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What the world can learn from the Indian microfinance crisis?January 23, 2012
Microfinance Focus, January 3, 2011: The “great Indian microfinance crisis” has shaken the world of microfinance. An industry that grew at 90% on an annual basis from 2002-03 to 2009-10 was reduced to just 7% growth in 2010-11 with its portfolio over the period October 2010 (when the crisis started) to September 2011 (at the time of writing) estimated by M-CRIL to fall by around 33%. As measured by CRILEX, M-CRIL’s growth index for microfinance, India’s microfinance industry is estimated to have reached 9,000 by 30 September 2010 but to have fallen back to just 6,000 a year later. How such a situation came to pass is the stuff of legend, repeated many times over in the history of industrial growth – a slow growth “tortoise” phase, an accelerating “nimble hare” phase, an uncontrolled growth “charging bull” phase and, now, a “bewildered deer” caught in the headlights of draconian regulation, uncertain which way to go. Whether, like Starbucks the coffee shop chain, recounted in its famous story published recently, it will learn some lessons and revive or whether, ostrich-like, it will battle on accusing its detractors of being negative and gradually sink into oblivion remains to be seen.
In order to consider what the world can learn from the crisis, we must first consider what caused it. It is not the purpose of this piece to go over the ground, yet again, that has been covered extensively over the past year by journalists, analysts and academic writers; nevertheless it is useful first to clear away the debris of causes that were laid in the path of the charging bull but, in practice, were not the cause of its downfall. Understanding what caused it to trip is the first step in identifying the lessons the world can learn from the fall.
The debris: What did not cause the charging bull to fall
Exorbitant interest rates: It is astonishing in travelling the world to talk about the crisis, to discover the number of people in countries from China to Peru who think that it was exorbitant interest rates that caused the crisis. In truth, as the M-CRIL Microfinance Review 2010 has shown, interest rates in Indian microfinance are amongst the lowest in the world. Microfinance yields of the order of 25%-28% are lower than the 35%-40% of MFIs in Southeast Asia and far lower than the higher rates of 40%-60% that are the norm in other parts of the world. The number of MFIs with annual percentage rates (APRs, the theoretical charge of the loan to the borrower on the MFI’s loan terms) in excess of 40% is no more than a handful amongst the 60 leading MFIs in India. This, in a country where even SMEs financed by the commercial banking system regularly face APRs of the order of 18%-20% and where moneylender rates for the poorest borrowers range from 36% in a few of the more prosperous regions to 60%, 120% and more elsewhere.
Client coercion: For all the noise in the media about client coercion, particularly in the state of Andhra Pradesh where the crisis started, there is little evidence of a systematic approach by any of the more significant MFIs to acquire forcibly the physical assets of delinquent clients or to harass them deliberately in order to force them to pay their loans.
The hurdles: What did cause the fall
High growth: The high rate of growth of the Indian microfinance industry was referred to in the opening paragraph of this piece; a number of MFIs grew even faster. The sustainability of a particular rate of growth is clearly different for organizations of different sizes. It is the stuff of folklore, a nimble hare can go at high speeds indefinitely but would eventually slow down from exhaustion, a brake applied by nature to its over-enthusiasm, but a charging bull is likely to face physical obstacles even before the limited capabilities imposed by its lumbering physique cause it to stop. Some of the largest MFIs in India had become charging bulls by the time of the crisis with staff complements of the order of 10,000 and more and annual client acquisition targets in the millions. In a country with an economic growth rate of 7-9% per annum, and a relatively limited educational system, the most competent staff had many other employment options and meant, for the largest MFIs, a staff turnover ratio of the order of 30-40%. Imagine having to train some 4,000 staff in order to replace those who leave plus another 10,000 because your ambition extends to doubling the number of clients served in a single year. Naturally, with so many new staff, short-cuts in client acquisition and laxity in control systems become increasingly likely. The lumbering size of the charging bull takes its physical toll on the body of the animal.
Multiple lending leading to over-indebtedness: However, there is also collateral damage to the environment through which the bull charges. The industry’s quest for growth at all costs resulted in an over-simplification of its relationship with clients cutting out all its social messages and focusing simply on micro-money circulation; inducting clients for the sake of maximizing portfolio size while ignoring the possibility that they already had loans from other sources, and ignoring less developed parts of the country due to the well known first mover disadvantage in mass market situations – the first mover develops the market and the late comers crowd in and enjoy the benefits.
M-CRIL estimates that these practices resulted in around 40% overlap in those easy to reach clusters (nationwide) where microfinance operations became established. These overlaps reached the extent of 200% and more in some of the more microfinance oriented parts of states like Andhra Pradesh, Tamil Nadu and West Bengal – so acute was the problem in some places that borrowers in Kolar district of Karnataka reported running from one meeting to another and/or spending as much as 2.5 hours per weekday at meetings where no more business was undertaken than making repayments, completing loan applications and receiving repayments (1). This effectively reductionist approach meant that the relationship between the MFI and the client was reduced to one that is little different from retailing; the development solidarity, preventive health and basic literacy objectives of the MFI group meetings of the 1990s were abandoned in the rush for growth. Worse, since some clients had as many as four or five MFI loans there was also a tendency to over-indebtedness. [In the absence of functioning credit bureaus and for lack of accurate information on client incomes, the extent of such over indebtedness is impossible to estimate; surveys based on recall and voluntary reporting by clients are unreliable on account of the natural tendency of clients to under-report both incomes and debt].
Unfortunately, in obtaining “easy money” from multiple agencies, it is likely that a few microfinance clients mismanaged their financial affairs, as people tend to do at any level of society, and cases of over-indebtedness emerged. Even if we assume that this was a very small proportion of the total number of clients, say just 0.05%, this would amount to 9,000 such cases and the emergence from these of a few cases of suicide cannot be ruled out. Whether or not these suicides are attributable to coercion by staff with limited understanding of their employer’s social responsibility to clients in genuine difficulty is a matter of debate.
Thus, did the charging bull damage its environment, knocking down bushes and saplings in its path as it sped along, sapping its energy in the process. When it was actually felled, too many of the clients who might have been expected to rise in protest against such interference with their commercial relationships, breathed a sigh of relief at the immediate prospect of not having to rush from meeting to meeting, desperately managing cash flows in order to repay their loans.
Conflict of interest – government as competitor and regulator at the same time: What caused the crash in the end was not the oncoming physical exhaustion of the charging bull but by the insurmountable obstacle of state regulation, the lumbering elephant with its own microfinance programme but less efficient collection processes. As in 2006 when there was a less pervasive crisis, government officers responsible for the state-sponsored self-help group (SHG) programme observed with increasing concern the repayment of MFI loans by the same clients who placed a lower priority on the repayment of SHG loans. SHG loan repayment rates fell nationwide from a claimed 98% in the late 1990s to just 70% around 2007 even as the microfinance industry’s rush for growth continued unabated.
Come the media’s muck raking in the lead up to the SKS IPO and, in its aftermath, the sacking of its CEO, suicides allegedly caused by MFI stimulated over-indebtedness and coercive collection practices became the centre of attention. Regrettably there are reports of farmer suicides in India every year and AP is often at the centre of such reports. These suicides are blamed, in turn, on agricultural loans from commercial banks, the failure of the monsoon and the collapse of the cotton economy in this semi-arid zone. This time, however, suicides were blamed on microfinance and provided the state government of AP with a handle to proceed against the industry. Accusing the MFIs of coercion, the state government introduced such draconian regulation of the practice of microfinance that it effectively brought the industry to a halt with collections down to 10% of expected repayment levels with portfolio risk going up to 50% for some of the leading MFIs with substantial portions of their portfolios in the state. The charging bull had been felled by a brick wall suddenly placed in its path.
Over-reliance on a single source of funds: One way of reviving the injured bull at this point might have been to provide it with first aid to enable it to resume its journey at a more sedate pace. Thus, the microfinance industry could have continued to reach ever-larger numbers of financially excluded clients in other parts of the country if the supply of funds for lending outside AP were available. In practice, the charge of the Indian MFIs had been fuelled by a combination of private investor funds for equity complemented by vast amounts of commercial bank funds as debt.
By March 2010, the volume of commercial bank debt with Indian MFIs was of the order of $4 billion or over 70% of the total funds deployed by the industry – a substantial amount for the MFIs but a minuscule fraction (0.64%) of the financial system. Yet, at the first sign of trouble, commercial bank funds for MFIs to lend anywhere in India (not just in AP) dried up. Despite the maintenance of the quality of microfinance portfolios in other parts of India at high levels, the banks have yet to return, in any significant way, to lending even to MFIs with no activities in AP. It is this indirect effect, and not just the direct effect of the AP regulation, that has resulted in the 33% decline of the Indian microfinance industry. The fact that investment (except from a few publicly funded sources like the IFC) also dried up at the first sign of trouble was only to be expected. The injured bull had been deprived of all but the most minimal aid.
…from nimble hare to sleek mare
It is not the argument of the author that development organizations should not grow beyond a certain size. The argument is that they should grow at a more manageable, sustainable pace, evolving from the nimble hare to acquire the dimensions of a sleek mare able to negotiate obstacles with a more versatile disposition than the angry, single-minded charging bull. Key to such dimensions would be
1 A moderate rate of growth that both enables new staff to absorb the organization’s culture and undertake client acquisition in tune with its development mission and ensures that the system of control for rules governing aspects like client acquisition, loan refinancing and collection practices keeps pace with its expansion. M-CRIL’s experience suggests that growth rates of the order of 30%-50%, inversely proportional to the size of the MFI, are likely to be sustainable.
2 A better understanding of the needs of low income clients for financial products so that the industry evolves from the simple regime of the “one size fits all” conventional Grameen loan to a set of (3-4) products specifically designed for the clients the MFI aims to serve. This would need to be regionally adjusted for loan size, loan term and repayment frequency depending on the economic activities of its clients. The focus should be on the credit needs of clients along with the conventional MFI focus on minimizing its own risk by limiting its exposure to individual clients. The net result of focusing on limiting MFI exposure is to force the client to seek loans from more than one source increasing the risk of over-indebtedness because nobody has actually assessed her capacity to service the full volume of her debt.
3 A greater engagement with the political economy of the regions in which they operate so that bureaucracy, politicians and media are all kept aware and sympathetic to the MFIs’ operational practices and goals.
4 A conscious effort to ensure that there is a diversity of sources of funds not just in terms of numbers of lenders/investors but also the type of such fund providers – commercial banks, development banks, social equity investors, private equity investors and, equally, clients as depositors. It has been shown time and again (BRI Indonesia, Grameen-2 Bangladesh, SEWA Bank India) that microfinance clients have as much need for deposit services as for credit, yet regulators, unfortunately, are more concerned with the damage to their reputations from the defalcation of a few financial institutions with public deposits than they are about the loss suffered by low income families from the theft of cash and physical assets from their homes because they do not have access to deposit services. Wherever the deposit option is available (as in Bangladesh) it provides an additional anchor of stability to the microfinancial system.
In recent years, many countries – Bosnia, Morocco, Nicaragua, Pakistan amongst others – have suffered microfinance crises for similar if not the same reasons. Unfortunately, many more – Cambodia, Georgia, Nepal, Nigeria, the Philippines – are also ripe for such troubles if corrective action is not taken. The fate of the Indian charging bull has caused some sober reflection; but there is an overwhelming tendency in international development for local operators to plead regional uniqueness as a reason for not learning lessons from others. MFIs everywhere would do well to learn the lessons of the Indian crisis. The issues discussed here are mainly generic; becoming a charging bull is not the path to long term success, the key is to understand how to evolve from a nimble hare into a sleek mare
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