Business Times

Collateral free micro finance: Will the proposed Micro Finance Act kill it?

By Dulan de Silva

The role of micro finance meaning collateral free credit in reducing poverty in Asia and other developed countries including Sri Lanka during the last 20 years is unarguable. This was the rationale for giving Prof. Mohamed Younis the Nobel Prize for his contribution to poverty reduction and the reason why so many billions of dollars were invested by every single donor agency as well as many governments including Sri Lanka for micro finance.

Micro finance has undoubtedly contributed to Sri Lanka’s sharp drop in poverty from 22.4% to 15.6% in the last 10 years. If anyone wants evidence of collateral free micro finance’s contribution to poverty reduction, read “Analysis of the Effects of Micro Finance on Poverty Reduction” by Jonathan Morduch and Babara Haley for CIDA published as NYU Wagner Working Paper ( It should be noted that not only increases in income and savings result from micro finance but also it helps the poor to smoothen income as most poor including farmers, fishermen and even labour have seasonal income. It provides small credit for health and other emergencies and some NGO MFIs have commenced loans for house repair and other basic needs.

This article deals with the need for regulations and funding for NGO MFIs who primarily provide collateral free credit with borrower group guarantee as opposed to Banks, Finance Companies, Leasing Companies and Public Limited Companies who provide small loans with collateral or personal guarantee and still refer to this as micro finance.

The reason for writing this article is that the current Draft Micro Finance Act as shown in the Central Bank web site encourages formation of profit-motivated Public Limited Companies . The so-called micro finance of private banks, leasing companies, public limited companies and finance companies are loans averaging Rs.100,000 to 500,000 and given with collateral or personal guarantee. Provision of such small loans with collateral existed from 1960’s with both Bank of Ceylon and People’s Bank providing credit to paddy farmers taking land as collateral and no one called this micro finance. As opposed to this NGO MFIs provide small loans averaging below Rs.30,000 and with no collateral.

The draft legislation as it stands today states that a NGO MFI or a Guarantee Company (not for profit company) can only work in three districts. Further the government’s decision to take over the key source of funding for NGO MFIs which is the National Development Trust Fund under the new Sri Lanka Savings Bank threatens the main funding source for collateral free micro finance. The article stresses the importance for the government to provide an enabling environment for NGO MFIs to continue to provide collateral free credit to the poor specially for revival of North East and other poor dry zone areas of Sri Lanka.

Thus prior to imposing regulations the government should have an understanding of what micro finance is, a defination of what it is and have a well thought out policy.

Samurdhi: Government’s alternative to NGO MFIs

May be the government believes the country doesn’t need collateral free micro finance from NGO MFIs as it has the Samurdhi micro finance program. Some say Samurdhi is the world’s 4th largest micro finance program. But it also undoubtedly the world’s worst micro finance program of any significant size. It has not been objectively evaluated by any micro finance expert, has never been audited or supervised by an external party. It has 24,000 plus staff who are paid by the government and hence is hugely subsidized with the government bearing a cost of over Rs 1 billion annually. Further its success depends so much on the free money transfer some of which are made into compulsory saving. Few objective studies done by outsiders are cited below.

Respected researcher Dr R. Gunatilaka and Dr.Rozana Salih in a paper prepared for the Institute of Policy Studies done in 1999 titled “How successful is Samurdhi savings and credit programme in reaching the poor” and quoted by its Director Dr. Saman Kelegama at a meeting of ADB in Manila, have argued that Samurdhi's group savings and intragroup credit component and the Samurdhi Bank programme are functioning as vital sources of emergency credit for Samurdhi beneficiaries. However, programme sustainability is heavily reliant on the income transfer component. They also found that the micro-enterprise credit component has failed in its objective of promoting the poor to a higher income growth path. The high rate of default makes the micro-enterprise development credit program completely unsustainable in the long run.

Then Dr Salih in a paper presened to ILO Geneva in 2000 states that the long-term viability of the banks are questionable both financially and as social institutions in case the income-transfer component of the programme is eliminated.

Attempts to re-structure Samurdhi micro finance by ADB under the Rural Finance Sector Development Programme failed and considering the level of politicization of the organization it is unlikely to be sustainable on the long term. Hence it would be very dangerous to depend solely on Samurdhi to provide sustainable micro finance to the poor.

Sri Lankan situation

The first NGO to commence a modern micro finance programme in Sri Lanka was Sarvodaya under the name of SEEDS. This program commenced in 1986 and had 161,280 direct clients and over 200,000 indirect clients as at 31st March 2010 with an outstanding loan portfolio of Rs.3.8 billion. Over 80% of its direct loans are collateral. SEEDS works in 25 districts and is now profitable, contributing profits to the social welfare work of Sarvodaya. SEEDS also provides direct employment to 1,080 persons.

Berendina Micro Finance Institute, another smaller NGO MFI provides loans at 11 to 14% and in three years has become operationally sustainable seeking funds only for expansion mainly to the East. All its loans have no compulsory savings as done in Samurdhi, has no individual or group collateral as taken by banks or leasing companies.

Thus NGO MFIs are not only providing collateral free credit they are also not a burden on the treasury nor donors.

The micro finance network has collected data from 50 MFIs and it shows that 14 leading NGO MFIs which currently work in more than three districts provided over 400,000 families with loans, 90% of which are collateral free small loans to the poor. These are small loans generally averaging around Rs.20,000. Thus NGO MFIs assist over 1.5 million people (7.5%) of the population. Further the effective interest rates of a majority of NGO MFIs are much lower than that of the majority of these finance and public companies. This is due to additional charges imposed by them and due to the fact that the borrower has also to bear the cost of visiting the institutions for a number of days to fulfill the requirements to be eligible for a loan.

The micro finance sector specially the NGO MFIs are thankful to the government for bringing forth the draft Micro Finance Act as displayed in the Central Bank web site. This is an encouraging move for the sector as it permits poor clients to save with NGO MFIs. To the poor savings are as important as credit. Secondly this provides a source of capital for NGO MFIs to expand as they were shrinking due to limited access to capital. SEEDS was forced to apply for the status of a finance company due to not being able to access savings freely.

However there are recommendations in the Act which will seriously affect the NGO initiated micro finance work. This is in particular the clause (Part 11) sub sections (1) (2) (3) which restricts NGO work to three districts only. This will seriously harm the growth of genuine modern poverty focused collateral free group inter se (group guarantee) micro finance. If this condition has been imposed in the draft Act due to fear of lack of assets in some NGO MFIs this could be addressed by providing a national license only to those NGOs which meet minimum capital requirements and also by enhanced deposit insurance and other alternative ways.

If NGOs are forced to become Public Limited Companies in the long term they will also be driven by private profit motive . This has already happened in Latin America where in countries such as Peru, Equador and Bolovia all good former NGO MFIs are joint stock companies with profit motivated private investors controlling them. Average loan size of these so called micro finance agencies is over US$500 whilst a large number of poor now have no access to micro finance.


In the initial years of micro finance in the 1970s and 1980s NGOs were dependent on grants from donors to provide loans as well as for initial capital and administrative costs. But over time this changed and by early 2000 such access was not there and all funding came from loans mostly soft loans provided by development agencies.

The Government of Sri Lanka with funding from World Bank initiated the Janasaviya Trust later changed to National Development Trust Fund (NDTF) to provide funding and capacity building for NGO MFIs and Co-operatives who provide collateral free credit to the poor. However early this year NDTF and its Rs.7 billion fund have been handed over to the newly formed Sri Lanka Savings Bank. Though the current Board and management of the bank may continue with funding for NGO MFIs and co-operatives, one is not sure what will happen over time. This puts at risk the main source of funding for NGO MFIs and Co-operatives that provide loans to the poor. In contrast the World Bank initiated PKSF the sister organization for NDTF in Bangladesh remains autonomous and has provided US $262.14 million to 192 NGO MFIs in the year ended 30th June 2009.

Secondly the Exchange Control department has stopped allowing NGO MFIs mostly Guarantee Companies from taking foreign loans for micro finance. As there are a number of international social loan providers in this sector which provide low interest loans for good MFIs, this is a major blow to the growth of the sector. So far not a single NGO MFI has failed to repay previous foreign loans and secondly the government is not responsible even if a NGO fails to repay such a loan. In the proposed regulated environment chances of access to such foreign loans will increase and hence the government should consider permitting NGO MFIs to receive foreign loans from social investors.

Bangladesh and Indian situation

In Bangladesh large ‘not for profit’ NGOs dominate the field and not Public Limited Companies. For example in Bangladesh where Micro Finance Regulations were enacted in 2006, NGO MFIs are permitted to work in any number of districts and dominate the sector. There are 503 NGO Micro Finance Agencies licensed by the Micro Finance Regulatory Authority.

Some 15% of the population of Bangladesh benefit from NGO micro finance. In Bangladesh large NGO MFIs such as ASA alone has 5.4 million loan clients, US$ 457 million in outstanding loans, US$118 million in savings and the average loan size is a mere US $178 as of December 2009. ASA is profitable, ploughs back all profits for further expansion and they together with other NGO MFIs have contributed significantly to halving poverty levels of Bangladesh from 1970s. Well over 90% of all NGO MFI loans in Bangladesh are without asset collateral and purely based on group guarantee. As stated earlier they have a secure source of funding and capacity building in PKSF and the government also permits foreign loans to MFIs.

In India too NGO MFIs are significant with Indian Rupees 351 billion in outstanding loans to 86 million clients as at 31st December 2009. The other main provider of collateral free micro finance in India is Self –Help-Groups and not Public companies. Self Help Groups (SHGs) provided 54 million loans worth Indian Rupees 241.9 billion (US$ 5.43 million) in the year ended 31st March 2009.The government of India has ensured funding for SHGs by instructing the banks to provide a % of its loans to these entities at subsidized rates. The highest drop in poverty in any state in India in the last 10 years has been in Andhra Pradesh, the state which has the largest amount of Self Help Groups.


The proposed Act promotes profit making Public Limited Companies and discourages NGO MFIs and not for profit Guarantee Companies. The current Finance Company Act and the Leasing Company Act are adequate for any profit minded companies to provide small loans to people keeping collateral. The Micro Finance Act should focus only on collateral free loan providing NGO MFIs and on Cooperatives if the current Co-operative Act is inadequate.

If the proposed Act is implemented as it is, a large number of profit minded companies will flood the market as the capital requirement will be below that of Finance Companies and they will by and large provide loans taking assets as collateral. They will also be able to take in savings. There is no need for this as the existing Finance Act does not prevent anyone from doing such business. Some regulatory and policy requirements needed for these NGO MFIs to grow and contribute to poverty are:

  • Limit the Micro Finance Act and Regulatory Authority only to NGO MFIs (not for profit agencies) and Cooperatives.
  • Let the Banking Act, Finance Company Act and Leasing Company Act be the regulating authority for small credit by profit minded institutions.
  • Enable NGO MFIs to work in any amount of districts without limiting them to three districts.
  • Define micro finance loan size to be below a defined figure and insist that average loan size is kept down below a defined figure. Both to be adjusted based on inflation.
  • Discourage asset collateral by NGO MFIs by limiting this practice only for loans above say Rs.100,000. Ensure that such loans are only around 10% of the loan portfolio.
  • Ensure that all assets of such NGO MFIs are registered in the name of the NGO and not that of private individuals.
  • Ensure the independence of the National Development Trust Fund (NDTF) under the Sri Lanka Savings Bank and restrict its loans only to NGO MFIs and Cooperatives and any government banks. Or revert it to its previous autonomous state as final amalgamation has not yet happened.

Unlike the highly subsidized Samurdhi Program, NGO MFIs are not a burden to the Treasury. It can be a powerful tool in rehabilitation of North East. The government should take into account these facts and consider making required amendments to the Micro Finance Act to focus on NGO MFIs providing collateral free micro finance and Cooperatives only and to create an enabling environment for them to grow and perform in order to make an even greater contribution for poverty reduction in the island.

(The writer is Chairman of Berendina Micro Finance Institute and an International Consultant on micro finance and poverty alleviation. He was the founder Chief Executive of SEEDS (Gte) Ltd).

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