on 15th October 2010, the Government of Andhra Pradesh in southern India issued an ordinance which significantly reined in the microfinance institutions (MFIs) operating in the state. The matter has gone to court and is slated to be heard in the week of November 8, 2010. Coming as it does in the wake of an extremely successful Initial Public Offering by India’s largest MFI, SKS Microfinance, that mopped up an estimated $350 million, this move has come as a rude wake-up call to everyone engaged with microfinance.
That microfinance serves a purpose is never seriously questioned. Grameen Bank in Bangladesh and its replicators in so many parts of the world, along with the relatively unsung Self-Help Groups) (SHG) in India, have created an alternative to the 60-120% interest rates charged by money-lenders (the only other real competitor but with a rather violent recovery system) on the one hand and a dysfunctional rural banking system on the other. How else would people in rural India for instance get access to collateral-free credit that is delivered and collected at the doorstep?
The ability of the MFIs, particularly the Grameen replicators, to rapidly scale up their lending is another clear benefit. This is something formal banks have been less than successful in, especially in India, and even the otherwise robust SHG model has struggled to replicate the speed and reach. It is not surprising that microfinance is one of the fastest growing amongst financial services, reaching credit to an increasing number of people who had no access to this in the past.
But while this crisis is Indian, it has again reopened a range of basic questions about microfinance wherever it is practiced in the world. What is the basic purpose of microfinance? Why are interest rates so high? How can microfinance play a bigger role in poverty eradication?
Nobel Laureate Mohammad Younus, the creator of the Grameen Bank and the global microfinance movement, is supposed to have famously said that it only required $50 to get a woman out of poverty, implying that microfinance is indeed about poverty eradication. Critics have questioned this position. If that is what microfinance does, they ask, then why is poverty still so stubbornly widespread? And what business can generate enough profits to get the borrower out of poverty after paying interest at 28%? These questions have constantly haunted the sector and there are no real answers forthcoming. Some of the findings reported at the recent Microfinance Impact and Innovation Conference in New York seemed to prove the critics right!
At the heart of it all is the vexed issue of interest rates. By all accounts, 28% reducing balance – which is what most MFIs in India charge – is a lot. Indian MFIs have always claimed that since they are not allowed to accept deposits and are dependent on banks for funds, their costs of capital are high. But how have these lending rates been calculated and what attempts have been made to reduce them is not very clear, except perhaps to the experts. MFIs dread interest rate caps but what is not clear is are they doing enough to address this on their own? The fact that MFIs in Andhra Pradesh immediately agreed to drop interest rates by 2% when the government clamped down on them was just cannon fodder to critics of microfinance who have argued that MFIs were simply profiteering.
Perhaps microfinance suffers from promising something that credit alone cannot deliver – poverty eradication. It is widely acknowledged that poverty is complex and multidimensional in its causes and manifestation (which is why indices such as HDI and MPI were created to convince the world that development had to go beyond economics to human well-being). It is therefore quite evident that credit alone will not lick it. But what is significant is that no major Indian MFI – save BASIX and, in a limited way, perhaps SKS – have ventured beyond microfinance to providing larger development services like livelihoods and education. Also, development practitioners will tell you that working with the really poor requires patience (both to properly assess credit absorbtion capacity and build group processes) and low cost funds (to build capacities of the poor to best utlise funds), MFIs seem to have neither of these, especially when they are funded by impatient mainstream investors with quarterly time horizons.
Hopefully the Andhra Pradesh crisis will result in some good outcomes. One good outcome would be a more modest and realistic understanding of microfinance as a profitable business that provides small, collateral-free credit at the doorstep of anyone who needs it and agrees to follow some basic rules – nothing more, nothing less. Another would be more MFIs going the BASIX route of providing a more comprehensive set of services and finding the patience and grant funds necessarily to seriously impact poverty. And third, a more comprehensive regulation that recognises the unique role of MFIs and balances the needs of the borrower and the profits of the lender.
The worst outcome would be a set of rules and regulations that kill the microfinance sector, as that will certainly not provide borrowers the credit services they need. That would certainly amount to throwing the bathwater without even attempting to save the baby!