AMID the furore over loansharks imprisoning borrowers in apartments to enforce repayment and the subsequent clamour for tough government action against these callous moneylenders, three popular myths need to be debunked.

Myth No 1 – A high proportion of those who borrow from loansharks are gamblers. This statement is unlikely to be true. Gamblers almost always default on their loans. If loansharks lent mainly to gamblers, their non-performing loans (NPL) would be unsustainably high and they would soon go out of business.

That loansharking is a thriving business suggests most borrowers are non-gamblers with a good record of repayment.

Myth No 2 – To curb loansharks, the government should prosecute moneylenders and reduce significantly the number of moneylenders.  

Moneylenders who resort to violence should be prosecuted under relevant criminal and civil laws and this should be done quickly and consistently. But jailing loansharks could shrink the number of moneylenders without addressing the fundamental problem of demand.  

Despite exorbitant interest rates charged by loansharks and despite widespread publicity about their tendency to use violence, that many individuals continue to patronise loansharks suggests there is strong demand for fuss-free, unsecured personal loans.

Jailing loansharks will reduce supply without impacting demand. This phenomenon is evident in another sphere – drug busts. Whenever the police confiscate a huge cache of illegal drugs, inevitably, the street prices of these illegal drugs escalate.

This doesn’t mean the government shouldn’t prosecute loansharks. What it needs to do is adopt a two-track approach – enforcement and greater competition. 

Myth No 3 – Making loans without collateral is a losing business because the rate of repayment is low.

The phenomenal growth of microfinance institutions (MFIs) suggests otherwise. MFIs lend small sums of money to individuals to start profitable businesses. Properly run, the rate of NPLs is very low and some MFIs are highly profitable.

In Malaysia, the most notable MFI is Amanah Ikhtiar Malaysia (AIM). Under Budget 2009, AIM will be disbursing RM500 million this year to those earning RM1,500 or less.

In 1997, 618 MFIs had 13.5 million customers worldwide. Ten years later, the number had ballooned to more than 3,000 institutions serving 154.8 million customers with an estimated US$30 billion (RM105 billion) in outstanding loans, the Consultative Group to Assist the Poor, a World Bank unit that tracks and assists MFIs, says.  

A major challenge MFIs face is funding. Because most MFIs don’t accept deposits, the traditional source of capital is donations from individuals, philanthropic institutions and governments. But donations can’t keep pace with demand for microfinance.   

Recently, MFIs have begun to attract attention from some mainstream banks like US-based Citigroup, France’s Societe Generale, Germany’s Deutsche Bank and private equity groups. 

Sequoia Capital, a venture capital firm that funded Google’s startup, has invested US$11 million (RM38.5 million) in SKS Microfinance, the largest MFI in India. In 2007, Helios Investors, a UK-based private equity firm, paid US$175 million (RM613 million) for a 25% stake in Equity Bank, a Kenyan MFI eager to expand and challenge bigger banks. 

Banco Compartamos, a profitable MFI in Mexico, adopted another route. In April 2007, it raised US$467 million (RM1.6 billion) in a partial initial public offering (IPO) that valued the MFI at a staggering US$1.5 billion (RM5.3 billion). From 61,000 clients in 2000, Compartamos now has 1.2 million active clients and its rate of NPLs is just 1.9%.

Compartamos’s success stems from the fact it charges an interest rate that generates a profit – sometimes 100% interest on some loans. This profit-making stance has been harshly criticised by Muhmmad Yunus, the economist and Nobel Prize winner who founded Grameen Bank in Bangladesh in 1976.  

However, Gil Crawford disagrees with Yunus. Crawford, the chief executive of Microvest, a US-based fund manager with US$70 million (RM245 million) in microfinance in its portfolio, argues the alternative will force potential borrowers to turn to loansharks who charge even higher interest rates.

Providing more capital for MFIs also helps to foster greater competition, Crawford says. In Bolivia, competition has caused lending rates to fall from 100% to less than 30%, he points out.

Investing in MFIs can be profitable. Crawford says his first fund exceeded expectations by earning a 20% return last year.

“Oftentimes, microfinance companies’ returns on equity are higher than in the banking system,” says Robert Annibale, Citigroup’s London-based head of microfinance.

In short, encouraging the growth of more MFIs to provide greater competition to loansharks rather than jailing them is a better solution to the fundamental issue – the lack of fuss-free unsecured small loans that will enable the poor in this country to improve their businesses.    

Opinions expressed in this article are the personal views of the writer and should not be attributed to any organisation or financial institution she is connected with. She can be contacted at siokchoo.nsamail@gmail.com.