Understanding India’s Microcredit Crisis

November 29, 2010

This post first appeared on Aid Watch.

The Indian microcredit industry has pitched into what appears to be a replay of the American subprime debacle. I just spent a week in India, talking to nearly everyone. I learned there were so many complexities—history, politics, institutional rivalries—that to just view events through the foreign lens of the subprime crisis is…actually about right.

The microcredit industry indeed appears to have grown irresponsibly fast, partly out of pursuit of profit. But this is not a simple morality play. The state government’s response (an October 14 ordinance) is draconian, tantamount to banning mortgages after a mortgage crisis. Why such a crackdown? The rise of private microcredit threatened a big, World Bank–financed government program that provides credit and other services.

Until last month, India was home to the fastest microcredit expansion the word has seen. Between 2003 and 2009, the number of microloans shot from 1.0 million to 26.7 million. Unlike in Bangladesh, which India recently surpassed in number of microloans, investor-owned, for-profit companies do most of lending in India. SKS Microfinance went public in July, earning tens of millions of dollars for founder Vikram Akula, venture capitalist Vinod Khosla, and others. This inevitably led many to blame the hypergrowth on pure greed. I don’t doubt that pursuit of profit played a big role, but Akula’s new book also persuades me that he concluded—along with most of the Indian microcredit industry—that reaching the poor required being profitable enough to attract serious venture capital.

Nipping at SKS’s heels were other microcreditors, also based in Hyderabad, which helped make Andhra Pradesh India’s microcredit hotbed. Villagers experienced the arrival of 2, 3, 4, even 8 or 10 microcreditors within the last few years, all eager to press loans into the hands of women. Loan officers learned that they could line up customers more quickly in villages where their competitors already operated, for there the women would have been educated in the mechanics of microcredit—and might want new loans to service old ones. So loans were heaped on top of loans.

Even Vijay Mahajan, the president of the microfinance industry association, has been bluntly critical:

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.

Unfortunately, while loan disbursement became irrationally exuberant, loan collection remained insistent. Microcredit is about mass-producing low-quality services in order to keep costs in line with the small amounts transacted. For the machine to run efficiently, clients must keep up on their payments. Microlenders also pounce on delinquency to prevent it from snowballing, so that women will not ask, “Why should I pay if she is not?” Loan officers now stand widely accused of harassing borrowers, yelling at them outside their homes, even threatening violence. The pressure has been blamed for at least 54 suicides. While the allegations are individually dubious, arising as they do in a politically charged, media-scrutinized environment, the link to suicide is plausible. Microcredit is the least flexible, least forgiving form of credit available to the poor of Andhra Pradesh, thus most likely to push them over the edge.

So the Andhra Pradesh government responded to a real problem. However, its response is also a real problem. As I explain on my blog, the October 14 law has frozen microcredit in across the state; it contains provisions that would be unconstitutional in many countries; and it could bankrupt several lenders. The law is defending a rival government program that provides credit and other services to millions of women in self-help groups. Because these groups are communal rather than corporate, they tend to be more lenient than microcreditors. When cornered, women with multiple loans default on self-help group loans first. Thus did the public and private programs collide.

These events should be cause for introspection at the World Bank, which has financed both sides, but especially the government’s self-help group support program (with $1 billion or so). The latter may well be doing much good. But World Bank money has also beefed up a political economy hostile to private sector solutions.

Perhaps the heedlessly expanding Indian microcredit industry deserved a smackdown. But what matters most is not what is fair to the microcreditors but what is best for the poor. The Indian government has built an impressive 50-year track record failing to meet the financial service needs of the poor. Under the right circumstances the private sector can help fill the gap. The goal should be to reform microfinance, not kill it.

Possibly Related Posts

• India’s Microcredit Monsoon
• India Dispatch
• Rare Canvassing of Client Voices in India

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1. joe Says:
   December 10th, 2010 at 5:27 am

   did you really talk to “nearly” everyone in India?

   good blog post though

2. Zubin Sharma Says:
   April 18th, 2011 at 6:16 pm

   Dear Mr. Roodman,

   Wanted to thank you for your blog and open-book–both have been very informative and interesting. I have some questions regarding the crisis in India and some suggestions moving forward. I’ve been reading parts of “Portfolios by the Poor,” by Morduch, et. al, which you’ve written about as well. In chapter six, the authors discuss how in Bangladesh, borrowers often have accounts with multiple MFIs. Yet, we did not see the same crisis there as we did in India. Do you think this is reflective of the models used in each country? In other words, MFIs that can take deposits, such as Grameen, the size and number of loans they can provide is limited by the savings of their borrowers, whereas investor-owned MFIs, such as SKS have an oversupply of capital, and investors looking for returns, causing them MFIs to provide risky loans? Thus, I seemed to have inferred from your articles that multiple lenders in villages in AP contributed to the crisis, but I wonder why multiple lenders in Bangladeshi villages hasn’t created the same mess there. Also, if there is any literature that could shed light on this topic, it would be greatly appreciated.

   Thanks!

   Zubin

3. David Roodman Says:
   April 18th, 2011 at 7:01 pm

   Hi Zubin,
   I have tended to attribute the problems in India to the speed of the expansion, which owes in turn to the amount of money available from foreign and domestic investors and banks. Actually, Bangladeshi MFIs historical did more microcredit than microsavings, so their lending was not limited by the amount of savings on hand. Of course it is possible that overlending has occurred in Bangladesh too. It is so hard to tell. But any problems there may be softened by the fact that a lot of people also have money saved at the same MFIs. The savings will help them repay loans in times of difficulty and they may be less likely to default on institutions that also hold their deposits.

   –David