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Crisis by Invitation

Published on November 22, 2010

MFTransparency board member Narasimhan Srinivasan writes about responsible microfinance in this special series on the situation in the microfinance market of Andhra Pradesh.

Click here to read the CGAP Microfinance Blog


Crisis by Invitation – Narasimhan Srinivasan, November 19, 2010

This post is the next in a special blog series on the microfinance crisis in Andhra Pradesh, India. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by this crisis and what it means for the future direction of microfinance. We welcome your participation in this discussion through comments.

The microfinance sector had been given enough warning signals

Governments legislate on conduct of business—from both positive/ enabling and negative/restrictive standpoints. While most regulations on business, commerce and industry are positive, some are highly restrictive on account of the nature of business. For example, manufacturing and using radioactive material or dealing with habit-forming psychotropic substances is restricted on account of the potential harm to society. Now the microfinance business seems to have been equated with, say, trade in habit forming psychotropic drugs.

The law in Andhra Pradesh (AP) is based on the premise that MFI loans are addictive, available freely and can cause damage to the user over the long term. Hence, it seeks to control the availability, delivery process and price of MFI loans. If indeed this premise is correct, the question is does all credit to vulnerable people fall in this same category—or does only MFI credit carry the potential to harm?

But regardless of validity of the law (which has been challenged), did the MFIs do anything to warrant the promulgation of this law? The sector had enough warning signals that the government was hardening (justifiably) its stand.

The earlier Guntur experience in the same state in 2006 apparently had vanished from corporate memory. The Kolar incidents last year brought up the problems of concentration of loan exposures and erosion of lending discipline induced by competition. The reaction of the sector to Kolar was to announce codes of conduct and some arbitrary limits on the number and amount of loans. The more fundamental problems in customer appraisal, pricing, recovery methods, transparency, and customer grievance handling were being taken up for resolution, but too slowly.

The AP government came up with district level task forces earlier this year to enquire complaints against MFIs and very clearly indicated its discomfort. The response from the MFIs was not substantial, either in terms of dialogue with the government, or reforming operations in the field.

The exponential growth and high concentration in AP was not accompanied by the required sensitivity in dealing with vulnerable people. The number of loans of SHG members and MFI customers when put together were more than 10 times the number of poor households in the state.

Any charge of excessive debt is believable, given the large number of loans and the fact that the average MFI loan per household in AP exceeded Rs 65,000 ($1400). While one-third of microfinance loans were given out by MFIs, the remaining two-thirds were given through the SHG linkage program. Which loan was the last straw is not clear.

Justin Oliver in his blog last week referred to the Access to Finance (A2F) survey by IFMR which describes the high propensity to borrow in AP. Of the total microfinance loans of Rs 463 billion ($10 billion) across the country, AP had absorbed almost Rs 170 billion ($3.6 billion). That this level of micro-debt was excessive was not a secret—the government, MFIs, investors, researchers and practically everyone else knew.

Apart from the formal debt for which some numbers are available, there have also been significant levels of informal debt which is estimated at 75% of all debt in the A2F survey. The sentiment was that somehow the high levels of debt will be absorbed without major problems. The State of the Sector Report 2009 (SoS) pointed out the risk of high levels of debt concentration and called for a detailed study before expanding services in the three southern states.

Suicides were linked to microfinance in some of the media. While suicides are extreme decisions, the symptom of excessive burden of debt in some cases is not the real cause. AP has an average of 2000 farmer suicides each year—if 54 suicides as reported in some papers are attributed to MFIs- what are the remaining attributed to?

Do we need laws restricting some other sectors of the economy for the other suicides?

Excessive debt itself reflects that the present levels of income are inadequate. There is a clear role for public policy in creating viable income opportunities for poor people; banks and MFIs at best can finance such opportunities—they neither have the resources nor the competence to promote livelihoods significantly.

An apparently unconnected, but material, development is the successful IPO of SKS, which seemed to have changed the sentiment all around. Such a possibility was highlighted in SoS 2009. The report cautioned “Once an IPO is made and trading on the exchange floor commences, a ‘Compartamos’ like situation might develop. ‘Capitalists making private profits out of poor man’s hard earned money’ would be the subject of media discussions. Political interference capping interest rates and bringing the sector under heavy handed regulation is most likely. This might shut out further private equity flows. Even as investors are willing to offer a good valuation, in the interests of future of the sector and other MFIs that need to grow, the promoters seeking to go public must do so responsibly.”

What is at stake here?

What is at stake is not only Rs 167 billion ($3.8 billion) in microloans in AP, but also the future of microfinance in India. While Rs 52.5 billion ($1.1 billion) is the exposure of MFIs that will be directly affected by restrictions on collections, visits to the borrowers and bundling of weekly installments in to monthly installments, the damage potential is deeper.

The competitive edge of MFIs—frequent contact at the door at a time convenient for customers and maintaining credit discipline through peer pressure—is broken. The meetings with borrowers now depend on the benevolence of panchayat officials. The effect on liquidity of MFIs is devastating because collections are uncertain.

The MFIs’ ability to service their bank loans will be severely impaired (already some MFIs have reportedly defaulted). The asset category—loans to MFIs—would go below investment grade and this would affect loan flows from banks to MFIs across the country and not just AP.

The vitiation of credit discipline would affect loans given by banks to SHGs both under government and non-government programs. The SHG loan portfolio in AP is about Rs 117 billion ($2.5 billion). SHG loans as an asset class will also undergo a re-rating and will likely be downgraded.

On the whole, the problems will not be confined to MFIs, but they will extend to banks. As a result the entire microfinance sector in India will be at risk.

While the law is intended to protect customers, it also opens up rent-seeking opportunities for middle-men. The law requires a voluminous amount of information flow but it is doubtful that the designated registration authorities have the physical or technical capacity to handle that much volume.

Where do we go from here?

More than 15 years of hard work has gone into the sector. For the mindless actions of a few with a profit motive, a large number of customers are set to lose linkages to institutions that had helped them over the years. Here are some things we could do:

Improve communication to customers
MFIs should strengthen their communication with customers. Media campaigns aimed at customers should assure customers that they would get their next cycle loans if they repay in time, subject to legal limits. MFIs should encourage customers to come over to the branches to pay back their loans. In their communication to customers, MFIs should list areas of deficiencies identified in their functioning and how they plan to set them right in future.

Ensure liquidity to MFIs
Banks should ensure that adequate development funding is available to the MFIs to consolidate their operations and move from weekly installments to monthly installments at the customer end. Interim liquidity for the next six-month transition period for MFIs to move from one business model and process to another dictated by law is not only a legitimate requirement but also a dire necessity.

Ensure better and client-focused governance
For the long term, MFIs should have time bound strategies to focus on quality customer appraisals, cash flow based lending, change in lending and recovery processes, transparency in operations and information disclosure. The change in strategies should be communicated publicly to demonstrate that MFIs are willing to learn and adapt to changing requirements and expectations. That will build confidence amongst stakeholders.

Ensure client-focused regulation
For the Reserve Bank of India and the central government, significant legislative effort is required to keep the business of financial institutions away from restrictive money lending laws administered by state governments. While AP might have a large number of SHGs, other states do not have a ready substitute for access to finance if the MFIs close down. Even in Karnataka, the customers of MFIs outnumber members of SHGs. Finding an alternative for about 27 million customers is not easy and in any case beyond any short-term strategy that might be developed. The preferred strategy would be to work with the MFIs and clean up their business.

The microfinance sector does not really require regulation relevant for financial sector. It requires regulation relevant for customer protection. Institutional stability and sustainability issues are best addressed by funding banks and investors in equity. Regulation should just ensure that these institutions, by intent and practice, are providers of responsible finance to vulnerable people.

The 27 million existing and millions more future customers deserve better from MFIs and the government. There is no brand of microfinance that is an unmixed blessing. Hence a battle for supremacy is of little relevance and should not impact lives of vulnerable people adversely.

Even if we cannot work collaboratively, let us resolve not to work at cross-purposes. The customer should be at the core—not only in MFIs and banks, but also in those who seek to regulate.

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