Part 2: The Issues, Players and Outcome
In the past few months, the Indian microfinance industry has learned that not all publicity is good publicity. A few Kiva Fellows wanted to learn what the issues were, and what can be done to prevent them in the future. We will present our findings in a series of blog postings over the coming days. Given the inherent complexities, the multiple viewpoints and an ever changing political and legal landscape, our work is only intended to provide a top-level summary of the situation as it stands now. If you are interested in learning more about microfinance in India, we encourage you to explore these issues beyond what is presented, and to draw your own conclusion.
The microfinance sector in India is similar to many sectors that experience rapid growth – for every well run industry leader, there are several subpar, cut-rate institutions. In microfinance, this means organizations that support base of the pyramid entrepreneurs and focus on financial inclusion have been joined by predatory lenders who are focused solely on profit. It is also important to understand the role that the government and regulatory bodies have played over the past few months. In this piece, I will attempt to summarize the private and public sector issues individually.
The Rise of Indian MFIs
India was home to the fastest microfinance expansion in the world from 2003 – 2009, with the number of microloans rising from 1.0 million to 26.7 million (MIXMarket). However, unlike its neighbor Bangladesh, for-profit companies address the need for most people in India. Last summer, SKS went public (WSJ) and made millions for its initial backers. This began a rigorous debate about the level of appropriate profit based on lending to the poor and whether the rapid growth rates were driven by greed. However, those behind SKS and other for-profit ventures argued that reaching the poor in a large scale required being profitable enough to attract private capital. In an interview to Forbes India, Vikram Akula, the founder of SKS argued:
“Grameen Bank reaches 7 million clients and that’s amazing…[but] it … took 35 years to do that… Can you imagine how many generations it will take to reach 150 million poor households in India if we took that approach? We have to scale more rapidly, and only commercial capital will meet our huge funding requirements.”
The Problem with Copycats
Following at SKS’ heels (and success) were a string of other organizations based in the state of Andhra Pradesh. These new organizations decided to go after the same market since the villagers already understood the MFI’s model and how it worked. In some villages, farmers reported the arrival of over half a dozen microcreditors in quick succession. In an effort to grow their loan books, they were often willing to make villagers multiple loans without doing proper due diligence. The lack of a well-organized, high quality credit bureau didn’t help. Incentives for loan officers were often aligned with the number of loans they issued, as opposed to the quality of the loan. As a result, loans were given to individuals who were already at their debt capacity. Even Vijay Mahajan, the president of the microfinance industry association, has been critical (NY Times):
“In their quest to grow, they kept piling on more loans in the same geographies…That led to more indebtedness, and in some cases it led to suicides.”
Currently, loan officers stand accused of harassing and threatening borrowers, often in front of their neighbors and friends. As the vast majority of the loans in India are done on a group basis, if one of the borrowers cannot make his or her payments, the credit-worthiness of the whole group is put at risk. Mainstream media has gone as far as to claim that this has led to a string of suicides in the region. While the allegations remain dubious, it is possible. After all, social and economic pressures are often the drivers for suicides in the developed world as well.
(Too) Swift Justice?
The Andhra Pradesh government, reacting to a string of sensational news pieces in the media, decided to crack down late last year. It passed an Ordinance (refer to Part I of this series) in October of 2010, intended to protected the borrowers from further harassment. However, the drivers behind the Ordinance were far from altruistic. To understand this, we must quickly look at the history of small loans in India.
Before the emergence of non-governmental MFI’s around the world, a more government-driven solution was created in India to deliver financial services to the poor – the Self-Help Group (“SHG”). In this system, a group of women (10-15) join together and open a savings account. Once their savings reach a certain level, they can borrow more than they had saved. The National Bank for Agricultural and Rural Development, a government agency, backstops and drives the system with wholesale loans to commercial banks. These SHGs are organized by ‘promoters’ who get paid for their service. Thus, the interests of these promoters were threatened by the rapid rise in MFIs. These promoters not only resented the competition being brought in by the growing MFIs but also wondered how the MFIs could maintain a near-perfect repayment rate. This led some of the promoters to infer physical coercion on behalf of the MFIs. The recently passed Ordinance (Full Document) specifically tries to protect these very SHGs and their place in the market.
The Ordinance imposes burdens on MFIs without an equivalent demand from the SHGs. For example, the MFIs must obtain permission from the district government before lending to a SHG member but the SHG does not have to do the same. MFIs must also register with the district government it operates in and the district can shut down operations at any time “after assigning sufficient reasons” even if they are only at the investigative stage.
There is also a political drama unfolding on the side which much of the international media has ignored. The former Chief Minister (“CM”) of Andhra Pradesh, YSR Reddy, died in a helicopter crash in September of 2009. Shortly after, lobbying began to anoint his son, JM Reddy, as the next obvious CM. He failed to get the political backing needed from his party and eventually, Konijeti Rosaiah was picked as the new CM. Sakshi TV, a network owned by JM Reddy, spent the next few months criticizing the policies of the newly elected CM. This included the links between MFIs and suicides. Mr. Rosaiah, pushed by his own party for appearing weak to voters, passed the Ordinance without giving the MFIs and the public a chance to voice their opinion. Meanwhile, JM Reddy quit the party, formed his own independent party and continues to rally against the MFIs in an attempt to appeal to the base of the pyramid voters.
To summarize a complex issue, while government regulation was needed in this sector, the response was rash. The Ordinance was a loud, populist and heavy-handed attempt to appease critics, protect political interests and may end up harming the microfinance industry and its clients for the long term in India. The Ordinance comes off as assuming that MFIs are devils—companies that act out of pure greed rather than a mix of profit maximization and the pursuit of growth and genuine commitment to the financial inclusion of the poor. It also assumes that SHGs and district officials to whom MFIs must now pay obeisance are angels. The biggest problem right now is that the government cannot play the role of a referee because it is also a player. While the organization behind SHGs, SERP, is not technically a part of the government, it is an extension of it. SERP was directly threatened by the growth of MFIs.
At the same time, the Ordinance kicked off a much needed debate within the country and the microfinance industry globally. Self-regulation for the microfinance industry clearly failed in Andhra Pradesh. For the time being, the Ordinance put a freeze on the situation. If the problems with the Ordinance are not fixed quickly, it could put a permanent freeze on the microfinance industry in India. By some estimates, almost 90% of rural Indians do not have access to financial services. The SHGs alone cannot serve the need for India’s poor. MFIs are necessary to fill in that hole.
Work in Progress
Soon after the Ordinance was passed in Andhra Pradesh, the Reserve Bank of India initiated a panel to study the issues surrounding microfinance in the nation. Earlier this month, it released a report with its findings. A summary (Malegam Report) can be found here.
This is generally accepted as a much better piece of regulation which will take the place of the current Ordinance in Andhra Pradesh as well as regulate microfinance across the country. In the article referenced above, the author states:
“The Sub-Committee has cautioned that while recognising the need to protect borrowers, it is also necessary to recognise that if the recovery culture is adversely affected and the free flow of funds in the system interrupted, the ultimate sufferers will be the borrowers themselves as the flow of fresh funds to the microfinance sector will inevitably be reduced.”
Another interesting analysis of the Malegam Report is available here. As this is a recent development, expect all parties to share their views in the coming days and weeks.
To continue looking into the issue further, I encourage the following as starting points:
CGAP – Advancing financial access for the world’s poor (www.cgap.org)
Center for Global Development (www.cgdev.org)
The Economist (www.economist.com)
New York Times (www.nytimes.com)
Washington Post (www.washingtonpost.com)