India, November, 08 2010 -
The current demonization of the industry is as much an oversimplification as the earlier beautification. The facts tell a more complex story, from which both industry and government emerge flawed - but neither irredeemably so.
To some in the investment industry, microfinance seemed to offer almost miraculous redemption. Here was proof that venture capital could be benign, and still deliver Gordon Gekko-esque rates of growth, reminiscent of the dot-com boom era, while still contributing to uplifting objectives such as poverty alleviation. Was it all too good to be true? The recent fall from grace of the microfinance industry, to the accompaniment of sleazy stories about promoters, and links to thuggish recovery practices and borrower suicides, seem to suggest as much.
In fact the current demonization of the industry is as much an oversimplification as the earlier beautification. The facts tell a more complex story, from which both industry and government emerge flawed - but neither irredeemably so.The Different Microfinance Models
To understand the present crisis, it is necessary to go back to its origins. Microfinance in India actually originated in a government-sponsored model,which linked groups of village women to banks, and relied on grants or public funds for group mobilization. This is the Self-Help Group (SHG) model. The model used by most privately-funded microfinance institutions (MFIs) is the Grameen-style Joint Liability Group (JLGs). Unlike the SHG model, the JLG model creates individual credit histories, if skewed by group guarantee.
The state of Andhra Pradesh (AP) made particularly significant investments in subsidizing financial inclusion through SHG programs but, at least till last month, also allowed private-sector MFIs following the Grameen/JLG model to flourish, largely unregulated. In this welcoming climate,at least four of the country’s largest MFIs originated in AP, alongside numerous other mid-sized MFIs.
Since around 2005 large sums of private equity began to flow into the sector, and private MFIs grewrapidly, as microlending became a replicable, systematic, and profitable business. Unfortunately the government programs, despite being well-intentioned, had neither the discipline nor the sustainable business model to compete. The AP Government’s 2004 interest rate subsidy scheme (Pavalavaddi) only added to the subsidy burden.Government and Private Enterprise
The State believed it was serving its poor through low-cost loans via SHGs, yet commercial microfinance lenders were able to attract clients and achieve a better repayment rate, despite higher interest rates, by dint of their door-step service and frequent small-value repayments. Tension between the government and the private sector led to the Krishna Crisis in 2005-06, when several MFI branches were closed down at the behest of the local government in Krishna District of AP. This crisis, complete with headlines almost identical to this year’s, foreshadowed this year’scrisis, which came to a head with the passing of the Andhra Pradesh Microfinance Ordinance on the 15th of October, 2010.
This Ordinance was promulgated partly in response to sensational media reports on suicides attributed to indebtedness to MFIs. The Ordinance was built on the premise that MFIs are exploitative, charge “usurious” interest rates, and use coercive collection methods.Regulation – or Victimization
In fact, with a median Operating Expense Ratio of 11.8%, Indian MFIs are amongst the most cost-efficient in the world (and their interest rates among the lowest). Larger MFIs generally have greater operating efficiencies, and are therefore able to charge slightly lower rates than smaller ones, as their operating and financing costs are generally lower. The often talked-about cap on interest rates would only reduce incentivesto scale. The stipulations of the AP Ordinance could lead to increased service delivery costs and higher interest rates, thus defeating its intent entirely.
An initial analysis suggested that far from making microlending more poor-friendly, the Ordinance could delay or even block service delivery due to onerous registration requirements, and result in haphazard implementation of discretionary provisions. In the limit, it was possible to see the Ordinance as threatening to close the entire sector by imposing unimplementable requirements on the sector.Emerging From the Crisis
However, events in the last fortnight have significantly changed stakeholder perceptions. Both government and industry appear to be moderating extreme positions. The government has toned down some of its rhetoric, and the industry has acknowledged that the Ordinance has forced some desirable cleaning-up. It is possible that the current crisis could become a turning point, leading to a more balanced, better-governed and better-understood microfinance industry.
The current situation is by no means entirely rosy. Investors are understandably reluctant to invest in the sector at this time. VineetRai, founder of Aavishkaar Goodwell and chairman of Intellecap, says the sector will see a short-term drop in valuations. However this offers a “huge opportunity to invest … in real value deals”. Meanwhile some Foundations and development agencies with a long-termoutlook are still investing. CDC, the UK government’s development finance arm, recently put $10 million into Lok Capital.
The industry in the field is struggling, with collections having dropped from their usual 98% and above to 30% and below. However, the crisis seems to have catalyzed the process of putting a code of conduct in place, and tracking multiple lending through the establishment of credit databases. Acknowledgements by the industry that all was not wellissome augury for future improvements.
In addition, as compliance with the Ordinance progresses, some anecdotal evidence has come in showing Government in a far more responsive light than it is usually given credit for. The registration process has been substantially web-enabled,allowing MFIs to register and upload data quickly and with less opportunity for localized variations in interpretation of rules. There is a faith-restoring anecdote of the state Principal Secretary having responded to a request made after 10 pm one evening with a resolution by the following morning. These anecdotes suggest that the industry is working towards accommodation with government. Intellecap is monitoring these developments, and will report on them in more detail.Looking Ahead
We set out to tell the basic story of the industry in India. Ultimately, industry and government both share responsibility for the current crisis – and for bringing the industry out of the crisis.
Looking ahead, stakeholder education is clearly critical. Much of the commentary on the crisis has revealed appalling ignorance of the benefits the industry brings, the value of private capital, and (important in this context) why interest rates are what they are. The industry associations, Sa-Dhan and MFIN, have important roles to play. The media could also play a more responsible role.
The industry clearly needs to establish visibly more ethical practices, in a sector which has the potential to help millions of poor people. Importantly, there must be industry-owned and industry-administered channels to penalize transgressors.
More regulation is now inescapable; principles that the best in the industry fully recognized, but were unable to implement fully through self-regulation. India’s interests, and the cause of poverty reduction, will be best served by skilled and co-operative regulation. There are, we believe, grounds for cautious optimism. Time will tell if it is justified.