject poverty.

At present, the worst exploiters of the war-torn regions are lease-hire purchasing and micro-finance schemes. These schemes have been predatory, charging exorbitant interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
and extracting people’s assets. Their aggressive and often abusive collectors disrupt community and familial life to the extent that the women’s federations in some districts, particularly Jaffna and Kilinochchi, have appealed to their Government Agents to ban such schemes. The depth of the problem is also reflected by the increasing number of suicides and attempted suicides in the north and east linked to such indebtedness.


Credit and Dispossession

Credit has always been a problem for rural communities, as money lenders and other loan sharks have exploited and even bonded rural populations. In fact, even the history of co-operatives in Sri Lanka began over a hundred years ago as an effort by colonial officials to address rural indebtedness which they felt was undermining agricultural production. From the formation of co-operative credit societies in the 1910s to the formation of the People’s Bank in the 1960s, these formal financial institutions were initiated by the state to relieve rural people from the grip of predatory lenders.

Ironically, in recent times it is some of the formal financial institutions that are functioning as loan sharks. This situation is a consequence of the state’s failure to regulate these institutions, even as it privileges the financial sector as a whole.

Next, micro-finance schemes have become increasingly prevalent as rural women in the war-torn regions have become desperate for cash to sustain their homes

Central banks around the world have focused on regulating deposit-taking institutions, fearing that the collapse of such institutions would undermine confidence in the financial sector. Lending by financial institutions is not a priority for regulators, as they consider it the risk of the firms that lend, provided it does not affect the overall stability of the financial system. However, this does not address the tremendous impact of predatory lending on desperate marginal populations enticed into such schemes.

Next, while credit has always been important for economic production, in contemporary times, the role of credit has been complicated by a shift towards financialised accumulation. While capitalism has always worked through the accumulation of profits by exploiting labour in the process of production, over the last four decades, under the latest phase of capitalism called neo-liberalism, substantive levels of accumulation are through speculative and exploitative financial processes.

In recent decades, the repeated stock market and real estate bubbles and busts are reflective of such financialised accumulation and attendant crises.And it is the marginalised population that face the brunt of such crisis. For example, the sub-prime mortgage Mortgage A loan made against property collateral. There are two sorts of mortgages:
1) the most common form where the property that the loan is used to purchase is used as the collateral;
2) a broader use of property to guarantee any loan: it is sufficient that the borrower possesses and engages the property as collateral.
crisis of the late-2000s in the United States, severely affected Black and poor-White households who were evicted by their mortgage lenders, when the financial crisis ensued. In this way, mechanisms of financialised accumulation resulting in dispossession, are often masked and promoted as much needed credit for marginalised populations.


Predatory Loans

The north and east, economically and financially isolated from the rest of the country for decades, became a prime ground for extraction after the war. Consumer goods and vehicles on lease hire purchasing enticed the war-torn population. The purchasers make a down payment and then instalment payments continue for a number of months, and without adequate incomes, loans are taken to pay instalments. Eventually, they default on instalment payments and their leased articles are seized. Furthermore, the leasing company rarely pays back to the purchaser the additional value – accrued by the purchaser’s payments plus the value of the reclaimed article, above the original value of the article –as stipulated by the agreement. Thus the leasing company makes a windfall profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. , while the purchaser in turn has lost both the leased article and increased their debts.

Next, micro-finance schemes have become increasingly prevalent as rural women in the war-torn regions have become desperate for cash to sustain their homes. While some NGOs and even state agencies introduced micro-finance, drawing on the false idea that it can contribute towards poverty alleviation, the entry and proliferation of profit making micro-finance companies in recent years has resulted in predatory loans. In many villages in the north and east, women have taken multiple micro-finance loans, which entail weekly payments. Typically, a micro-finance company sends its agents into a village, who find a woman to base their operations, either out of her home or at a public facility in the village. That woman then creates groups of three to six women, who have to agree to cover each other for the weekly instalment payments. Such groups put tremendous social pressure on each other to make regular payments. The collectors sent by the micro-finance companies roam around the village are usually harassing those who do not pay the instalments. Such intrusion into village life has led to many a family breaking up, conflicts among neighbours and relatives who have taken loans together, and increased the vulnerability of women to abuse.

At present, the worst exploiters of the war-torn regions are lease-hire purchasing and micro-finance schemes. These schemes have been predatory, charging exorbitant interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates and extracting people’s assets.

In examining the micro-finance loans by these companies, most women borrowers do not know the interest rates, while some of their loan documents state the interest rates are on the order of 26% to 28%. Indeed, compared to some of the subsidized loans by state institutions for rural reconstruction of 5% and 8% loans, this is an extremely high interest rate. But the effective interest rate is much higher as I found out with many cases. For example, a loan of Rs. 100,000 at 28% annual interest means that at the end of the year they should pay back Rs. 128,000 which includes the principal and the interest. But these micro-finance schemes work by requiring weekly payment of Rs. 2,560 from the second week for the next 50 weeks. In other words, both the principal and interest payments are being made from the second week requiring a weekly flat payment. When I calculated the effective annual interest rate of this so-called 28% micro-finance loan, it was an incredible 69%. Thus micro-finance schemes are lucrative, and at such high interest rates, even if a third of the loans default, the company can still make a hefty profit.

Now, even successful companies rarely make returns above 30%. So, how can self-employed women make returns well above 80%, necessary to create a small income after they pay interest payments on the order of 69%?


Borrowing and Recovery

Predators thrive on desperation, and it is the most vulnerable in society that get caught by such micro-finance schemes. Rural women who have taken multiple loans, often speak of the Monday loan, Tuesday loan, Wednesday loan etc., referring to the different micro-finance companies, and spend much of their time finding ways to pay the instalment for that day of the week.

From the micro-finance companies’ point of view, they are recovering most of their loans. The crisis of non-performing assets that the Central Bank may be concerned about does not come about because there is recovery. The micro-finance business model is about loan recovery, often through coercive and abusive mechanisms, and certainly not about production or livelihoods. And it is these forms of indebtedness and dispossession that have thrown the war-torn society in the north and east into a severe rural economic crisis.

In this context, it is not just the micro-finance lobby Lobby
Lobbies
A lobby is an entity organized to represent and defend the interests of a specific group by exerting pressure or influence on persons or institutions that hold power. Lobbying consists in conducting actions aimed at influencing, directly or indirectly, the drafting, application or interpretation of legislative measures, standards, regulations and more generally any intervention or decision by the Public Authorities.
, but also the neo-liberal think tanks and economists that resist any moves to put a firm interest rate cap on such micro-finance schemes. If there was a strict policy ending loans say above an effective annual interest rate of 20%, it would certainly make a dent on predatory loans. Furthermore, given the need for rural credit, the Government needs to take responsibility and consider viable credit schemes, while in parallel considering a programme of credible rural development creating jobs and incomes. However, given the economic policy trajectory of the Government promoting financialisation, a solution anytime soon seems unlikely. Our solidarity now should be with the increasing voices and emerging struggles against the ruthless exploitation by today’s loan sharks, and that in turn may begin challenging the Government’s dangerous embrace of finance capital.


Source: The Daily Mirror, Sri Lanka


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