Maybe it’s too early to seek real explanations for the microfinance tragedy in AP. The dust hasn’t settled yet, but I’m struggling to come to grips with the big “why?”. (For a summary of events until Tuesday, see here.) My usual blog sources of all colours for all things development are silent, so far. But the Indian media are buzzing with coverage and an occasional piece of analysis. From what I can tell from these reports, the crisis was caused by a failure to regulate and a set of ultra-perverse incentives for microfinanciers and their employees.
What happened? In the past 6 weeks or so, some 30 to 60 microcredit borrowers in Andhra Pradesh (according to different sources) committed suicide over their loans. Individual stories had surfaced increasingly throughout early and mid-October about borrowers suffering under heavy debt burdens and massive pressure from agents; with measures apparently even including child abduction as punishment for loan default and agents urging borrowers to take their lives to reap credit life insurance. Protests ensued, and last week, the AP government issued an ordinance imposing rules of conduct and compulsory registration on MFIs (microfinance institutions). A consortium of MFIs (MFIN) claimed this had halted their business completely, and this week the MFIs submitted a petition at the AP High Court asking to quash the government’s ordinance.
This Indian news video concisely tells the horrific story.
The High Court today officially permitted MFIs to continue their business activities, while upholding the terms of the ordinance that MFIs may not engage in coercive practices and must proceed with registration. Meanwhile, employees of SKS Microfinance and Spandana have been arrested for harassing borrowers. SKS shares have dropped by over one fifth, indicating that investors are worried about profitability (rightly so). An Indian apex organisation has proposed for all its members to cut interest rates – more about that below.
According to NDTV’s research (see video above, and Associated Press), 17 out of the suicide victims had borrowed from SKS Microfinance, which went public just this summer at a valuation of 1.5 million US Dollars, paying out multimillions to founder Vikram Akula and investor Sequoia Capital (an American venture capital firm) and other private shareholders and international NGOs.
Whether that money has blood on it may be too early to tell. But I will argue here that the drive for profitability in the microfinance sector has contributed significantly, perhaps even decisively, to this tragedy in Andhra Pradesh.
Milking the cow for as much as it will give
At this week’s meeting of the microfinance sectoral organisation/lobby group Sa-Dhan, which represents 260 MFIs, the organisation’s executive director Mathew Titus admitted MFIs were not forthcoming in following voluntary codes of conduct. He also acknowled that the suicides and the resultant government ordinance had created a crisis of confidence in the microfinance sector. But the far greater, and unintended, admission of Sa-Dhan is that interest payments have been excessively high; the cow will simply not give milk forever at this rate. At its Thursday meeting, Sa-Dhan members agreed collectively to cut interest rates by 0.5 to 2 percent – the Indian broadsheet The Hindu smells an image makeover:
The step to snip rates is seen as part of the industry’s fresh initiatives to clear its image in the wake of the suicides in rural Andhra Pradesh allegedly due to coercive methods employed by some MFIs to collect dues and the subsequent ordinance clamped by the State Government.
The Hindu is probably right. SKS, which increasingly looks to be a central figure in this tragedy, has even offered to cut its lending rate by 2 percent. It looks like microfinanciers in India are worried they will lose public support, and are hurrying to cut back on their profitability until this storm blows over.
The incentive structure facing MFIs thus far has been to maximise profitability, attract investment capital, and then generate returns for shareholders. At least for the moment, that incentive structure has moved back while the cultural capital embodied in microfinance investments (in the Bourdieuan sense) must be restored/recapitalised through visible “socially responsible” behaviour
For years, the received wisdom among supporters of microfinance commercialisation has been that competition among privately-owned profit-maximising MFIs will lead to the lowest possible rates for borrowers (though some have begged to differ). If MFIs India now can suddenly cut back rates in order to attract or retain capital, they must be currently overcharging borrowers. Of course the Indian microfinance market is far from perfectly competitive, and the concerted action by MFIs in lowering interest rates and challenging the AP government’s ordinance shows that microfinanciers can even get together to co-ordinate and set prices.
Given that “a vast majority of MFIs in India are non-profit NGOs, which are legally not “owned” by anyone” (Vijay Mahajan and G. Nagashri’s words), the range of interest rates charged is surprisingly narrow. Sa-Dhan members (mostly NGOs) charge 19 to 27 percent, while MFIN MFIs – “31 non-banking finance companies (NBFC) MFIs including the top 10 MFIs” – “normally” charge 24 percent. In this comparison, the non-profit microfinance sector appears to act as if it were a profit maximiser, guided by the ideal that microfinance companies must be “sustainable”, i.e. able to hold their own on the capital market against other investment opportunities. In the case of the for-profit sector, nomen est omen. Dropping interest rates in response to the AP tragedy constitutes an admission that both sectors’ ideal of profitability has been pursued on the backs of the poor.
Failure to regulate – even worse than a revolving door
Given such evident market failures in the stylised “market” for microfinance in India, the need for regulation is clear. Until now, the regulatory focus of Indian microfinance has been self-regulation. While some industry observers have worried about an emergent microfinance bubble since early 2010, industry chiefs like Mahajan have been professing their insouciance. Private regulation remains unenforceable.
In terms of formal regulation, the Indian government fence-sat for a long time on whether or how to regulate microfinance, stalling for years. In early 2010 finally a draft bill was circulated by NABARD with the call for input from “stakeholders” – the regulatees were supposed to tell the regulator how to regulate them. In that draft, a cap on interest rates was never proposed, and Non-Bank Financial Companies (the corporate form preferred by most Indian commercial MFIs) were exempt from the proposed regulation. The bill to date hasn’t been passed by the Indian national parliament, Lok Sabha.
After the mass suicides, the AP government’s heavy-handed clampdown on MFIs’ has to be seen in the context of Delhi’s failure. Hyderabad had to act to protect the poor, even if in a rushed and perhaps populist way. Vague in its wording, the AP ordinance created confusion and allegedly led MFIs to halt their activities – at least officially since, as arrests of MFI workers showed, debt collection was still going on locally. (According to the Times of India, even Vikram Akula of SKS was under risk of arrest for some time, until the AP High Court decided to quash the arrest clause.)
India’s federal system grants states power over security, but few powers for financial regulation. By forcing MFIs to divulge interest rates and register at the local level, the AP government took an important step towards finally enforcing transparency. Given the coercive tactics reportedly employed by MFI employees, there would surely have been more straightforward means available to preserve lives and prevent abuses than to issue an unclear ordinance which left open whether loan officers would be arrested for recovering loans, or not. But the resounding message from Hyderabad was not to MFIs to halt their business activities. The main message as I see it went to Delhi: Regulate!
This is part 1 of my explanation. Part 2 follows here, tracing the perverse incentives at the micro level which have contributed to the crisis.
(phil)
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October 23, 2010 at 07:12
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October 28, 2010 at 17:59
Rajan Alexander
When we started out in development a couple of decades ago, we instinctively targeted to reduce the influence of money lenders, if not eliminate them completely. Why? They were the traditional oppressors and exploiters in society. Micro-savings and revolving loans worked very well until the most fancied MFIs burst into the scene. MFIs operate under these two beliefs: “Having access to expensive credit is better than no credit” and “the observed rate is where demand equals supply”. These two beliefs were ironically the very same fulcrum the traditional money-lenders operate with.
The result is an “Animal Farm” situation where we are now not able to distinguish between “pigs” and “humans” and vice versa. In fact, money-lenders have got a make-over by packaging themselves as MFIs. A good example is Mohd Yunis of Grameen Bank comes from a traditional money-lending caste. And of course, he got the Nobel Prize and so did Al Gore & Pachauri. Thank God the Nobel Committee did not confer Gandhiji the same distinction, by clubbing him with these scamsters.
The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 – showing how much the market had confidence on their profitability while “banking with the poor”. The promotors of SKS became multi-billionaires over-night! MFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn’t match! Profitability that permits SKS to pay Rs 1 crore as bonus to their just fired CEO!
And how do they attain profitability?
A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the microfinance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Microfinance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300. For those of us in the field, this conduct of MFIs is no surprise.
MFI research puts irinterest rates between 25-30%. But my experience (and this is my 30 years in the field) put this figure several times higher. Even if we take this range which they described as the lowest in the world, the only benefit of such loans is for working capital and not capital formation. What is the kind of subsidies Rata Tata gets to produce a one lakh car? We all are aware that a mere 0.5% rise in banking rates can crash the stock market, so sensitive is their profitability linked to interest rates. Compare this with those the poor is asked to bear.
AP’s share of outstanding microfinance loans represents nearly 40% of the sector’s total portfolio, according to CRISIL. Now if MFI is all about access to the poor, we can ask the question, why the clamour to be concentrated in a state which belong to top-five in development in the country? We would have thought they would have gone to the five lying at the bottom rung of the country. But no, they avoid it like plague. It is easy to see they do this on repayment potential of states. The interests MFIs pursue are interests of self sustenance and their own growth. The poor is hardly in the radar except for rhetoric. In fact, it is on the blood and coercion of the poor, MFIs like SKS can giveaway Rs 1 crore as bonus to the CEO.
The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. Rather than regulate MFIs, I for one will welcome the day of their demise.
October 28, 2010 at 21:32
philmader
Rajan, thank you for your lucid analysis. Your point (about “the observed rate”) really touches the crux of the issue. Microfinance bases its legitimacy on a revealed-preference logic: as long as the poor are coming back for more, we must be helping them by giving them more. But the fallacy involved is all to obvious, and this time they are all but coming back for more. I think this is part of the reason why many are so baffled by the events in AP and are beginning to doubt the veracity of the reports. If the AP crisis (the second in 4 years) is to be taken seriously, it will undermine that legitimacy.
The co-inciding payouts and suicides challenge the win-win legend on which microfinance is premised, and will no doubt induce some donors to withdraw their support for this sector (as Unitus for instance already has). A fully private microfinance will be easier to regulate, being seen as a business which (like any other business) can do good but also cause massive harm when under lax supervision. Perhaps, however, the end of cheap (free) capital and the introduction of normal supervision will kill the sector. Akula has hinted in the past few days that this might be the case.
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