[Reader-list] Microfinance: A Fairy Tale Turns into a Nightmare

Shashidhar shashidhar at butterfliesindia.org
Tue Nov 2 14:57:17 IST 2010

Good write up on the MFI nightmare in Andhra





Microfinance: A Fairy Tale Turns into a Nightmare 
M S Sriram 
It was inevitable that the commercial model of microfinance in India, with
its minimalist and standardised model of lending, would grow into a bubble
and run into trouble.
Many microfinance commercial organisations have entered the market in search
of profits and are competing to lend to the poor. In the process they have
put the “understanding” of the needs of the poor aside and have started
chasing targets and numbers. For these institutions, the poor are not seen
as human beings having individual identities and needs. Instead they are
seen as data points that add up in their profit statements. The anxiety for
growth is dictated by the fact that the investors in the market-based models
are impatient and look for high returns – and then exit! 
There is a new intensity in the discussion on microfinance – about multiple
lending, interest rates and on whether a bubble is being built around
lending to the poor. There is a heated debate about the interest rates of
microfinance institutions (MFIs) and whether they could be termed usurious.
There has also been a boardroom fracas at SKS Microfinance – an event
unrelated to the larger one about the delicate relationship between MFIs and
their clients, but it is nevertheless hogging equal headline space in the
press. The commercial section of the industry has reacted with the industry
association – the Microfinance Institutions Network (MFIN) – coming out with
a code of conduct. The State has indicated its displeasure about the level
of interest rates and it has sent an advisory to the commercial banks. The
Government of Andhra Pradesh, facing a lot of flak from the local press and
the opposition parties, has promulgated an ordinance in order to “rein in”
There is indeed a sense of déjà vu to the entire episode – of a crisis
following heady success. The success had culminated in the oversubscription
of the SKS Microfinance initial public offering, allotment of shares at the
upper end of the indicative price band, listing of the scrip at a premium,
and its continuous rise thereafter. As this was sinking into the minds of
the players in the microfinance market – and with the next rung of
institutions ready to harvest the gold rush – the same SKS Microfinance was
in the news for all the wrong reasons. 
Three Models 
This article looks at the growth in microfinance, keeping the current
developments in perspective. But before looking at the current episode, it
is important to have a perspective on how the microfinance space is
organised and who the different of players in the market are. At this point
of time there are three significant interventions in the provision of
universal access to financial services. 
(1) The people’s movement which has existed outside of the government
schemes, banks and other interventions by entrepreneurs. This is led by
non-governmental organisations (NGOs) that have remained true to the
community-based model and have emerged by organising people to sort out
their financial mismatches without the intervention of the external world,
and if there is an intervention it is a conscious choice collectively
exercised by the people. 
(2) The intervention by the government pre-existed the people’s movement and
was expressed in the form of the self-help groups (SHGs). This has usually
been supply-driven, addressing the institutional and physical infrastructure
needs and offering standardised supply-side solutions or “schemes”. In
Andhra Pradesh the State has almost usurped the community model through the
Indira Kranti Patham scheme (earlier known as Velugu). Clearly the role of
the government in Andhra Pradesh has moved beyond being an independent
observer. In this case the State is in a peculiar position of being a player
as well as an arbiter of microfinance practices. 
(3) The market forces, which look at the poor as a market, have found a
mechanism to deliver credit through an efficient delivery model. This
approach is more than a decade old and has made rapid growth. This growth
has encouraged us to look at the business through a different lens. 
Each of these interventions has a different approach and uses a different
methodology to reach out to the poor. These methodologies have an important
bearing on the process and packaging of financial services. The SHG model
was promoted as an alternative to the available options of financial
intermediation. It was at one level rooted in the community and at another
level was integrated with the larger banking system. The dealings were on
the basis of mutuality, thus providing the power of a collective. The
approach, by definition, was a slow one because there had to be a good
understanding on how a collective based on the principles of mutuality
worked. It required patience, tolerance and an appreciation of the
constraints that the fellow SHG members faced. It made members think about
their financial services needs of their households, and also those of their
neighbours who were members of the collective. This helped the members think
responsibly because they were dealing with their own money or the money of
the members of the collective. This methodology ensured that people were
together to narrate a growth story, a story of their confidence and how they
were taking charge of their own lives. 
This movement is very time-consuming. The collective has to go through the
many phases of forming, storming, norming and performing. Even if the
process is slow, the edifice will be strong and lasting. This edifice can
continue to serve the poor and the marginalised on an auto-pilot basis once
it stabilises. Once this happens, it shows that the poor can not only take
control of their resources, but as these resources grow they can hire
professional help to manage their resources. This transformation does not
happen overnight, but through a long process of community intervention.
Unfortunately, there is impatience, and then there is the State. If the
groups succeed, there is an urge to replicate the model quickly across the
country. The success of community-centred microfinance has attracted the
government. The State deals with large numbers and its anxiety to deliver
development at a pace that can do justice to the incumbent combination is
understandable. The State learnt quickly from the SHG movement and decided
to adopt it as one of its “schemes”. The bank linkage programme has been
going on for years, and each year the government increases the targets to
the banks for linkage and ports several other welfare schemes on to the
Market for Inclusion 
The last type of player in the inclusion market is a product of market
forces. In the last decade there have been several people who for years
worked in the development sector with communities and became impatient for
growth. They embraced a market-based model of inclusive finance. The idea
was that if we are able to make this activity of inclusive finance
inherently profitable, then more and more people (who work for profits) will
see merit in operating in this market. And with a good number of players,
the market will not only expand, but because of competition the poor
customers would eventually get a good deal. 
Unfortunately there have been numerous instances where our belief in the
market has been belied and microfinance adds to the scepticism about the
school that believes only in markets. During the initial phases of the
intervention by the market model of mFIs, most of us looked at the growth of
these organisations with a sense of awe. These organisations brought
efficiency to their operations. But gains in efficiency are usually a
function of standardisation. Standardisation worked at two levels: (a) The
organisations themselves offered standardised products, that allowed them to
reduce operating costs. (b) The individual identity of each organisation and
what it stood for vanished. In the field one could therefore see little
difference between one MFI and the other.Rhyne (2001) writing about MFIs in
Bolivia has said that the institutions tend to converge operationally to the
dominant microfinance paradigm. The paradigm of commercial microfinance is
that of minimalism. That credit should be provided efficiently and quickly
and a sharpening of financial viability have influenced institutions
operating in this space. 
Bolivian Experience 
In microfinance itself, there were significant lessons to be learnt from
Bolivia. For instance, Rhyne indicates that the number of institutions that
had a subsidy drastically fell in about four years, and each of these
institutions lost its core identity. FIE, an MFI known for technical
assistance to a single community-based enterprise, Fades, which used to
focus on lending for community infrastructure projects, and ProMujer, which
specialised in empowerment training; all dropped most of the operational
practices that differentiated them from the dominant paradigm. 
This “convergence” is happening in India as well. The minimalist model
disburses credit in as efficient a manner as selling soaps and shampoos. It
has its merits. For instance, in a largely agrarian society where large cash
inflows take place only during the harvest season and the local economy
operates on peaking of financial activity in this season, forcing a weekly
repayment is by definition defying the logic of agrarian cash flows.
However, by forcing this weekly discipline these institutions have possibly
expanded the market for credit – persuading people to think about activities
that give a weekly cash flow that can service their loan. This could thereby
have made more cash move through the hands of people and reduced their
However, the downside of a standardised model is that unless the cultural
and economic nuances of each location are understood, there could be cracks.
A standardised model closes innovation, reduces responsiveness and prevents
customisation and once it reaches stability it expects to grow at a
scorching pace. When something – particularly in financial services – grows
at an unnatural pace, it is going to build into a bubble sooner or later.
Such a process in the market-based microfinance sector may be happening now.

The hope that the demonstration of one market-based experiment will attract
more players has come true. Many more organisations have entered the market
and are competing to lend to the poor. In the process they have put the
“understanding” of the needs of the poor aside and have started chasing
targets and numbers. For these institutions, the poor are not seen as human
beings having an individual identity, characteristic and need. Instead they
are seen as data points that add up to their profit statements. This anxiety
for growth is dictated by the fact that the investors in the marketbased
models are impatient and look for returns (and then exit!). The evidence
from Bolivia is available before us. Microfinance in that country went
through a phase of intense competition, leading to over-indebtedness and
even the collapse of a few institutions. A reading of the microfinance
movement of Bolivia in the 1990s looks like a contemporary Indian
commentary. All the elements – client poaching, competition, reckless
lending, over-indebtedness of the client – that eventually caused cracks in
the efficient credit delivery mechanisms were present in Bolivia. 
Effects of Rapid Growth 
One of the visible indicators of the standardised model is its religious
belief in zero tolerance of default. The organisations following the market
model have possibly seen too much of indiscipline in the delivery of credit
to the poor and have realised that this is one variable that has to be
controlled at all cost. The story of organisations having a near 100%
recovery rate for years is a fable difficult to believe, given that no
household or economy can be insular to shocks all the time. Yes, the
commercial models have been able to control one cause of default – intent.
But it is well known that default also happens when the ability to repay is
impaired. The new generation of MFIs has possibly not learnt to deal with
this aspect. For a long time, while the MFIs were growing at an unnatural
pace through geographic diversification, the borrowers were probably growing
at a normal pace. With competition setting in, more and more MFIs
concentrated on the same geographies. 
With the client getting multiple choices and the anxiety of the client to
get as much of finance as possible from multiple institutions and this
coupled with the overzealous suppliers of credit meant that the client
herself was trying to grow at an unnatural pace, or that the client had
begun to resort to adverse usage of credit. Unfortunately the standardised
models do not have the patience to engage with the client. It is one thing
to justify the high cost of credit at lower levels, but we also have to
realise that at higher levels of indebtedness, interest rates become onerous
from the point of view of the poor households.  
Servicing five MFI loans of Rs 10,000 each at 28% is not the same as
servicing one such loan. And since the MFIs have not provided themselves
with a mechanism of coping with default, the pressure on the borrower turns
out to be intense. And this pressure could potentially lead to suicides. We
do not know whether the current spate of suicides in Andhra Pradesh is a
result of the MFI loans and the intense repayment pressure on the clients.
These are claims made by the state government. Vikram Akula, the chairman of
SKS Microfinance acknowledged that 17 of the 30 suicide cases were related
to borrowers of SKS (Indian Express, 15 October 2010). 
However he is not helping the cause of the MFIs by stating that “the
deceased borrowers were not defaulters of SKS and they would have been
driven to suicides by other factors such as pressure for repayment of dues
by other MFIs that lent money to the same borrowers” (Mint, 15 October
2010). The collective response of the microfinance institutions has also
been found wanting. All that they have offered is a code of conduct, which
is observed in violation! A meta level credit bureau makes a mockery of what
is clearly acknowledged on the field. You do not need a database of clients
and loans. The clients themselves are openly talking of multiple borrowings.

Governance Issues 
Unfortunately, the celebration of the market endorsement of this business at
the “bottom of the pyramid” could not have been more ill-timed. At the
ground level, the stress was showing. Clients (for whatever reasons) were
committing suicides. At the institutional level, it appeared that the
boardroom battles were all about stock options, cashing in, cashing out and
severance packages, when each of the boards should have been discussing
whether their business model was showing cracks. Instead of being
introspective, the response of the MFIs has been stubborn and defensive. 
State Response 
The response of the State has also not been in the desirable direction.
Obviously, all the action is centred around Andhra Pradesh which has the
highest concentration of MFIs and the largest exposure through the SHG-Bank
linkage model. The government has responded with a heavy hand by passing an
ordinance that has shifted the discourse from the basic problem to a legal
frame. This almost appears like the government taking revenge on the
competition with its monopolistic regulatory power. While there are nuances
in whether the Government of Andhra Pradesh has the ability and the
inclination to digest the administrative implications of the ordinance, it
has once again shown its inability to target the errant microfinance
institutions, and has instead come down heavily on the entire market. Given
that the State itself is a dominant player in this market, this
heavy-handedness creates an undesirable competitive barrier to an
alternative model of credit delivery. Instead of harping on caps on interest
rates and threatening to remove microfinance from the priority sector list,
it is necessary for the State/Reserve Bank of India to look at specific
instances and pull up the delinquent organisations. The RBI has set up a
committee to look into the issues pertaining to MFIs and has asked the
committee to submit a report within three months.  
But what is not clear is why the RBI is not carrying out a routine
inspection of the portfolio of some MFIs that are under its purview in order
to understand the issues of ghost clients and multiple borrowings and take
action to discipline the erring organisations. Some of these organisations
have serious governance issues that are not being investigated. The
institutional representatives on the boards of these MFIs have not exercised
their independence. The promoters have gotten away with significant
instances of skimming and there seems to be no dissent voiced on the greedy
executive compensations and short-sighted behaviour of the management of the
top MFIs.  
So on the one hand, while the larger directional of the movement of the
State/RBI in terms of financial inclusion seems to be good – directing
payments through banks, calling for financial inclusion plans, opening up
branch licencing, removing the cap on end use interest rates and so on – its
response to the rapid growth of microfinance has been somewhat alarmist.
Hopefully the State and the RBI would do what is well within their mandate
in specific cases. This would be a superior approach compared to the
policy-level clampdown that they have been talking about.



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