Recent media coverage of microfinance has focused largely on scandals surrounding the microcredit industry in Andhra Pradesh, India. Outlets from the BBC to the Financial Times to the Sydney Morning Herald have run stories about the implosion of the microfinance industry in Andhra Pradesh, and just today another article has appeared in the Guardian’s Poverty Matters Blog. So what really happened, and is it representative of the microfinance industry as a whole?
In August, the microfinance institution (MFI) SKS, which is India’s largest MFI and one of the world’s fastest growing, undertook an ‘Initial Public Offering’ (IPO) on the Mumbai Stock Exchange, which means that for the first time they sold shares in the business on the public market. The IPO raised an enormous amount of money – around $350 million US – and meant that for the first time SKS was accountable to shareholders for profits. The commercialisation of MFIs that started as not-for-profit entities is hugely controversial, with opponents claiming that it undermines the centrality of poverty reduction in the industry, while supporters point out that if we are to reach the estimated 2.7 billion people around the world with no access to financial services we need to look to profit-making organisations because donor funds are just too limited.
Secondly, the media started to pay attention to stories of over-indebtedness among microfinance clients, particularly in some areas of India including Andhra Pradesh where many clients have simultaneous loans from several different MFIs. Stories abound of debt-related suicide – although there are also counter arguments claiming that the rates of suicide among microfinance clients have not been shown to be abnormally high. Together these two stories have fuelled media and political attacks on the very concept of microfinance.
In mid December the Andhra Pradesh government accused the microfinance industry of charging usurious levels of interest and encouraging over-indebtedness, and passed a law placing strict curbs on the industry and effectively directing borrowers not to repay outstanding loans. Unsurprisingly this has led to widespread defaults – the estimate is that only 10% of due loan repayments to MFIs are currently being made in the State.
There are several problems with both the media and Andhra Pradesh government responses to the issue. Firstly, microfinance is not a uniform sector. While many MFIs focus closely on client welfare, there are also organisations that identify themselves as providing ‘microfinance’ that many observers would struggle to differentiate from loan sharks. So, when talking about microfinance it’s important to define what we are referring to. It is far too sweeping a statement to say either that all microfinance is positive and helps to reduce poverty, or that all microfinance creates poverty traps and is harmful to the poor.
While no-one would deny that there are problems in the microfinance industry in Andhra Pradesh, in the case of these scandals it seems as though the accusations of exorbitant interest rates were rather overblown. Most MFIs charge interest rates between 18 and 35%, and India in fact has the lowest microfinance interest rates in the world. While these rates are higher than many loans offered by formal banks, this is simply a reflection of the fact that it costs more to offer small loans to very poor people, and the rates generally compare very favourably with those offered by other informal sector providers, which are often in the region of 100% or more.
An interesting recent initiative that is opening up the interest rates charged in the sector to greater scrutiny is MicroFinance Transparency. On the website datasets reveal the range of pricing for products in various countries – currently including Kenya, Bolivia and Cambodia among others. Data is currently being collected for India, with 80 MFIs (including SKS) having provided data so far. As Chuck Waterfield, President of the initiative recently said, “Microfinance is the first industry of any kind in the world to practice global, voluntary disclosure of true pricing.”
So some of the accusations against microfinance in Andhra Pradesh are probably not justified, particularly as the Andhra Pradesh government is actually in direct competition with MFIs for the ‘market’ of providing financial services to the poor as it also offers credit through its ‘Self-help group-Bank linkage’ programme. A recent blog from the Harvard Business Review suggests that “What we are really seeing in Andhra Pradesh is the fallout from a long-standing competition between MFIs and the state government, each of which believes it should be the source of financial services to the poor.”
On the other hand, overindebtedness of clients is a very genuine concern. In many MFIs, incentive structures for loan officers – the people who actually sell loans to clients and then collect the repayments – push them to expand rapidly at all costs, with little focus on ensuring the debt is sustainable for the client. Commercial MFIs in particular are under a lot of pressure to expand in order to keep funds coming in. So the detail of how MFIs operate is hugely important.
Although there is little empirical evidence available about which types of microfinance are most effective at helping the poor to get out of poverty, at RESULTS we suspect that studies currently being undertaken by the UK Department for International Development (DFID) among others are likely to show that the best way for MFIs to fight poverty is to foster close supportive relationships between loan officers and clients. This includes ensuring that clients receive basic financial literacy training, are not encouraged to take on too much debt, and setting up incentive structures for loan officers that emphasise client retention as well as new loans made.
This is why we are currently engaging with DFID to push them to ensure that social performance monitoring – which means actually tracking the social impact of MFIs including their contribution to poverty reduction as well as their financial performance – is integrated into all the programmes that they support. Our recent submission to the public consultation on DFID’s capacity-building fund for microfinance in Africa emphasised this point heavily.
The tragedy of the situation in Andhra Pradesh is that the heavy-handed government response may actually make things worse for the poor. Even with the government’s self-help scheme, many poor people have few options for obtaining the financial services that they need and microfinance organisations do fill a real need. The danger is that restricting the operations of MFIs will push people back into the hands of real loan sharks. For an interesting assessment of an alternative regulatory approach to dealing with the real problems of hyper-growth in the industry, see this blog by Sanjay Sinha, Managing Director of Micro-Credit Ratings International Limited.
So to answer the question in the title of this blog post: yes, we believe that international aid has a role to play in supporting microfinance in those areas where there are still billions of unserved people such as Sub-Saharan Africa. It can be catalytic in helping to establish the institutions to reach those 2.7 billion still outside the financial system. But it is absolutely crucial that it supports the right kind of microfinance – microfinance that prioritises poverty reduction and has the client at the heart of its mission.
We’d be interested to hear your opinions and look forward to reading your comments below.