In late 2016, many presumed Indian microfinance institutions would be adversely affected by India’s sudden demonetization law. Surprisingly, events unfolded quite differently to expectations.
On November 8, Prime Minister Narendra Modi announced the withdrawal from circulation of all Rs500 and Rs1,000 bank notes in a bid to combat black money and curtail the use of counterfeit cash. The objective was also to slowly introduce the country’s population to a digital economy. The action was driven by good intentions, although it initially caused so me disruptions in the economy.
In India, where ADB’s Private Sector Operations Department has been carrying out the Microfinance Risk Participation and Guarantee Program since 2012, many of our partner microfinance institutions temporarily stopped lending to low-income people as they were not clear how those loans would get repaid – in particular in rural areas. In the first few days and weeks, collection rates dropped to as little as 10%-20%.
Five months after demonetization, the uncertainty has started to fade.
The situation regarding the drop in collection rates has improved significantly. As of February 2017 most microfinance institutions reported collection rates of over 85%. By the end of the next quarter, with the exception of a few geographical pockets, collections are expected to normalize. Disbursements are also returning to normal.
Demonetization showed the poor’s resilience to external shocks
Two things struck me in the aftermath of demonetization, after talking to borrowers, partner banks, and microfinance institutions.
The first was the resilience shown by most microfinance clients. I expected expressions of angst from groups of inconvenienced people, but witnessed none. Microfinance clients patiently waited in long and winding queues in blistering heat to exchange their old bank notes for new ones.
Some were absorbed in their own thoughts, resigned perhaps to the fact that without the acceptable currency in their hands, their daily routine would simply come to a halt in India’s overwhelmingly cash-based economy.
Our partner microfinance institutions told us that most clients really wanted to keep on repaying their loans, and did not use demonetization as an excuse to default; they simply did not have the new bank notes available. One can only imagine how difficult it must have been to exchange new notes in rural areas with few commercial bank branches.
A catalyst for digitization
The second highlight is how demonetization has spurred innovation in the digital space. The experience triggered an appreciation of alternative modes to cash transactions such as digital delivery channels and mobile phone banking, e-wallets, or bank transfers.
Microfinance institutions that had digitization on the back burner reacted with speed to adapt to the new environment. Bank accounts were opened, loan disbursements by bank transfer introduced, e-wallets established, clients briefed.
India is becoming a world leader in digital microfinance. This is supported by India’s national identification system, Aadhaar, which has provided unique IDs to over 99% of the country’s adult population. Digital financial services can have many benefits, like cost efficiency for institutions. This is crucial when delivering services in more remote, less populated areas, where transactions are few and amounts small.
Digitization also makes banking more convenient and secure for clients, especially women. Payments can be made anytime, anywhere, for example through a mobile phone app, without having to carry cash or visit a bank branch. The downside is the target population is generally not knowledgeable about these new digital financial products, and delivery channels need to be carefully introduced by financial literacy and technology training programs.
By harnessing digital finance, we can supplement the resilience of India’s microfinance clients with real-time support when they need it most.