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Backgrounder on India’s Microfinance Crisis
November 1, 2010
What’s happening in Andhra Pradesh?
On October 15, the government of Andhra Pradesh, India’s fifth-most-populous state, issued an ordinance aimed at protecting women who “are being exploited by private microfinance institutions through usurious interest rates and coercive means resulting in their impoverishment and in some cases leading to suicides.” The ordinance seems designed to quash microcredit in the state, where it has grown explosively in the last five years through a process of commercialization that has brought ample capital and made millions for some investors and founders.
Unfortunately, the ground truth remains murky for those removed from the situation. On the one hand, the harm of microcredit appear exaggerated in much of the current rhetoric: the inflammatory suicide charges may have been ginned up by the papers and political players with vested interests in other forms of microfinance. Still, there is good reason to worry that the fast expansion has gotten many poor people into debt trouble—into situations in which repayment is coerced, verbally or even physically, by peers and loan officers. What is beyond doubt is that the Indian microcredit industry, the largest in the world, is in serious peril; and that this crisis is sure to seed discussion worldwide about whether and how microfinance institutions (MFIs) can commercialize responsibly.
What does the ordinance do exactly?
The ordinance requires, among other things, that all microcreditors cease disbursing and collecting loans immediately, pending registration with local officials—a registration process whose tempo would lie entirely in the hands of these officials. The ordinance also gives such officials the power to revoke registrations at any time for any reason. And it limits interest rates to 100%/year, which is odd since most MFIs there charge in the 20’s. More subtly, the ordinance has fostered an hostility toward microcredit throughout the state. On October 22, police arrested loan officers working for SKS and Spandana, two big lenders, for harassing a borrower named Ammulu. They indicated their interest in arresting the chiefs of the two organizations, Vikram Akula and Padmaja Reddy.
The Microfinance Industry Network (MFIN), formed earlier this year, quickly sued, and won a temporary stay on October 22. However, as I have blogged, microcredit loans are like sand castles: without constant maintenance, they quickly fall apart. Why? In the absence of collateral, three main factors coax steady repayment out of microcredit borrowers: the habit and discipline of weekly payments, peer pressure from jointly liable borrowers, and access to new loans if old ones are repaid on time. By creating uncertainty and cuing local officials to obstruct microcredit, this ordinance is undermining all three factors. If people doubt that MFIs will be around tomorrow, they will think twice before repaying today. And if their neighbors stop paying, they’ll think thrice, for fear of being fools. Default can spread like a contagion.
The uncertainty is biting. One Indian microcredit executive quoted in the Financial Times sounded as if he was dying of thirst: “Cash flows are getting worse day by day . . . We cannot sustain this for long. We will be dead very soon.”
Whence the backlash?
Andhra Pradesh is the hotbed of microcredit within India, which in turn just surpassed Bangladesh as the country with the most microloans. The growth rates have been unprecedented and stupendous. SKS Microfinance, the leader, exploded from 11,000 borrowers in 2003 to 5.8 million earlier this year. SHARE, Spandana, and BASIX, also based in Andhra Pradesh, have grown comparably, reaching more than a million clients each.
The expansion has been based on the importation of the group microcredit model, famously refined by the Grameen Bank in Bangladesh, into the similar context of southern India. But in contrast with Bangladesh, where the microcredit industry grew more gradually and is largely non-profit or cooperatively owned, another basis of the Indian expansion has been commercialization. The big Indian MFIs are for-profit. This has allowed them to raise funds from venture capitalists such as Sun Microsystems founder Vinod Khosla. And it allowed SKS to go public this summer, a deal that earned Khosla $117 million.
With the equity in hand as a shock absorber for losses from defaults, the Indian MFIs have then gone to banks to leverage each dollar of equity into a typical $3–9 in loans, which they then pour into new microloans. In fact, India’s priority sector lending rules, somewhat like the U.S. Community Reinvestment Act, require that domestic banks channel 40% of their credit to certain activities or groups of people deemed particularly deserving. Currently, MFIs qualify to drink from this torrent of capital. In a sense, then, the multimillion-dollar profits of Khosla, SKS founder Akula, and others accrue from the subsidy embedded in this social policy.
Just as in 2007, when Mexico’s Compartamos went public, the sight of investors making millions off loans to the poor has aroused intense controversy. Among the charges:
- It is immoral to get rich off the poor.
- When microcreditors cede ownership to outside investors, they can no longer be trusted to put the poor ahead of profits. Indeed, argued Nobel laureate Muhammad Yunus in a debate with Akula, “microcredit” becomes “moneylending.”
- The interest rates are usurious…even though they are not much higher than those charged on U.S. credit cards.
- There have been harsh collection practices, perhaps particularly among dubious fly-by-night operations appropriating the mantle of microcredit. There are stories of goons hired to threaten defaulters with violence. And now microcredit-induced suicides are being reported in the papers and government documents.
- Just as in the subprime crisis in the U.S, which was also partly propelled by social policy [but see comments below], the fast growth has caused careless lending. While it is hard to judge this issue precisely, there seems little doubt that many people are borrowing from several MFIs at once, that micro-debt levels have risen fast, and that all of this is cause for serious concern. On the one hand credit can be a life saver (if it finances medicine); on the other, when credit is easy, people are often poor judges of how much they can handle.
In my view, the primary issues are the last two, perhaps especially the last: has rapid growth caused microcredit to hurt more than it helps? I take the suicide reports with a lot of salt. Last year, rigorous studies found little impact of microcredit on poverty—and demonstrated the danger of drawing conclusions based on heartwarming stories. We should interpret heartrending stories cautiously too. Stories can cut both ways: a Wall Street Journal reporter just visited the mother of man whose suicide police were investigating for a microcredit link. The mother blamed his death on debts to moneylenders, not microcreditors.
So is the backlash is all about the harm to poor people?
No. The truth appears be more sultry. Before the non-governmental, Bangladeshi-style MFIs stampeded onto the scene, a more distinctively Indian, more government-driven method for delivering financial services had grown large: the Self-Help Group. In this system, some 15 women join together, open a joint bank account (which most have never had individually), and begin to save regularly. Once their savings reach a certain level, they can borrow even more than they have saved. The National Bank for Agricultural and Rural Development, a government agency, backstops and drives the system with wholesale loans to the banks.
But SHGs do not generally arise spontaneously. Groups called “promoters” organize them, and get paid for the service. Thus the interests and the ideology of these promoters, which have formed 4.5 million groups so far, are directly threatened by the rapid advance of the MFIs. A new report from Intellecap, a consultancy based in the Andhra Pradesh capital of Hyderabad, compares the drama to a Bollywood plot. The propriety the upstanding, establishment-minded first-born brother clashes with the brash, somewhat overzealous younger one. More specifically, the report argues that SHG promoters and their allies, in addition to resenting the competition, may be mystified by the how the MFIs achieve nearly perfect repayment rates (unlike SHGs), and infer physical coercion.
The role of SHGs as an interest group is not conjecture: The recent ordinance casts itself as defending SHGs. The women it seeks to protect, referred to in the quote at the top of this backgrounder, are stated to be the women of SHGs. The provision allowing local officials to revoke registrations singles out SHGs as complainants who could prompt such action.
So is the attack on microcredit warranted?
While the moves in the grand game are easily described, what is going on in the villages is hard to discern. Sensationalist stories about suicide do not suffice to inform us.
Though the largest backlash against microcredit in India, it is not the first. Investigations of past incidents have concluded that while local religious and political leaders, and certain vested interests, instigated the challenges, the microcreditors had much to answer for, in pushing credit and collecting payments so aggressively. Some, for example, forced women to sit in the weekly group meetings for hours until everyone made payments. This time around, the situation is similar, according to one industry insider. SKS founder Akula once told me that he took inspiration from Coca Cola, a company that came into India and quickly scaled up with a standardized product. But if a soft drink industry’s growth outstrips demand, this becomes immediately obvious through depressed prices or overfull warehouses. When a credit industry grows to fast, the very growth can mask the problem. The fundamental source of the instability is that credit is like an addictive drug: people who buy too much often respond by buying more.
That said, as the Financial Times has argued, this precipitous, politically driven, and vaguely worded ordinance is unnecessarily destructive of the microfinance industry specifically and the Indian business environment generally. It is far from the ideal as an approach to wrestling with the complex challenge of reining in microfinance so that it optimally serves the poor. Most worrisome is the appearance that interests and ideology of the SHG camp are overriding an open-minded, empirical analysis of whether a sudden shutdown in access to credit serves the poor.
In connection to the question at the heart of my forthcoming book (draft chapters listed at right)—does microfinance work?—the Andhra Pradesh debacle drives home a key point. To evaluate microfinance, you cannot just look at randomized trials in isolated locations, important as those are. You must also come to grips with the dynamics of the industry. Imagine if rigorous studies of subprime mortgages in the U.S. in 2003–04 had concluded that they were working great—borrowing households earned more, spent more, etc. That would not have been the whole story. A tough, core question for me is: when is growth development…and when is it the opposite?
What will happen next?
Knowing little about the Indian political scene and legal system, it is hard for me to speculate. And I suspect those closest to events are unsure. Investors have knocked down SKS’s share price, one indicator of future prospects, by 40%—but that only brings it back to the IPO price, which is still arguably quite rich. In fact, SKS is better positioned to weather the crisis than most of its competitors. It alone got to market in time to raise more capital (while the others will have to put their IPO plans on hold), and has a low debt-equity ratio (“leverage”) of around 3. That means that it could sustain losses of one-third of its loan portfolio without defaulting on any of the loans it owes to banks. (Shareholders would be wiped out though.)
A best-case scenario is that the Indian industry survives, wounded, wiser, and more responsible. In that case, this episode will be seen as a brutal but perhaps healthy check on the excesses of an industry. But because the main assets of the industry—its outstanding loans—are so delicate, this outcome is by no means assured.
And while the circumstance of the crisis are unique to India, it seems likely to spawn discussion worldwide about whether and how commercialization of microfinance can be done responsibly. What can socially motivated investors, who still provide the lion’s share of capital to microfinance, do to assure responsible conduct? When is their own eagerness to pour in money part of the problem?
Possibly Related Posts
- India’s Microcredit Monsoon
- Everything You Always Wanted to Know about Suicide in India* (*But Were Afraid to Ask)
- What’s Really Happening in Andhra Pradesh
12 Comments on “Backgrounder on India’s Microfinance Crisis”
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November 1st, 2010 at 4:20 pm
Not sure you are at all correct to attribute the financial meltdown in the US with “social policy” lending. The analyses I have seen suggest this is a real red herring. The numbers and amounts of social policy lending, such as through the community reinvestment act, as a percentage of and compared to performance of all (bad) real estate loans, are miniscule.
November 1st, 2010 at 4:38 pm
Was thinking more of Fannie Mae and Freddie Mac. Surely they played a significant role, and surely they were guided by various congresses and presidents?
November 1st, 2010 at 5:07 pm
Then, respectfully, I would reword and be more precise because otherwise you seem to be invoking the discourse of blaming “social lending” (in the US, tied to a racialized construction of the undeserving and economically non-viable borrower) for the ills of unregulated lending and derivative market gaming by major institutional actors, for profit.
November 1st, 2010 at 5:31 pm
You may also want to read a private sector mortgage expert’s view. Note in the comments and follow-ups he addresses the point you raise regarding freddie and fannie:
http://activerain.com/blogsvie.....gage-mess-
November 2nd, 2010 at 7:29 am
David:
You liken the apparent conflict between SHGs and MFIs in Andhra Pradesh to one between older and younger brother. This sounds nice, but perverts the implied biological relationship. Historically it is the MFIs which mothered the SHGs, starting in the 1980s (and some of them presumably earlier). MYRADA is perhaps the most prominent mother, joined by NABARD as the father of a new approach. It is this marriage which led to what might be called a paradigm change: from credit management groups to savings and credit groups (only the latter may be correctly called SHGs), starting in 1992 as a pilot project of SHG Banking (or Linkage Banking as it had been previously called in Indonesia).
Here are a few Working Papers (WP) from http://www.uni-koeln.de/ew-fak/aef/ that provide some background:
WP 2007-1a: From Informal Microfinance to Linkage Banking: Putting Theory into Practice and Practice into Theory
WP 2005-9: The Evolution of SHG Banking in India
WP 2004-1: Transaction Costs of SHGs: A Study of NABARD’s SHG Banking Program in India
WP 2002-7: Commercial Aspects of SHG Banking in India: A Study of Bank Transaction Costs
WP 2001-3: SHG Banking: A Financial Technology for Reaching Marginal Areas and the Very Poor in India.
WP 2005-9 gives the historical back background.
There is a wealth of literature. I just mention a few titles:
Frances Sinha, Microfinance Self-help Groups in India – living up to their promise? Bourton on Dunsmore, Rugby, Practical Action Publishing, 2009
Malcolm Harper, What’s wrong with groups?; and Frances Sinha, SHGs in India; in: Thomas Dichter & Malcolm Harper, What’s wrong with microfinance? Bourton on Dunsmore, Rugby, Practical Action Publishing, 2007
Girija Srinivasan & N. Srinivasan, Informal Group-Based Savings Services: The Indian Experience. In: Kim Wilson, Malcolm Harper & Matthew Griffith, eds., Financial Promise for the Poor: How Groups Build Microsavings. Kumarian Press 2010.
Best regards,
Hans Dieter Seibel
November 2nd, 2010 at 7:37 am
How MFIs have affected SHGs in India:
If you are a subscriber to the DFN you have read the following assessment on 1 Nov:
On Oct. 27 I raised the question „whether, or to what extent, the microcredit crisis… has affected the SHG microfinance sector (SHG banking, linkage banking) coordinated by NABARD”. Below is an answer I received from C S Reddy, CEO of APMAS, Hyderabad. Please be reminded that as of 31/3/2009 at national level this sector comprised 6.1m SHGs with bank savings accounts, among them 4.2m SHGs with a bank loan outstanding. NABARD (in http://www.nabard.org/pdf/Stat.....131109.pdf) does not report data on MFI loans to the SHGs under its SHG Banking program.
[SHG = self-help group; JLG = joint liability group]
“The exponential growth of the MFIs in India is definitely affecting the SHG movement in the country, in spite of the SHG federations coming up. The following is the impact of MFIs in the SHG movement:
• Most MFIs will lend to women if they are members of an SHG. MFIs split the SHG to form the JLGs. MFI field staff would talk negatively about the SHGs and SHG federations.
• Most MFIs put pressure on women to repay their loans resulting in some of these women defaulting to the SHGs. Once one or two SHG members default to their SHG, other women also stop paying.
• SHG members are targeted by all the MFIs in a given area. As they borrow from SHG and also from 3 or 4 MFIs, the loan from SHG is at times used to repay the MFI loans.
• Active SHG / SHG federation members or leaders are lured by the MFIs to become their agents. As a result they neglect their own organizations.
• The women who are able to access a loan in less than one month from an MFI are wondering why they should be engaged in all the processes related to SHGs and SHG federations.
• SHGs still have difficulty in opening bank accounts and obtaining loans in many parts of India. MFIs are converting this into their advantage.
• Over the past 2-3 years, banks seem to be more interested in lending to the MFIs rather than SHGs / SHG federations.
The aggressive growth of MFIs and the coercive recovery methods employed by them coupled with their high interest rates result in indebtedness and completely weaken SHGs & their federations that have been developed with significant investments over a period of time.”
November 2nd, 2010 at 8:51 am
Rather off-topic from microfinance, but Gil is completely right, as is the blog he links to. If we don’t learn the right lessons from the US financial crisis, we’re bound to draw the wrong conclusions in Andhra Pradesh and elsewhere also. Did Fannie & Freddie play a significant role? Somewhat. Were they the causative factor? Definitely not. The crisis would’ve certainly happened without Fannie or Freddie.
There has been a clear and concerted effort by free-market ideologues to find fault for the crisis in government mandates or regulation. Trouble is, to do so, one has to ignore the heart of the crisis — an unregulated, free-for-all market where all along the chain, from the mortgage brokers to the dealers selling junk MBS & CDOs, there was minimal to no concern about the actual performance of the mortgages. The rating agencies abetted this, and the ignorance of investors fed it. That’s it. That’s the heart of the crisis. If you want to learn more, I very highly recommend Michael Lewis’ The Big Short.
So what exactly WAS Fannie’s role? To understand, you have to go back to 2004, when the two agencies shared between them some 80% of the US mortgage market. By 2007, that share had dropped to just over 40%, and it was the new Wall Street engine, fed almost entirely by lenders NOT under CRA requirements, that was the reason for the drop. Not surprisingly, the agencies reacted, over time loosening their standards so as to remain relevant in a market that was passing them by.
Ironically, and what the free-marketers don’t seem to realize, is that the greatest losses for Fannie ultimately came not from CRA-like loans (both agencies had Affordable Housing Goal mandates from HUD), but from Alt-A loans, which rarely tended to qualify for Housing Goals. These were loans to people with good credit, but were done as interest only, no income documentation, or other risk factors (often in combination with each other). In fact, they tended to be dilutive of housing goals, since the ratio of Alt-A loans that met goals tended to be lower than the total portfolio average. A lot of them were in high-growth states, like CA, FL, NV. And because purchasing them necessitated direct competition with Wall Street (which had the advantage of selling off the risk to ignorant investors), these loans weren’t even very (if at all) profitable — their primary purpose was to maintain market share.
These two categories — interest only and Alt-A (which overlap a lot) were the largest contributors to credit losses. If you’re really curious, take a look (p.6): http://fanniemae.com/ir/pdf/se.....ummary.pdf. (The % of credit losses at bottom of the page is especially informative).
No doubt, the agencies certainly have their share of the blame. But blaming CRA and government mandates requires ideological persuasion to trump facts — something that has been increasingly popular in the US, and is clearly also at play in Andhra Pradesh…
November 2nd, 2010 at 1:08 pm
References to CRA and to Fannie and Freddie are both, I would argue, red herrings. Most of the institutions most associated with crisis–like Countrywide–are not banks and were not subject to the CRA. And if Fannie and Freddie have prominent roles, how do we explain the presence of property bubbles and damaged financial systems in countries like Spain and the UK that have no similar GSE?
To be sure, Fannie and Freddie’s problems didn’t help, but I think it’s hard to argue they are central to the problem.
November 2nd, 2010 at 3:20 pm
Wow, Daniel’s comment hit the spot – that is, with me reading it as a description of what happened in AP, not of the US subprime market. Daniel: “There has been a clear and concerted effort by free-market ideologues to find fault for the crisis in government mandates or regulation. Trouble is, to do so, one has to ignore the heart of the crisis — an unregulated, free-for-all market where all along the chain, from the [1] *mortgage brokers to the dealers selling junk MBS & CDOs*, there was minimal to no concern about the actual performance of the [2] *mortgages*.” Replace [1] with *investors and banks to the loan agents pushing credits to improve their salaries* and [2] with *microloans*, and you get what happened in AP.
Daniel’s finding in late 2009 that 16 percent of the population in AP already had a microloan (which includes children and non-poor, of course), and his warning about that as a sure sign of a bubble, has an eerie ring now. The Economic Times reported this March that in some areas “25% of borrowers had more than five loans, while three loans was the average for all borrowers.” If those figures are true, something had to give soon. First it was the borrowers that had to give (CS Reddy of APMAS has confirmed that “the excesses on the ground are real”), and now it is the MFIs. My point is that a LACK of regulation coupled with a structural politico-economic drive for profits (driven in practice by managers and shareholders, and in ideology by the notion that only profitable undertakings can help the poor) allowed and encouraged an aggressive and collectively suicidal, yet individually rational, competition for market shares. That’s far from rocket science. It’s not even new – Keynes, Kindleberger.
Now blaming the bubble on those who prick it (the jealous state, the zealous SHG movement) is a simple confusion of cause and effect. David’s story, while rich in detail, is only too simplistic in its search for causes. I will only believe in a media-government conspiracy to disown the MFIs when I see it proven (David never commits to such a story, but alludes to it repeatedly). The Bollywood Brothers narrative is a farce, an attempt to present the most microfinance-friendly state in India as an adversary to the microfinance industry. The opposite is the case. As Prof. Seibel rightly points out, the SHGs and their specific regulatory environment have played an important (perhaps key) role in promoting the MFIs in AP.
As I have noted in my blogging, the AP government had a mandate to act. It did so in typically AP government way – populist, loud, heavy-handed – but it started the necessary soul-searching. Vijay Mahajan on the weekend admitted on TV “Alot of the reasons for invoking the ordinance were the creation of the microfinance sector itself. There has been a certain degree of wrongdoing by our sector. And as the president [of MFIN] I am the first one to accept it, I want to do it on record.” (Link: http://indiamicrofinance.com/d.....tv-18.html) That takes courage. Now thanks to AP’s ordinance the mandate is with the Indian government to finally do its homework and create ways for the poor to get out of their microfinance debt. Whether that might mean the demise of some MFIs which could only survive in a bubble enviroment of accelerating growth is I think justifiably a secondary concern.
November 2nd, 2010 at 3:37 pm
Sorry, I forgot to add that, thanks to the ordinance, higher-than-reported interest rates are (apparently) being discovered – up to 60.5% (http://www.thehindubusinesslin.....310100.htm)
November 3rd, 2010 at 5:42 am
In India any initiatives by the myopic Political Society, corrupt & incompetent Government and uncivilized & out-dated Bureaucracy never intend to do any sustainable good to the society. The personal/private priority of the Individuals involved from the above specified process dimensions of the ‘Governance’ perpetually overrides the needed priorities for community concerned. So, as a whole India of today like any failed nation, can never prevent impoverization of the vulnerable communities
or willing to undo its wrong doings indulged over the decades to protect from the impoverization of the vulnerable communities. The classical evidence is the growth poverty is getting effectively re-inforced and intergenerational by the growth of GDP in India.
So, India survives on the stimulus that creates vulnerable communities and accelerates the poverty.
The politicians & the Bureaucrats of India need sanctions, in particular social sanctions, at least for the next 15 years from the responsible World communities, if the World communities respect their own consciousness for India.
November 3rd, 2010 at 6:55 am
The interested reader may have a look at The Report of the Task Force on Credit Related Issues of Farmers where there is some discussion of Microfinance institutions (MFIs) (particularly see chapter 2 where in 2.5 a crucial discussion is made between MFIs owned by users themselves, MFI owned by third parties for profit and MIFs owned by third party not for profit.
The report submitted in June 2010 had already indiated in 2.5 about ‘sprialing unserviceable debt in the forseeable future’.
Comments on the report are being solicited till 9 November 2010 that may be sent to tfml@nabard.org
The report is available at
http://nabard.org/pdf/TaskForc.....ebsite.pdf