In 2010 the global microfinance sector was shaken by a crisis in India, which saw repayment rates plummet and led many to reconsider the benefits of microfinance as a tool for poverty alleviation. Two years on it is easier to see what caused the crisis, and it is now possible to re-examine the events of October 2010. It is also possible to make an early appraisal of the Indian government’s response, which comes in the form of a new law to regulate microfinance on a national level. As the ‘Micro Finance Institutions (Development and Regulation) Bill 2012′ passes through the Indian parliament, the RESULTS blog looks back at the causes of the 2010 crisis and what the new regulatory framework means for microfinance in India and elsewhere. It is clear that the crisis in India was a low point in the history of microfinance, but it is also becoming clear that the situation presents an opportunity to reconsider the way microfinance is supervised. This should allow all of us involved in microfinance to learn lessons for the future, in order to ensure that poor people have access to appropriate financial services that help rather than harm them.
To see the root causes of the crisis we must go back to the decade preceding 2010, during which the Indian microfinance sector (and that of Andhra Pradesh state in particular) grew at a rate of almost 90% per year. The number of microfinance institutions (MFIs) exploded, and many expanded aggressively into regions that were already in some cases well-served by existing MFIs. Huge amounts of capital flowed into MFIs’ coffers from investors and international agencies, reflecting a belief in the ‘double bottom line’ (the idea that microfinance could generate profits and reduce poverty), and many MFIs did all they could to lend this money to poor clients as quickly as possible. Many of these clients ended up with multiple loans from different lenders, and as their ability to repay diminished, the MFIs’ loan officers (who are usually paid low, performance-related wages) were under increasing pressure to ensure that the MFI they worked for would be repaid before its competitors. Some loan officers began harassing clients for repayment, and in a small number of cases loan officers engaged in completely illegal activities such as the abduction of borrowers’ children or theft of their property.
As these trends became more prevalent, a number of borrowers committed suicide in a series of cases that were widely reported in the Indian media and sparked a backlash from the local government in Andhra Pradesh state. Local officials implemented a directive that prevented MFIs from collecting repayments outside government offices, as well as publicly offering support for borrowers who couldn’t or didn’t want to repay their loans. Unsurprisingly, repayment rates collapsed to around 10%, and many MFIs suffered huge losses. In the months that followed, Indian and western media outlets were inundated with stories about the exorbitant interest rates being charged by MFIs and how over-indebtedness was causing borrowers to commit suicide. In some cases the idea of microfinance itself was held responsible for their deaths, with headlines like “Impoverished Indian Families Caught in Deadly Spiral of Microfinance Debt“, and this is where we can begin our reconsideration.
Almost two years later, it is possible to take another look at what happened. As far as the suicides are concerned, while there is little doubt that coercive practices did contribute to deaths (a study by the Society for the Elimination of Rural Poverty concluded that 54 deaths linked to microfinance loans could be identified) the suicides are also unfortunately part of a much larger trend amongst certain segments of Indian society. Articles in respected medical journals such as the Lancet and the British Journal of Psychiatry illustrate the tragic prevalence of rural suicide in India, which was documented long before the commercialisation of microcredit. Some commentators have also suggested that high interest rates played a part in driving microfinance clients to suicide, however as Sanjay Sinha (head of Indian microfinance rating agency MCRIL) has frequently pointed out, the average microcredit interest rates charged in India are amongst the lowest in the world.
Having said that, what happened was clearly unacceptable and there is no doubt that action has to be taken to prevent it from happening again. The 2010 crisis in Andhra Pradesh must not be ignored and should not be forgotten. Even if the idea of microcredit itself didn’t cause the tragic deaths that prompted the government response, it is clear that a failure to co-ordinate and oversee the microfinance sector in Southern India created a situation where borrowers felt under intense pressure to repay loans that they couldn’t afford. It is this failure of oversight that the Indian government is now trying to address with the new legislation on microfinance.
The new bill, which is currently passing through the Indian legislative process, will go some way towards addressing the root causes of the 2010 crisis. The law will put almost all Indian microfinance institutions under the supervisory control of the Reserve Bank of India (RBI, India’s central bank), and allows for the creation of national and regional councils that will license and directly oversee the operations of MFIs. Institutions will also be required to report their financial performance on an annual basis, and regulators will be given the power to put limits on the profitability of microfinance institutions.
Of further significance in the bill, however, is the way in which it acknowledges the importance of microfinance as a tool for poverty alleviation and financial inclusion. The bill itself describes the role of the RBI as being to “regulate, promote and ensure orderly growth of the micro finance institutions and take measures as it deems fit, for the purpose of promoting financial inclusion through such institutions.” The bill also provides for the creation of a fund that will support microfinance by providing loans to capitalise MFIs, as well as grants for staff training and capacity building, and this is a very positive step towards the creation of a sustainable, pro-poor microfinance sector in India.
This acknowledgment of microfinance’s importance to the people of India is significant, because it shows that it is not the idea of microfinance which is broken, but rather that steps need to be taken to ensure microfinance institutions are fit for purpose. This fits with the conclusions of the inquiry report produced last year by the All-Party Parliamentary Group on Microfinance, which concluded that despite significant problems in the sector, microfinance can be a valuable tool for relieving poverty provided that it is properly supervised. (RESULTS provides the Secretariat for the APPG, supporting the parliamentary officers in their work, including the inquiry.)
As the Indian Government takes steps to ensure that the growth of the microfinance industry becomes better regulated, we at RESULTS will also continue to call on investors and regulators in donor countries to make a positive contribution to challenging the issues and building a microfinance sector that benefits poor clients as much as possible.