Archive for: microfinance in India

With around 20 million borrower accounts estimated for March 2012, India still has one of the largest microfinance industries in the world – even though the number is much lower than 32 million in October 2010 when the microfinance crisis began.  However, in March 2012 it also had the dubious distinction of having perhaps the worst portfolio quality in the world (at the national level).  Since October 2010 commercial bank lending to MFIs, which made up over 70% of their funding, has been consistently drying up mainly because of perceived political risk. Read the rest of this page »

Indian microfinance institutions (MFIs) have been criticized in some quarters for their high interest rates, indebteding clients, and coercive recovery practices. The recent study by the National Council for Applied Economic Research (NCAER), sponsored by the Microfinance Network (MFIN), brings much-needed data into the discussion. Covering over ten thousand households across multiple Indian regions, this study merits attention.

How do some of its assertions hold up?

• The study reaffirms that the banking system has low penetration of credit and that MFIs and SHGs fill an important gap.

Informal lending still constitutes almost half of all loans. However, in regions where either MFI or SHG (or both) types of lending are deeper the level of informal borrowings is lower. The study also confirms the widely accepted notion that the sources of lending vary widely by region. Read the rest of this page »

“Although [microfinance] has promise on a small scale, history suggests that when scaled up, and especially when used as an instrument of government policy, it will likely create significant problems…”

So wrote distinguished economist Raguram Rajan in Fault Lines: How Hidden Fractures Still Threaten the World Economy –perhaps influenced most by his familiarity with Indian style microcredit.

A year ago I might have glazed over Professor Rajan’s comments.  But I have followed closely the events that have unfolded among MFIs in Andhra Pradesh in India and with Professor Yunus at the Grameen Bank in Bangladesh over the past year. And I’ve had many conversations with those with insight into microfinance and the broader political economy in both India and Bangladesh.

Until recently, microfinance in India (really microcredit) had been driven by innovators and entrepreneurs, but also enabled by government policies such as of priority sector lending and regulatory restrictions prohibiting deposit mobilization for most MFIs. These policy prescriptions eased the flow of credit while cutting off options to innovate around deposit services.  And a rapid expansion of credit-only MFIs occurred in a country that is a vibrant and hotly contested democracy.  Competing parties and candidates fight tooth and nail for votes promising lower staple food prices, unemployment benefits, electricity, and other basic needs. Read the rest of this page »

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.

–N. Srinivasan, the author of Microfinance: State of the Sector Report 2008, 2009 & 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.

Fresh Data from IFMR’s Study Reveals a Complex Situation

The crackdown by the Andhra Pradesh state government on microfinance institutions was based on a number of assumptions about what’s happening with microfinance here in India.

[In case you haven’t been following what’s happened over the last month, check out a good overview of what’s happened by David Roodman here, and other analysis by N. Srinivasan, Vineet Rai, Beth Rhyne, and the Wall Street Journal.  A sampling of articles in the Hyderabad press that helped precipitate the backlash is here:
Times of India September 29, 2010, Times of India October 18, 2010, Times of India October 26, 2010, Times of India October 28, 2010]

For those not familiar with Indian microfinance, an important distinction to make is that the controversy now is about one type of microfinance institution in India, which makes up about half of the microfinance market.  These are what I’m calling “MFIs” here – institutions (both for-profit and not) that make loans to groups of five women in “joint-liability groups,” mostly following the original model of the Grameen Bank in Bangladesh.  MFIs give loans directly to these groups of women, but are not allowed to accept deposits.

The other half of the microfinance market in India are “Self-Help Groups,” or SHGs.  This model has been promoted by the Indian government, and involves larger groups of roughly 10-25 women, who save amongst themselves and distribute their pooled savings as credit amongst the group.  Since the late 1980’s, these groups have been increasingly “linked” to commercial banks – meaning the bank gives a loan to the group, the group distributes credit to its members as needed (which is a lot more money than if they only lent out their pooled savings), and the group is responsible for repaying the bank loan, sometimes directly to the bank, sometimes through a separate “SHG promoting institution.”

The ordinance passed by the Andhra Pradesh state government was targeted at the first group of institutions, “MFIs,” and is at least partially (perhaps mostly) intended to stop them from competing with the second group of institutions, SHGs.  It’s only the MFIs that are affected by the current crisis.  Clients in Andhra Pradesh have essentially stopped repaying MFI loans, but SHG loans continue to be repaid for the time being.  It’s worth noting that some of the loudest complaints about MFIs have come from the Andhra Pradesh state agency that oversees and promotes the SHG program.  See here.

More than six months before these problems came up, the Centre for Micro Finance at IFMR Research, with funding from the Banker’s Institute for Rural Development at NABARD, conducted a household survey of 1,920 households in rural Andhra Pradesh to understand their access to and use of financial services.  Led by Doug Johnson and Sushmita Meka, this was a representative survey of the state’s entire rural population, rich and poor, and collected detailed information on household savings and borrowing from SHGs, MFIs, banks, moneylenders, friends and family, and other sources.  What we found is startling, and challenges many of the assumptions people have about microfinance in Andhra Pradesh.

Assumption 1:  The poor in Andhra Pradesh are “over-indebted” because of microfinance institutions pushing loans on them that they don’t need.

Debt is indeed prevalent in rural Andhra Pradesh.  An estimated 93% of all households have some sort of loan outstanding.  But only an estimated 11% of rural Andhra households had a loan outstanding from an MFI.  In contrast, 37% of rural households had a loan outstanding from commercial bank, 53% from an SHG, and a staggering 82% had a loan outstanding from an informal source, including friends, moneylenders, landlords, and others.

Overall indebtedness amounts are driven by informal loans and bank loans.  For people with loans outstanding, median outstanding amounts are Rs. 35,000 ($778) for informal loans and Rs. 20,000 ($444) for banks, but only Rs. 8130 ($181) for MFIs and Rs. 4600 ($102) for SHGs.

Assumption 2:  People frequently take loans from multiple MFIs, sometimes using one loan to pay off others.

“Multiple borrowing” is rampant.  Eighty-four percent of households had at least two loans outstanding, and one household we spoke with had 19 loans.  But the vast majority of these loans are informal.  Of course, even if we ignore informal sources, multiple borrowing is still pretty common.  But it’s not limited to people who lend from MFIs.  Multiple borrowing from banks and SHGs is pretty common too.

• 17% of households with an SHG loan outstanding had multiple SHG loans outstanding, and 58% had at least one more loan from a formal source.
• 26% of households with a bank loan outstanding had multiple bank loans outstanding, and 74% had at least one more loan from a formal source.
• 28% of households with an MFI loan outstanding had multiple MFI loans outstanding, and 82% had at least one more loan from a formal source.

We also find evidence that people who take multiple loans frequently take them out at the same time and for the same purpose, rather than staggering them as you would if you were using one to pay off the other.  This bundling of several loans suggests that many people just find it difficult to get all of the credit they need from one place.

Of course, just asking people whether they use new loans to pay off old loans may be a simpler way to answer this.  And of course they do.  Twenty-five percent of MFI loans are used, at least in part, to pay off other debts.  But so are 20% of SHG loans, and 15% of bank loans, though only 7% of informal loans.

Usage of Loan Money by Type of Lender

Assumption 3:  MFIs are specifically targeting existing Self-Help-Group members with loans.

Well…maybe.  Seven percent of households have both an SHG loan and an MFI loan outstanding.  And having an SHG loan makes a household 6% more likely to also get a loan from an MFI compared to households who don’t have SHG loans.  Clearly there is some targeting of the same population, but not a lot.

These results call into question the common impression that rural households in Andhra Pradesh are saturated by private MFI lending.  If anything, the survey shows that there may still be considerable room for expansion in the state given the high levels of borrowing from informal sources.

The point isn’t that Indian MFIs don’t need a greater degree of regulation – by their very success, Indian MFIs have achieved a level of importance that would warrant more careful and dedicated scrutiny by the appropriate regulatory authority (which is almost certainly not the state government).  But ill-conceived measures based on knee-jerk reactions which don’t take into account the needs of microfinance customers will only end up hurting the poor in the end.

–Justin Oliver

This post kicks off 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.

This is the first time that I have knowingly contributed to a ‘blog’; hence I am not familiar with medium’s etiquette.  Am I to oppose, to concur, or to add? I’ll try to do all three.

Steve Rasmussen poses a number of important questions; they are mostly about the future, and about clients, which is surely where our focus should be.

I shall not comment on the rights or wrongs, legal or ethical, of the ways in which the shareholdings of the SKS clients’ Mutual Benefit Trusts were handled; Professor Sriram has already covered that issue, very well.

I shall start by making some general assertions which I believe to be true, or perhaps at least to be provoking, which may be more useful than being true.

First, the impact of microfinance, for good or for ill, is exaggerated.  It is no more than second-rate retail banking for people who cannot afford the relatively decent services which all the readers of this ‘blog’ enjoy. Our banks serve us, more or less effectively, but they are much less important to us than our schools, our health care, our employment, our security, our communications… Let’s not fall into the trap of believing that microfinance, or the institutions which provide it, or still less the parasites which surround it, academics, commentators, consultants, researchers and so on, are so very important.

Second, the number of people who are still un-served by microfinance is also exaggerated. The figure of 150 million people omits the sixty odd million members of self-help groups in India, whose groups are served by commercial banks, the millions who have individual accounts with banks of all kinds, particularly cooperatives and credit unions, and the many more who are rather well-served by informal but often very sophisticated traditional institutions.

And every human being does not need financial services. Most households do, and there are not three billion un-banked households.

Third, the commercialisation of microfinance is a ‘done deal.’  To misuse a sentence from Abraham Lincoln, “the world will little note nor long remember what we say here.” When BASIX was started in Hyderabad our mission said we hoped to “access mainstream capital.” Now microfinance is a mainstream business, it’s been “Wal-Martised,” whether we like it or not, Compartamos and now SKS have shown the way, and soon many more will follow. The clock cannot be put back.

So, let’s look at microfinance, and SKS, through the same lens as we look at any other business. We don’t expect Wal-Mart or their peers not to rip off the poor because they want to help them. We hope that antitrust laws, other regulations, public opinion, and above all competition will stop them. Generally, albeit imperfectly, it works.

Mr. Sam Walton and his family have made vast sums of money by successfully satisfying the needs of millions of people, particularly not-so-wealthy people, and we don’t seem to grudge them their riches. If a donor had subsidised Wal-Mart’s entry into some apparently unattractive market; rather as DFID so cleverly subsidised Vodaphone’s MPESA in East Africa, and Wal-Mart had done very well out of it, as MPESA apparently has, would we complain? I think we would congratulate the donor for effective promotion of ‘market access for the poor.’

So although many people (and I include myself), find it distasteful, or may even think it stinks (are we perhaps secretly a little jealous?), when the promoters of SKS make millions out of a business whose original objective was to serve the poor, that’s capitalism.

We may prefer co-operative banks, which don’t make a lot of money for any one individual but do provide safe and accessible savings products to poor people. In spite of some notable exceptions, however, that’s not the dominant paradigm.

It’s more profitable to keep people in debt than it is to help them save.

As Peter Drucker wrote, “the purpose of business is to create and keep a customer,” MFIs certainly do that, and if we don’t like it we should maybe go back to Marx rather than nit-picking over the details.

— Malcolm Harper

Watch this space for a new post every week on the SKS IPO. Next week we feature Moumita Sen Sarma.

This post is the second in a special blog series on the SKS IPO. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by the IPO. We welcome your participation in this discussion through comments.

A rare microfinance occurrence took place in late July this year. The Indian microfinance institution, SKS, became the second pure MFI globally to go public by listing its shares on the stock market. SKS is one of the largest microfinance institutions in the world with almost 6 million clients, mostly poor women living in rural areas. It has also been one of the fastest growing MFIs over the past few years, with a compound annual growth rate of 165% since 2004.

From one perspective, the IPO was a great success. It was 13 times oversubscribed, the company valuation reached the top of the offer band price (valuing the company at $1.5 billion), and the share price rose 42% in the first five weeks of trading. In the process SKS raised $155 million in fresh capital that will allow it to grow and serve far more people than it reaches now.

But for most of us, including those closely associated with SKS, evidence of real success will only come when we know if many more poor people have benefited. The purpose of the IPO was not just to access capital markets, but to access them to serve the interests of poor people.

The SKS IPO story is told in a CGAP paper published this week. The paper shares facts and asks questions about SKS and the IPO to stimulate discussion of this landmark event for microfinance.

For six weeks starting today, CGAP will host a special series on this blog representing the views of global microfinance leaders on the IPO. The series will reflect a diverse cross-section of views on the implications of the IPO and its influence on future direction of the microfinance sector.

It is clear that we have a long way to go from the estimated 100-150 million people accessing microfinance services today to reach the almost 3 billion un-banked people. Scaling up outreach to many more poor and un-banked people is the main goal for most of the microfinance world. Microfinance growth has often been and is still funded by governments, international donors, and socially minded investors. In addition, an increasing number of MFIs are able to mobilize deposits (though not in India) and borrow from commercial banks.

However, MFIs still say that one of the biggest constraints to growth is not having enough funding. What the SKS IPO shows is that MFIs can indeed harness the vast resources of capital markets. The initial success of the IPO raises the stakes for SKS. Some will celebrate this milestone event as opening up new avenues and opportunities for microfinance while others will be skeptical that the goals of profit seeking capital market investors can be compatible with the interests of poor rural women.

The CGAP paper describes SKS’s track record of establishing and trying to sustain a significant ownership share in SKS for the borrowers. This was done through the creation of shareholding mutual benefits trusts (MBTs) whose shares were valued at $220 million at the time of the IPO and are worth even more with the subsequent rise in the share price. The MBTs sold some of their shares after the IPO, realizing $42 million that will go back to the original SKS Society. The Society intends to build up a network of high quality schools to serve the children of SKS clients and other poor people.

But SKS will be watched closely for more than that.

• Will SKS continue to focus on growth that reaches poor people who are not being served by others?
• Will clients be better served by an expanding the range of services, higher quality services, and more affordable services?
• Will the clients retain a strong voice in the affairs of the company to help it sustain a direction that serves their interests first and best?
• Will shareholders understand that doing what is best for the customer is fundamental to sustaining long term shareholder value?
• Will SKS’ social and financial performance help influence policies in India and globally in favor of greater financial access for more poor people?
• And ultimately, will the lives of the many poor people SKS serves change for the better?

The SKS story still has a long way to go. What it does next will be closely watched by supporters and critics alike but it now has the opportunity and obligation to show the world that the poor can access capital markets to their advantage.

—Stephen Rasmussen

Watch this space for a new blog each week on the SKS IPO. Next week, we feature Malcolm Harper.

This post kicks off a special blog series on the SKS IPO. Over the coming weeks we’ll be featuring a variety of voices on the issues raised by the IPO. We welcome your participation in this discussion through comments.

With the SKS IPO slated to hit the street by the end of July, we will have an opportunity to learn more about where the microfinance industry is headed.  There will be some details which the IPO transaction itself will shed light on, but the most important questions about the microfinance industry will take some time.  We should not rush to judgement.

The IPO will finally tell us where the price and valuation settled.  A price at the low end might dampen investor enthusiasm.  On the other hand, a valuation perceived to be a the high end might bring accusations of supernatural profiteering.  Expectations about the price and valuation may drive the initial reaction.  It will be very interesting to read carefully the reaction from the general public, opinion makers or policymakers to gauge broader perceptions of a changing microfinance industry within India.  Microfinance may finally move in the public’s view from a development sector to a fully commercial enterprise.  Another key issue is how smoothly the transaction is executed.  If it moves through seamlessly with strong subscription this should be a sign that future IPOs for microfinance are possible.

But the most important and contentious issues about the IPO will take more time for us all to weigh carefully.  It will be particularly important to see how the proceeds of several Mutual Benefit Trusts are used given the philanthropic purpose for which these MBTs were first created. This is something we may not know for several months or possibly even longer.  Another feature that may take time to learn more about is how new transparency and governance standards applied to public companies affects SKS’s performance.  And we will have to wait and see how the IPO affects the growth trajectory, expectations, and valuations of the broader microfinance industry. 

Will the health of the microfinance industry be advanced?  This is something we will have to look beyond the transaction itself into the months and years ahead. 

Keep your eyes on the CGAP blog in August for a forthcoming breakdown of the IPO transaction.

Gregory Chen

CGAP has been hosting a two-day online Virtual Conference “Responsible Finance: Making it Work in Microfinance” on April 12-13. The event is bringing together MFIs, policymakers, NGOs and individuals from across the world for a rapid-fire online debate and discussion.

Day one of the conference focused around the question “what is responsible finance, and why is it needed?” and featured guest moderators from four continents and nearly 300 participants commenting and following along with the debate. Hot topics of discussion included:

Read the rest of this page »