Microfinance Horizon

14 November 2010 [The Sydney Morning Herald]

Some extra money can make life easier, writes Matt Wade, but in India the booming microfinance industry has created misery.

It’s meant to lift people out of poverty. But the women of Peddammagadda say microfinance has become a curse. This shanty town on the outskirts of Warangal, a city in the south Indian state of Andhra Pradesh, has been overrun by loan agents from India’s highly competitive microfinance industry.

For the cash-strapped women of the neighbourhood, their offer of quick money was hard to resist and many now have multiple loans and unpayable debts.

Jyoti Kumar has nine loans and must make repayments of up to 1500 rupees ($34) each day of the working week, plus three monthly installments. The sari shop she started with her first loan did not turn a profit but she says microfinance institutions encouraged her to take on more debt. “When these people keep coming and offering us money we are tempted,” she says.

Jyoti Kumar’s monthly repayments have reached about $720 – more than double the family’s income. “Most of us have sold our wedding ornaments,” she says with a sad smile. “We have sold our kitchen utensils and sometimes we must deny our children food for days so we can make these loan repayments. I’m under tremendous pressure every day to pay.”

The Herald met 12 of Jyoti Kumar’s neighbours and each had at least six loans. Lending practices such as this have triggered a crisis in India’s $7 billion microfinance industry and cast a shadow over the strategy of using tiny loans as a solution to poverty.

The problems have centred on Andhra Pradesh – one of the world’s biggest microfinance markets and home to India’s largest microfinance institutions, including SKS Microfinance, Spandana Sphoorty Financial and Share Microfin Limited. Amid complaints about irresponsible multiple lending, exorbitant interest rates and aggressive debt collection, its government announced last month new regulations for the industry including fines and jail for coercive debt collection tactics.

Reddy Subramanyam, the state’s principal secretary for rural development, says the regulations were necessary because microfinance institutions have “mutated . . . to become exploiters of the poor by their usurious interest rates, multiple loans given without due diligence, lack of transparency and use of coercive methods for recovery.”

More than 100 microfinance institution loan collectors were arrested last month, court cases have been registered against microfinance institutions leaders and, in some towns, angry mobs attacked microfinance institution offices.

Encouraged by some local politicians, millions of disgruntled micro borrowers in the state have stopped loan repayments. At the same time, the stream of cash pouring into the microfinance sector from big banks and other financial organisations has dried up.

This has sparked a liquidity crunch reminiscent of Wall Street’s meltdown in 2008. Parallels between the Andhra Pradesh fiasco and the US subprime lending crisis that sparked the global financial crisis are “uncanny”, says Mathew Titus, who heads the microfinance peak body Sa-dhan.

Legal action by the microfinance industry has put a stay on the introduction of the regulations in Andhra Pradesh. But Vijay Mahjan, founder of a microfinance institution called Basix and chairman of the Micro-Finance Institutions Network which represents 44 for-profit companies, warns the sector faces collapse: “It cannot be business as usual for the sector any more.”

Another senior microfinance institution executive said the sector was in “real danger” and that the next fortnight will be “do or die”.

Because of the scale of India’s market, the crisis may have repercussions for the global microfinance movement. Amer Khan, who is researching microfinance at the University of Sydney, says the Indian problems had added to a “crisis of legitimacy” in the sector at the global level.

“The Andhra Pradesh crisis is part of a chain of events which are bringing microfinance a bad name, not just in the hallowed halls of global development finance industry, but more importantly at the societal level,” he says.

Vikram Akula, founder of SKS Microfinance, a giant microfinance institution, also warns that if India’s crisis is “not navigated successfully it will have a chilling effect on the microfinance sector around the world”.

The strategy of microfinance was first championed by Muhammad Yunus, a Bangladeshi economics professor who won global attention and a Nobel peace prize for his model of offering micro loans as a strategy to alleviate poverty. In the mid-1970s he noticed that because poor families lacked collateral they were being denied credit except from local money lenders who charged debilitating rates of interest. The lack of traditional forms of collateral, especially land, meant the poor were being excluded from banking services. As a substitute, Yunus proposed forming borrower groups where peer-group pressure – or mutual liability – would guarantee repayment.

He founded the hugely successful Grameen Bank in Bangladesh which became a global model.

There have been critics of the microfinance model from the beginning but the strategy proved popular with the poor and with donors in rich countries such as Australia, especially the business community.

One of the major attractions of microfinance was the prospect of sustainability – once a loan is repaid it can be distributed to a new borrower. Micro loans are typically about $250. Many microfinance institutions lend exclusively to women because they are more likely to spend extra income on their children than men.

India’s vibrant voluntary sector began experimenting with microfinance during the 1980s and it grew quickly in south India. But these organisations, mostly charities and trusts, started to bump up against financial and regulatory constraints. This restricted the amounts they could lend and the number of clients.

The microfinance veteran Udaia Kumar, of Hyderabad, says it became apparent that being a charity was “not the proper legal form to take up microfinance”. He revolutionised it in 2000 when he turned his non-profit NGO into a for-profit business. Share Microfin Limited is now one of India’s biggest microfinance institutions.

“We decided to transform into a for-profit status organisation to bring in equity, mobilise debt and provide services for a much larger number of clients to see that large-scale poverty reduction takes place,” he says. The shift allowed Share to access funds from financial institutions and private investors which in turn allowed them to dramatically increase the loan distribution to poor borrowers.

Over the past decade many microfinance institutions have made a similar change and new players have entered the sector. Professor Kurapati Venkatanarayana, a Kakatiya University economist who received a national government grant to study India’s microfinance sector, estimates there are about 800 non-bank finance companies in India, 147 of them of significant size.

The microfinance institutions became a convenient way for Indian banks to meet “priority sector lending” targets set by the government. Billions poured into the poor rural sector and now at least 40 banks lend to microfinance institutions. India’s microfinance sector has about $7 billion in loans outstanding, almost $6 billion of which has been borrowed from banks.

The cost of servicing millions of tiny loans is expensive, so for-profit microfinance institutions charge relatively high interest rates. They borrow from banks at 8-14 per cent but the cost of administering the loans, a provision for bad debts and other costs adds another 10-12 percentage points. Amid the crisis in Andhra Pradesh, India’s biggest microfinance institutions cut their interest rates from about 27 to 24 per cent, saying that is as low as they can go.

In July, the commercialisation of India’s microfinance sector was taken to a dramatic new level when SKS Microfinance, which works in 100,000 villages and boasts 7.8 million borrowers, was listed on the Indian stock exchange.

The founder and chairman of SKS, Vikram Akula, says that with economies of scale microfinance institutions can deliver lower costs of borrowing and other services to clients and make a healthy profit. “To a poor woman, what does it matter to her if we have higher profits if she is getting lower priced products over time,” he says. “But it does seem to matter to middle-class sensibility which says, ‘How can you make money – you must be doing something wrong.’ ”

There are strong differences within the microfinance movement over ownership and profit. In a debate in September, Yunus criticised Akula’s for-profit model. “Microcredit is not about exciting people to make money from the poor. That’s what you’re doing. That’s the wrong message completely,” he said.

Yunus called Mexican MFI Compartamos, which listed on the stock exchange in 2007, a “usurious money lender”. He has no objection to making a profit from micro-lending but says the poor should be the only beneficiaries. “Grameen Bank is owned by the borrowers and the profit goes back to them,” he says. In response Akula said: “Yours is maybe the more morally pure way but it’s a long way away from helping all the people who need it.”

Akula believes large-scale, profitable publicly listed microfinance institutions with the capacity to access significant sums of capital are needed to allow India’s poor access to financial services.

High-profile investors, including the founder of the IT giant Infosys, Naryana Murthy, and George Soros invested in the $350 million float. But SKS’s sharemarket listing appears to have stoked public concern about the sector by drawing attention to the huge value of some microfinance institutions and the wealth of their owners.

Vijay Mahjan feels the SKS listing “broke the dam” of public patience towards India’s microfinance sector. Now, just weeks after the triumphant share-market float, the sector is in chaos.

“I firmly believe that a commercial approach to microfinance will have the greatest impact in terms of poverty eradication,” says Akula. “But I now realise India may not be ready for it and I’m disillusioned by that.”

Mahjan says the express growth of the industry has “created a whole lot of preconditions for malpractice”.

The experiences of Jyoti Kumar and her highly indebted neighbours at Peddammagadda highlight many of these problems. Microfinance loans are meant to be for income generation but none of Jyoti Kumar’s neighbours has a successful enterprise. Elysha, who has six loans, started a vegetable-selling business that quickly failed and yet the loans kept coming. “Before the MFIs arrived we were happy but now we have lost everything including our self-respect. The only thing that remains is humiliation.”

Baby Rani, who has seven loans, tried to expand her sewing business but her income, about 15 to 20 rupees a day, has not improved. Her borrowings have mostly covered family health and education expenses. “I have not really purchased any goods with the money I’ve borrowed, all I do is recycle the loans,” she says.

Venkatanarayana says microfinance institutions are “dumping loans” on the poor by not verifying their capacity to repay. “Far too many of these loans are going on consumption rather than genuine investments – that just leads to a debt trap.

“Many of the women don’t even know which organisations they had borrowed from. They name these companies after the days they make collections like Monday company or Tuesday company.”

Microfinance institution leaders acknowledge multiple lending has become a problem.

“This problem has started because of the large number of institutions that have entered the sector and their fast growth which led to multiple-lending – too many institutions lending to a single client,” says Udaia Kumar.

“Naturally when the client is over-indebted problems have started.”

The women of Peddammagadda say they are harassed by loan officers. When another one of Jyoti Kumar’s neighbours, Kalawati, was recently hospitalised with acute fever, a microfinance institution worker pressured her children, aged 10 and 12, to make the repayment. They were told to visit their mother in hospital to get the money. “I was very upset because they even harassed my children,” she says.

Komala, a widow, claimed workers forced her to sell her wedding ornaments so her mother could repay a loan.

Venkatanarayana says microfinance institutions are also resorting to repossession of items such as sewing machines, farm tools, cooking utensils, TVs and other household goods to force loan repayments.

Politicians and government officials have blamed the combination of microfinance institution multiple loans and aggressive debt collection for scores of recent suicides in Andhra Pradesh.

“In the last three months more than 75 suicides have been registered due to the harassment of the recovery agents of the MFIs,” says Reddy Subramanyam, principal secretary of the rural development department in Andhra Pradesh.

A fortnight ago, Mrs T. Shoba, a microfinance institution debtor in the village of Mondarai, 80 kilometres from Warangal, doused her polyester sari in kerosene and set it alight. Neighbours say that in the chaos that followed her husband, T. Shrinivas, was also badly burnt. Both died from their injuries a few days later.

Last Tuesday their sons Upender, 12, and Arvind, 10, observed a traditional ceremony on the 10th day after the deaths by having their heads shaved. Mrs Shoba had recently borrowed 12,000 rupees ($280) from microfinance institutions even though locals say the family already had a large debt with local money lenders.

It is difficult to apportion blame in a tragedy like this – crop failure and heavy debts have long contributed to farmer suicides in India.

But Vijay Mahjan concedes that microfinance institution loans may be a factor in some suicides. “As a sector we cannot absolve ourselves of the suicides even though the causation is weak. We have contributed to creating conditions, at least in some households, where this has happened,” he says.

Udaia Kumar hopes India’s microfinance sector will emerge “purified” by the current troubles but warns the poor will pay if it starts to collapse. “If microfinance institutions fail now, it will mean the dream of financial inclusion for millions of the poor people will also fail.”

It all began as an act of kindness

1976 Muhammed Yunus makes a $27 loan to a poor woman in village of Jobra.

1983 Grameen Bank founded in Bangladesh.

Mid-1980s microfinance begins to take root in India and other developed countries.

2000 First Indian NGO switches to for-profit company.

2005 International year of microfinance.

2006 Yunus wins Nobel peace prize.

2007 Mexican MFI Banco Compartamos lists on the stock exchange.

2010 SKS lists on the stock exchange; 160 million micro borrowers worldwide.