Tragedy in Andhra Pradesh

Microfinance has created opportunities for millions of people at the “bottom of the pyramid” (BoP). These people live on meagre and mostly erratic incomes. Their work tends to be unhealthy if not dangerous. Around 400 million BoP people live in India.

This is also the country with the most microfinance schemes. The hub of Indian microfinance is the South-Indian state of Andhra Pradesh (AP), and the sector’s problems there have recently been making headlines internationally. While Indian microfinance certainly needs to improve dramatically, the scandal­ising media attention is exaggerated. It is based on a wave of suicides in AP, but it would be wrong to blame this depressing affair on microfinance institutions (MFIs).

In rural India, prolonged droughts and poor harvests typically trigger surges of suicides among the desperate rural poor. This is what happened in recent months in AP. The media, however, zoomed in on five dozen or so cases where indebtedness to a microfinance scheme contributed to the hopelessness that drove people to choose death over life. Microfinance, however, is not the prime reason for rural poverty. More often than not, it has provided people with opportunities to improve their livelihoods.

AP’s ongoing tragedy is of interna­tional relevance. Several trends that mark microfinance all over the world are especially evident in this state, and they have contributed to the current crisis, as this essay will show. The trends are
- credit- rather than savings-driven schemes,
- scaling-up with the goal of stock-market listing and
- inappropriate regulations and political interference.

Recent events in AP

In 2010, the AP-based SKS Microfinance became the world’s largest microfinance institution and went public by listing on the Mumbai stock market. A multi-million dollar initial public offering (IPO) appears counter-intuitive to rural destitution. Thus, several journalists wrote stories about profiteering MFI managers and suicidal villagers. However, they do not reveal the full picture and miss several crucial issues.

First of all, over-indebtedness is not a new phenomenon. It is a constant feature of absolute poverty. If over-indebtedness of the poor could be tracked, such data would serve as a good indicator of escalating poverty. So far, however, there is no methodology for doing so. Instead, India only has the brutal too-late indicator of rising suicide rates among the poor.

Typically, the rural poor in India are indebted to relatives, neighbours, shopkeepers and traders, landlords and, of course, traditional moneylenders or loan sharks. Like all rural poor, MFI clients tend to owe money on several fronts.

The London-based Economist (19.11.2010) recently reported that, in AP, 82 % of households have borrowed from informal sources, whereas only 11 % have an MFI loan. Moreover, the indebted persons, on average, owe informal lenders four times as much money – and at higher rates – than they do MFIs. Only three per cent of MFI clients were said to be indebted to more than one MFI. The Economist quoted a recent empirical study as its source. Such data show that MFIs, though contributing to over-indebtedness, were definitely not the core reason.

The credit-only problem

Nonetheless, MFIs were certainly not operated well in AP. The greatest single flaw is that they are credit- rather than savings-driven. For several reasons, most practitioners agree that savings-driven MFIs are to be preferred. Poor and not-so poor ­people alike desire a safe and reliable place for their savings. Given the opportunity, more people make use of such services than are interested in microcredits. Saving institutions provide the financial service most demanded by the poor.

Empirical research, moreover, has shown that MFIs that offer both savings and credit tend to perform better than MFIs that are geared to only one of the two. Poor people live complex financial lives and rely on a variety of mostly informal financial instruments, constantly intertwining savings and loans (see Collins et al., 2009). The famous Grameen Bank in Bangladesh is an example of this trend. It started out as a credit-driven institution, but it was later re-designed (“Grameen II”), and personal savings accounts have since been among its most popular products.

An important difference between credit-only and savings-mobilising MFIs is that the former depend on outside funding. Many MFIs, including SKS in AP and the Grameen Bank in Bangladesh, initially operated on grants. On this basis, most MFIs remain small and local. Some, however, manage to grow by serving as financial intermediaries, borrowing money from banks and other ­financiers and handing out microcredits.

Savings-mobilising MFIs do not face the same constraints. They draw on locally available capital (Seibel, 2010). Indian law, unfortunately, does not allow MFIs to do so. For credit-only MFIs with a desire to expand, access to capital is therefore the core concern. India is home to some of the largest credit-driven microfinance operations in the world. Among the 10 largest MFIs worldwide, by number of active borrowers, four are from India, and three are based in AP.

For an MFI in need of capital, an IPO looks attractive. Stock-market listing can mobilise a lot of money in a single stroke. SKS was the second MFI internationally actually going public. The first was Compartamos in Mexico in 2007. In both cases, MFI leaders were subsequently accused of personal profiteering. Indeed, the vast amounts of money an IPO can mobilise give those in charge scope to help themselves to considerable fortunes. Not by coincidence did SKS run into serious corporate-governance problems shortly after its successful IPO.

The IPOs of Compartamos and SKS were both many times over-subscribed. The one of SKS raked in around 350 million dollars. This MFI actually benefited from the global financial crisis because international investors were looking out for new kinds of assets. Indian microfinance certainly looked attractive in this context. SKS leaders, moreover, were in touch with Silicon Valley entrepreneurs, and obsessed about profit-driven growth.

There are several downsides to the stock market strategy. The worst are the pressures to grow fast and to be extremely profitable. Within a given sector, the companies that go public first normally rake in the most capital. Scaling up, as every MBA student learns, is a way to reduce costs per unit. In order to sell many shares, moreover, it is necessary to publish strong results. An IPO is ultimately nothing but a public auction where bidders respond to high profitability ratios. SKS promised a return of investment of up to 24 %.

Making matters worse, other MFIs in AP were gearing up to their own IPOs. In AP, the pressures to grow and maximise profits led MFIs to overstretch internal controls and under-invest in human resources.

Group entanglement

All of the big AP-based MFIs follow the Grameen example of working with joint-­liability groups. These groups are typically made up of five borrowers. The members are responsible to one another as well as towards the MFI. Basically, the group guarantees that its microloans are serviced. This approach only works out when groups understand what they are doing. They need to be trained and monitored closely by the MFI concerned.

The group approach makes sense when dealing with poor and often illiterate clients. It is labour intensive, however. In their rush to grow, MFIs in AP severely neglected some of their duties towards the self-help groups. Malpractices apparently included
- multiple affiliation of groups, and group leaders, to several MFIs,
- lending without adequate group training, and probably without appraisal,
- re-scheduling of loans to cover up delayed repayment,
- forging of group and/or customer identities (“ghost customers”) and
- sub-contracting of lending agents.

No doubt, such malpractices have contributed to over-indebtedness of individual borrowers. There is also evidence of putting pressure on members that became unable to service their MFI debt. The means used include threats, shaming in public, breaches of privacy and illegal repossession of declared or undeclared collateral.

The list of such incidents seems to be long. Some MFI staff members have been arrested by the police because of such incidents. It is absolutely plausible that such pressure contributed to some peoples’ des­pair up to the point of committing suicide. Any involvement in such affairs is of course unacceptable at institutions that state as their mission the empowerment of poor clients and the improvement of their livelihoods.

It bears repetition, however, that the MFIs did not create the problem of over-indebtedness. By early Decemberr, no case was independently reported that would single out an MFI as the exclusive cause of suicide. One report stated that MFI staff members played causal roles in 23 suicide cases, but it has been observed that this report did not say which MFIs were at fault, and the authors appear to be biased against India’s MFI industry (Rai, 2010).

All summed up, too many Indian MFIs opted for growth strategies that put their missions at risk without doing much to manage such risks. That does not make them responsible for the surge in suicides. But they are certainly responsible for ­having made a mess of microfinance. A lot of trust has been shattered, and it remains to be seen how the MFI industry in India will disentangle itself from this crisis. Apparently, many borrowers no longer feel obliged to repay their debts.

Less than perfect regulations

India’s regulative environment never served MFIs well. Whereas their counterparts in Bangladesh, for instance, are ­authorised to run savings accounts for their clients, Indian MFIs are not allowed to do so. The Reserve Bank of India, the central bank, is strictly enforcing such regulations.

Indian MFIs have severely limited options for broadening and diversifying their business models. Many began to act as insurance agents for registered insurance companies. They have probably extended insurance to more low-income people than any other agencies in the world. It is a bitter irony that this is now held against them. A typical MFI insurance policy, after all, is a life policy for borrowers. If the person deceases, the insurance covers his outstanding debt. The media – for instance the German weekly Die Zeit – consider such mechanisms an incentive for driving people to killing themselves.

Indian MFIs have taken different approaches to diversification. BASIX, for instance, offers agricultural extension ser­vices, Spandana introduced an agricultural loan and Ujjivan introduced a housing loan. Nonetheless, they all basically remain lenders. Their growth and their profitability hinges on lending more money to more people. Typically, the MFIs depend on India’s nationalised banks for refi­nancing. These banks have their own sad reputation for inefficiency, poor services and complacency.

Ultimately, India’s regulators and legislators failed to be part of the worldwide quest for expanding financial services to include the poor. They never come up with ­viable innovations in this area. Instead, they cornered MFIs into the credit-driven business model. Inadequate regulation, moreover, nurtures the informal-sector economics in which corruption, nepotism and illegal exploitation thrive.

It is a farce that Indian politicians now express outrage because of rich MFI-entrepreneurs who apparently collected their fortune by lending to the poor at usurious interest rates. The same politicians failed to create an environment conducive to healthy MFI growth. They failed their largest constituency, the low and very-low-income households.

The state government of AP has responded to the crisis by issuing an ordinance – a government regulation meant to precede a legislative act. The ordinance stipulates that
- MFIs must register their activities at the district level,
- any MFI executive who applies or orders coercive measures against borrowers or their families would be punishable by imprisonment of up to three years, and
- MFIs are prohibited from charging interest in excess of the principal amount.

These regulations quite obviously do not tackle the underlying problem of inadequate MFI regulations. Ultimately, the ­authority for regulating MFIs lies with the Reserve Bank of India and the central government. The latter has announced it will present a bill on the matter in January 2011. Let’s hope it takes some inspiration from Bangladesh where legislation has served MFIs better than in India in the past years. Repairing the damage done in AP will be much more difficult than it would have been to establish a regulatory environment conducive to MFIs in the first place.