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Waking Up from the Nightmare

As a response to the criticisms of microfi nance institutions' mad rush for growth and numbers (23 October 2010), this comment presents some possible solutions instead of writing off for-profi t microfi nance altogether.


from MFIs, both figures being the median

Waking Up from the Nightmare

amount outstanding for loans from that source, according to a recent survey by the Centre for Microfi nance).

Prabhu Ghate Since there was no time to appraise risk,

As a response to the criticisms of microfinance institutions’ mad rush for growth and numbers (23 October 2010), this comment presents some possible solutions instead of writing off for-profi t microfi nance altogether.

Prabhu Ghate ( is an independent researcher, journalist and consultant.

Economic & Political Weekly

January 1, 2011

his is in response to the excellent article by M S Sriram “Microfi nance: A Fairy Tale Turns into a Nightmare” (23 October 2010) and the editorial in the same issue “‘Modern’ Sahukars”. I agree with the broad analysis and diagnosis of both pieces, but feel Sriram does not go far enough in his quest for solutions, and strongly disagree with the concluding sentence in the editorial, which seems to write off for-profi t microfi nance altogether, contending that it has “no purpose other than to reap the highest returns on the back of India’s poor”.

Quest for Numbers

It is true that a high-profi le microfi nance institution (MFI) leader was until recently advertising “not just returns, but extraordinary returns”, and the “hamburger model of growth” which entails standardising every last operation so that new workers can be trained easily and branch offices replicated fast. As Sriram points out, in the mad rush for growth and numbers, borrowers became statistics, and the relationship with them became purely transactional, forgetting that many of them required different products with different sizes, maturities and repayment frequencies suited to the particular cash flow requirements of different activities. It was much easier to put everyone on the same cycle of a one-year, weekly repayment, loan, and then raise the size of the loan (for everyone) in the next round.

The same quest for numbers left the fi eldworker (and it should be recognised that MFIs have given productive jobs to many lakhs of unemployed youths with only a little education) with little time (or as important, incentive) to appraise the stressfree repayment capacity of borrowers by assessing total family income against total debt repayment obligations, including repayment obligations to informal lenders, which incidentally are much higher even in Andhra than MFI debt (Rs 35,000 from all informal sources as against Rs 8,130

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loan sizes were capped at Rs 15,000-20,000, forcing many borrowers to take out several loans at the same time to meet their credit needs. Some borrowers were just feckless, and spurred on by lifestyles advertised on the TV serials that dominate prime time, used their credit to buy consumer durables well beyond their capacity to repay. MFI leaders were either unaware of what was going on at the field level, or did not really want to know. There may have been a spurt in repayment difficulties during and just after the rains which were particularly heavy this year, which damaged crops and led to a temporary cessation of National Rural Employment Guarantee Act work, out of which many couples earned their weekly repayment obligations. Weekly repayments do have the advantage that they reduce instalment size and make it easier for the borrower to repay, which was one of Muhammad Yunus’ several innovations.

Drive for Profi ts

His most important innovation though was the peer group pressure exercised through groups of borrowers who collectively faced the prospect of losing their lifeline to credit if any one of them failed to repay. In conjunction with the drive for profi ts, the peer group pressure has proved to be lethal in a few cases, literally so. It has taken us some time to wake up to the fact that although the usual extreme response of borrowers who are genuinely unable to pay, is to lock up and leave the village, there are cases where the humiliation and embarrassment perceived by women in close communities drive them to commit suicide.

Clearly many MFIs (although not all) had lost their way and their values, blinded by the urge to maximise profits. However, none of this was inevitable, although it is true that excessive competition and overlending have led to repayment crises in other parts of the world too. By and large, however, microfinance is working well in most parts of the world, especially in countries which have a system of regulation, with an emphasis on


consumer protection, transparency in interest rates, and a grievance redressal mechanism. Prudential regulation of savings is usually a part of such regulation too, to enable MFIs to offer savings services, which are arguably a more urgent felt need than credit. If Indian MFIs could collect savings the way Grameen Bank does (it collects more savings than it extends as credit), i nterest rates would immediately come down by the difference between the rate at which they borrow from the banks (about 12%-14%) and the weighted average cost of savings, or by at least 6-8 percentage points.

India has not been able to pass a microfinance bill, which the sector itself has been clamouring for, because of opposition in Parliament to the absence of a cap on MFI interest rates. Nor has it been able to put in place a system of delegated self-regulation “with teeth”, under which self-regulation organisations (SROs), perhaps regionally organised, are recognised and supervised by the central bank or National Bank for Agriculture and Rural Development (NABARD), and delegated with the task of supervision. The industry association, Sa-Dhan, formulated a code of conduct after the Krishna and Guntur district crises in 2006. However, the code was observed more in the breach than in practice. A new association consisting only of MFIs organised as nonbanking financial companies (NBFCs), called microfinance institutions network (MFIN), was formed recently and has a lready taken steps to set up a credit b ureau to try to avoid overlending.

Possible Solutions

Sriram is quite right in pointing out that NBFCs are already under the purview of the Reserve Bank of India (RBI), and asks why the RBI has not undertaken action against errant MFIs, which would be a “superior approach” to a policy level clampdown on the entire sector such as that which the AP government has just undertaken. Indeed, the restrictions imposed on MFIs in AP are designed to force them to leave the state, leaving borrowers with no choice between MFIs and self-help groups (SHGs). The state government seems to have decided that the ailments that beset the SHG programme can only be cured by getting rid of the MFIs. However, most of these ailments stem from attempting to force the pace of growth of the SHG movement, subsidising it through “community investment funds” (80% of which come from the World Bank), and the pavala vaddi (or quarter interest rate) scheme under which interest rates to SHGs are cap ped at 3%, and universalising the scheme rather than letting it grow organically through the efforts of NGOs “that have remained true to the community-based model”.

The same pressures of expansion as in the MFI sector have worked against the original spirit of the SHG movement, with members dividing up bank loans equally rather than distributing them according to need, leading many members to spend them unproductively, and to the virtual cessation of “inter-lending”, or lending to each other out of the group’s corpus built up out of savings and interest on such loans, since the corpus itself tends to get divided up equally between groups each year, reflecting a lack of confidence in the longevity of the group and the poor state of accounts. Indeed, the Andhra model is now, with the assistance of the World Bank, to be replicated countrywide in the same standardised form through the N ational Rural Livelihood Programme.

It is true that the RBI should have been more proactive in inspecting MFIs that had particularly bad reputations for overaggressive growth, poor governance, and excessive executive remuneration. However, there is much more that can be done to curb excesses. The Small Industries Development Bank of India (SIDBI), which is the largest lender to the sector, has organised a lenders’ forum, which 12 of the lending banks public and private have joined. SIDBI also conducts ratings assessments of borrowers before it lends to them. Ratings have centred around financial, and more recently, social performance. However, since MFIN has come out with a new, stronger and more specific code of conduct, it is now possible for the lenders’ forum to conduct, through credible and competent third parties, regular code of conduct adherence assessments on an ongoing basis, with the threat of a cessation of lending to wrongdoers.

For-Profi t Microfi nance

Unless one is against profits per se, there is certainly a case for for-profi t microfinance based on reasonable profi ts normal to the financial sector. At least one MFI has announced that it will not seek a return on equity above a certain moderate level and will refuse to accept investors who seek more. Social venture capital companies could declare that they will refuse to invest in MFIs whose profi tability exceeds a certain level. Public sector investors such as SIDBI and NABARD could increase the amount of “patient” capital (including long-term subordinated debt) they have at their disposal to invest in MFIs. However, the time may have come to remind ourselves that it was the lenders who forced the transformation of a large number of NGO-MFIs into NBFCs in the first place, since, in the face of capital adequacy norms, the banks were unable to lend above a certain level to an NGO, which can have no equity (an NGO has no owners or claimants to residual surpluses). Indeed, there was a long debate in the sector on whether to transform or not. We may have exaggerated the economies of scale it is necessary to achieve before unit operational costs, and hence, cost-recovering interest rates start declining. There are at least two medium-to-large MFIs that have not transformed into for-profits (one of them, Cashpor, in eastern Uttar Pradesh and Bihar, is a non-profit, S 25, company which has struggled to obtain capital and loans in that legal form, but has still achieved an outreach of half a million borrowers, nearly all of them poor because they are selected on the basis of a means test using housing type as a proxy).

To conclude, there is an urgent necessity for the central government and the sector to build consensus around a revised microfinance bill, and get it passed through Parliament putting in place a system of regulation, whether direct, or through self-regulatory organisations. The combined effect of all these steps will be to wring the excesses out of the system and remove the uncertainty that surrounds the sector, allowing it to continue on the path of furthering fi nancial inclusion. Even after removal of the interest rate cap on small commercial bank loans of less than Rs 2,00,000, and four years of promotion of the business correspondent model (hedged in as it was with all sorts of unrealistic restrictions), the banks have left the field wide open to MFIs, who have reached more than 25 million small borrowers. Two-thirds of these are in states which are not yet saturated, unlike Andhra.

January 1, 2011 vol xlvi no 1

Economic & Political Weekly

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