On Microfinance: Who's to Blame for the Crisis in Andhra Pradesh?

The sensationalized newspaper accounts of suicides among over-indebted clients of some of India's biggest microfinance institutions threatens the future of microfinance in India.
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When a story on microfinance appears in major media outlets, the effect on the public image of the sector can be dramatic. That's why last Friday's article in the Wall Street Journal, "India's Major Crisis in Microlending," requires a response.

The story covers a microfinance crisis in the southern Indian state of Andhra Pradesh, triggered by sensationalized newspaper accounts of suicides among over-indebted clients of some of India's biggest microfinance institutions (MFIs): SKS Microfinance, Spandana, Share, and others. These cases underscore rising debt stress among possibly tens of thousands of clients, brought on by explosive growth of microfinance organizations in southern India. In the quest to meet their growth targets, loan officers often sell loans to clients already indebted to other organizations. The reports offered an opening for the state government, which runs a rival self-help group (SHG) program, to pass a restrictive ordinance severely curtailing the MFIs. The crisis threatens microfinance not only in Andhra Pradesh, but nationwide, as the Reserve Bank of India moves toward removing the priority sector designation that has fueled the sector's growth (by making it advantageous for banks to lend to MFIs).

The blame for this unfortunate situation falls most squarely on the MFIs that failed to restrain aggressive growth even as the market became increasingly saturated. Investors must also swallow a big spoonful of blame. Becausethey paid dearly for shares in the MFIs, they need fast growth to make their investments pay off.

The divvying up of blame doesn't stop there, however. Perhaps the most important target is the public sector policy environment that has treated microfinance institutions as orphan children of the financial sector rather than helping them to build solid foundations. In fact, the environment in which MFIs have grown up could almost have been expressly designed to promote over-lending.

The story starts from the nationalization of banking that was part of Indian socialism until the reforms at the end of the 1990s. The legacy of that era remains as a preferential relationship between the Indian banking authorities and their big, sluggish children: the public sector banks. Banking policy tends to be crafted with the public sector banks in mind, creating a strange mix of incentives for other types of providers.

Most importantly, although large MFIs were allowed to convert from non-profits to commercial institutions, they were not licensed to take deposits, in part because they would have become competitors to the public sector banks. Deposit-taking, properly supervised, would have allowed the MFIs to raise funds locally, both from clients and others in their neighborhoods. It would have created a balanced portfolio of products and revenue sources, rather than exclusive reliance on the micro-loan mono-product. Instead of unbalanced mono-product giants, MFIs like SKS might have grown up to look more like Mibanco in Peru, Equity Bank in Kenya or BRI in Indonesia, all with solid loan and deposit bases. When clients have a place to save (and banks have an interest in promoting savings) they may be less likely to fall into debt traps.

Next, Indian policies have led to poor governance frameworks for MFIs. In many countries, leading microfinance organizations like Mibanco and Bancosol (Bolivia) were commercialized with a mix of owners including the original non-governmental organization (NGO), international social investors (including development banks), and some local shareholders. The NGOs kept the focus on the mission, while the international social investors contributed a commercial orientation, also tempered by social mission. In Indian microfinance, NGOs are prohibited from becoming shareholders. Instead, authorities accepted a romantic notion that client ownership would create grassroots accountability, but this actually created a governance void. SKS, for example, established a client trust that gave clients a monetary stake in the company but left the voting rights to the founder/managers. At the same time, foreign investment rules have made it hard for international social investors to participate in ownership and governance. The results: founder domination, a pattern that affects each of the big three MFIs in Andhra Pradesh and leads to a lack of checks on decisions by managers, and the entrance of pure commercial players like Sequoia Capital India with their over-emphasis on fast growth.

Add to this the government support for the self-help group movement, which has been a very important success story, but which has received preferential treatment. In Andhra Pradesh, the SHG program received millions of dollars from the World Bank, facilitated by the Indian government. Nothing wrong with that, except that it created a preference for SHGs over MFIs throughout the state government.

The sole direct support from the Indian government to the MFIs, the priority sector lending targets, actually contributed to the excessive growth. It prompted the public and private sector banks to make large loans to MFIs with relatively little scrutiny, allowing MFIs to grow quickly without enough ballast in the form of institutional capacity building or a solid capital base.

As a finishing touch, one could cite the undermining of the MFIs' legitimacy in the public eye created by government's vacillating stances toward interest rates and occasional politically-motivated decrees of debt forgiveness.

This range of policies results from a combination of complex factors, and is much influenced by India's socialist history and popular politics. Many leaders within both the Reserve Bank of India and the Ministry of Finance have sought to create a better policy environment.

The crisis of the moment has, correctly, focused attention on modifying specific lending behaviors: restraining growth, instilling better client protection practices, developing credit bureaus. However, at the same time, there's an opportunity now for Indian policy makers to think more deeply about the role of MFIs in the financial sector. If they welcome the contribution MFIs can make to reaching the poor with financial services, they could begin to craft a set of ground rules that promote balanced product offerings, solid institutional development and good governance. Then perhaps we could talk about sharing the credit rather than the blame.

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