Microfinance In a Spot Of Trouble

I am keen on Microfinance and try to follow related news / articles as much as I can. Last year I had gone on a research project with some fellow students and stayed in villages for about 10 days. From the discussions we had with villagers and MFI operating in those villages, I got a feeling that though there are many MFIs now operating in India, they do not yet have a clear structure or system to operate with. Villagers further showed a tendency to recycle loans, and often waited for the government to waive off loans.

Though life style of some of the villagers seemed to have improved, I did not see Microfinance making major impact on their means of income. If income was stagnant, improved lifestyle could mean only one thing - that loan was being used to meet household expenses, and not as working capital.

It was thus no surprise when I came across this article:

"Ketaki Gokhale in the WSJ: 'A credit crisis is brewing in Microfinance'
Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more.
'I took from one bank to pay the previous one. And I did it again,' says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for $209, another for $293, and then $356.

At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance 'increased our desires for things we didn't have,' Ms. Taj says. 'We all have dreams.'
Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.
Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt overload is stirring up social tension. Many borrowers complain that the loans' effective interest rates -- which can vary from 24% to 39% annually -- fuel a cycle of indebtedness.
In July, town authorities asked India's central bank to either cap those rates or revoke lenders' licenses. 'Otherwise, the present situation may lead to a law-and-order problem in the district,' wrote K.G. Jagdeesh, deputy commissioner for the city of Ramanagaram, in a letter to the central bank.
Alpana Killawala, a spokeswoman for the Reserve Bank of India, said in an email that the central bank doesn't as a practice cap interest rates for microlenders but does press them not to charge 'excessive' rates.
Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.
The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they're not about to comply with that.
The repayment revolt has spread to other communities, including the nearby city of Channapatna, and could reach further across India, observers say.
'We are very worried about this,' says Vijayalakshmi Das of FWWB India, a company that connects microlenders with financing from mainstream banks. 'Risk management is not a strong point for the majority' of local microfinance providers, she adds. 'Microfinance needs to learn a lesson.'
Microfinance has taken the fancy of many lenders, getting venture funded, PE funded and funded up the wazoo. And they won't give up too easily, as SKS writes:
Ms. Gokhale reports that there is an over-indebtedness problem in one slum in one city in one state of India and goes on to assert that this indicates that there is a 'credit crisis brewing in 'microfinance.' Such a sweeping generalization based on anecdotal information from one neighborhood is absurd.
To the contrary, the data suggest a very different picture. Microfinance institutions in India, which serve 22 million clients, have consistent repayments rates of 95% and above—repayments that clients could not make if they were not generating regular income, given the weekly repayment schedule that most microfinance institutions follow.
In fact, the Microfinance Information Exchange (MIX), the Washington-based non-profit information platform, reports that the average repayment rate of leading MFIs in India—which have the lion's share of clients— is 98%. My own institution, SKS, which serves over 5 million clients spread across 70,000 villages and slums of India, has a 99% repayment rate. Meanwhile, our portfolio received a PR1+, the highest safety rating, from an independent external rating agency, for a debt instrument slated to list on the Indian stock exchange.
Er, but if you repay loans by taking other loans it will definitely show up as a high repayment rate? And as for an 'independent credit rating agency' rating them PR1+, haven't we learnt enough already from their fantastic performance so far? The rating PR1 could mean 'Paid to Rate 1+', for all I care.
Other Micro Finance Institutions (MFIs) answer here. (Unitus, Ujjivan)

The WSJ doesn't usually take badly researched articles, so I would be hesitant to label it unsound and run with the MFIs. Some of the points they make are valid - that it's perhaps wrong to use one city as a benchmark, and that other factors like religious tensions or a downturn in the silk industry could impact that city.

(Btw, Ramnagaram - where Sholay was shot, and the origin of 'Ramgarh ke vaasiyon' - has a lovely set of boulders and small rocks for climbing/bouldering, and I used to visit often when I was in Bangalore.)

Some of the excuses the MFIs put out - like the problem is restricted to two cities, etc. doesn't quite gel right; it feels like an overdefensive posture. Plus, they talk about the benefit of Microcredit - no one denies that. The problem is in expecting default rates to be low, and uncorrelated, an assumption that may no longer be valid when debt spirals occur, and when community resistance builds up.

Traditionally, money lenders belonged to the same region/geography/community - so there were social costs to defaulting; now, the lender is just a faceless external organization. If enough people took loans, they could just get together and default, with only a positive social impact (togetherness). As unsecured loan providers, the MFIs will have no recourse.

It may just be the beginning. MFIs can only make money when the defaults are too high for banks to provide lending, but low enough so the MFIs can get away without having to use strong-arm tactics for recovery. If the defaults get too large, the MFI will be in trouble. And once these customers get on their feet, the banks will grab them and the MFIs may end up only making commissions on selling bank loans. (A positive will be for the MFIs to become NBFCs or banks themselves)

RBI has a paper out, on expanding the definition of 'Business Correspondent', which now includes nearly anyone in a rural setting. The fight for the rural consumer is on; and it's not just loans now. I hope they all get enough knowledge to build businesses, invest in equities and debt (not just FDs) and buy proper insurance; that will be the next phase of the Indian Growth Story.

I'd like to hear whats your take on Microfinance in India.. where do you think the industry is headed?

Disclaimer: This post was originally written by Deepak Shenoy, at The Indian Investor's Blog.


Hi Gagan summarizing your whole idea in few sentences, it is just like lending you more credit cards. Which provokes one individual towards expending more. But then the question arises will the banks will stop there biz. due to the credit defaults arising from such personnel lending ?

Personally I feel so till now, we been unable to come up with a lending model, which can differentiate between a good customer & bad customer for small loans ranging from (10000-100000)INR.
Manoj said…
Interesting aspect.. I believe there should be a regulatory body for MFI's and a central database..

Restricting the borrowers from repaying the loans using unfair means (In this case lending from other MFI's) is one probable solution. This can be implemented if the central database policy is in place...

Since, the loans are taken for working capital, it should be ensured that they are being used for the same..It should be made mandatory for the borrowers to submit a periodical evolution of their business..

MF is still in a very nascent phase.. And to better organize it, there should be well defined and properly followed policies.. Only then will MF will unearth its true potential..
Madhu said…
Dear Gagan,
I am very dissapointed to read your blog and even dissapointed more knowing that you graduated from a premier business school which was supposed to impart you knowledge to analyse any sort of data provided to you before making even a argument forget any judgement.

I would not even like to get into a debate with you on this because you similar to Ketaki Gokhle ( the author of the article) believe in shortcuts without hardwork.

So if you really are interested in finding out what Microfinance is go and work in a microfinance organization for atleast six months and then come back and say it does not have any impact( but that would be a lot of hard work ..no metro or cities, dust, villages, no malls etc). It is very easy to stand outside the ground and curse all the players involved in the game but it takes a lot of balls to get inside the ground and play some ball..
Gagan said…
@ Praveen: Though the analogy is quite close, Microfinance varies vastly from Credit Cards. What you propose has following problems:
1. Average loan varies between INR 300 to INR 3000 / 5000, which is far too small to e tracked effectively.
2. So far very little default has actually taken place. The concern is what might happen few years down the line.
Gagan said…
@ Manoj: Thanks for your comment. The reason it is not possible to have a central database is because most, if not all, borrowers in Microfinance do not even have a Ration Card, or any other proof of identity. Further, given the small quantum of individual loans and negligible penetration of technology, what you suggest is currently not possible. Microfinance relies much on social pressure and mind set of the borrowers, and that has to change quite a bit if the problems are to be eliminated.
A couple of days back, I was watching some special feature on BBC about how some minor sort of credit bubble is in the making in India's largely unregulated Microfinance sector. If such a bubble builds and burst we would be in for a complete socioeconomic nightmare. The authorities have to strike a balance between the ease of capital availability and regulatory control.
Gagan said…
@ Madhu: Thanks for your comment Madhu. Perhaps you chose not to read the article in detail, or beyond first few lines, else you would have realized that all I have tried to bring out from the article is the growing dependence of BOP population on credit, and the kind of mind set that seems to be developing.
Sub prime lending in USA did end up in quite a different manner than was originally expected, and all indications say that Microfinance 'might' be headed the same way unless corrective action is taken.

Further, please do not make your own assumptions without knowing the person you are writing about. I have been working with MFIs in one capacity or other for past year and half, and was even involved in launch of a MFI in Bihar last year. Having studied from a premier B-school does not mean lack of balls automatically, you know.

Lastly, it would be great if you could share the work you have done with MFIs and lead us by your example.
pearl said…
Indeed an interesting post. Especially the part about high interest rates and cyclical effects are very true. I agree that microfinance rates may be lower as compared to those of money lenders, but in itself they are high. The cyclical effect creates a lifelong indebtness, which is difficult to come out from. Microfinance as a concept is great, and can do wonders for the sector it serves. But it is essential for the concerned institutions to put in place proper structures which help the population on a long term basis, and not merely focus on short term benefits.
Yashika Totlani said…
The microfinance industry is headed for the pits. Everywhere our debt-ridden farmers take bank loans to pay off old loans, with no means of paying them back. Its almost like a mini sub-prime crisis within our own country. The government keeps refilling the coffers, and farmers rely on waivers. Which is fair. The Indian farmer lives in the worst possible conditions in the world. To help them pay off their loans is the least a government (that spends crores on something as menial as building shivaji statues before elections) can do.

Good thought and a well-written article.
Madhu said…
@ Gagan: Well I have worked with MFIs for more than 3 years and continue to work with MFIs . Unfortunately your comparison of Microfinance and Subprime says it all. I myself was thinking to put that earlier into persective but still I would just give you a little comparison of subprime and Microfinace for your understanding( picked up from a blog):
both cases there is the idea of lending to people who historically did not have access to credit. Also, interest rates are typically higher for subprime borrowers than for "prime" borrowers, just as they are higher for micro-borrowers. Similarities seem to end there. Differences are that, while microfinance focuses on increasing economic productivity, subprime lending was for housing (which at least in the US is not likely to boost productivity). Lending to subprime borrowers is not done in "groups". It is very difficult to restructure the subprime loans (often that is why subprime borrowers default, because they are unable to refinance). Lenders do not maintain relationships with the subprime borrowers. The way loans are typically handled in the US, the loans themselves are "sold" to a third party who has no direct connection to the borrowers. Other big differences are that the subprime loans are secured (which effectively makes it possible for banks to leave the door open for defaults), that the terms of the loans are long, and the payment period not so frequent (monthly instead of 2 or 4 times per month) so that trouble is not spotted as quickly

Anyways for your information some data: Indian MFI market is expected on conservative basis as 60 Bn USD and the current GLP of all MFIs added is USD 3 BN. The NBFC is a highly regulated business under NBFC and its levereage can never be beyond a point because of RBIs CAR regulation. While in case of subprime the method applied to break loans was itself devised to get out of regulations( credit ratings)
I think like any other Industry MFIs are in a nascent stage of built up and there are ample opportunities of improvement but sensationalizing the MFIs and creating a unnecessary hulla over MFIs is very ridiculous and annoying. all the well wishers of poor who are so concerned for the poor have not been able to provide any choices to poor people in the last 60 yrs since independence despite spending billions of USD from govt. exchequer. So if now some entrepreneurs are trying to fill this gap and providing financial choices to poor , suddenly they have become profit mongers and the whole chivalrous gentelmen have suddenly come for the rescue of poor .

@yashika Totlani : sorry for offending you but you seem to know nothing about MFIs because neither are MFI loans meant for farmers ( agri lending) nor is the size of MFIs loan makes any meaning for farmers as it is in the range of 120 to 200 USD
Dark_Temptation said…
Hey!! of late i came across this article on Microfinancing and found it interesting to know the way MFIs are progressing... http://business.outlookindia.com/article.aspx?240795

But your article brings out the fact that it is not all that Hunky-dory :). Interesting,i mus say....
Gagan said…
@ Chintan: Well said bro... lets hope these issues are addressed soon, as Microfinance still has miles to go.
Gagan said…
@ Pearl: The high interest rate is necessitated due to high cost of operation in rural areas. As for Microfinance being a great concept, our sentiments exactly! :)
Gagan said…
@ Yashika: Thanks for the appreciation. It is not that Microfinance has not helped poor people. Many have benefited and have been able to start new mode of income. The problem starts when this credit is used to meet daily household expense, or even some emergency expenditure, after which repayments burn a deep hole in borrower's already small pocket.
Gagan said…
@ Madhu: Thanks for the refresher course in Microfinance and Sub prime loans. I must say it is very bold of you to assume that we are not aware of the differences mentioned by you.

I fail to understand why time and again you fail to realize that Sub prime is just being used as an analogy, and nothing more. Nowhere did we compare the purpose or methodology of issuance and distribution of Microfinance and Sub Prime.
And despite your 3 year old experience in the game, you seem unaware that some MFIs have converted Microfinance loans into securities and sold them in international markets, which was exactly what was done in sub prime loans also. The concern I have tried to highlight is easy mode of refinance available to MFI TG which just results in retiring one debt by taking a new one, and the borrower does not actually become debt free, though MFI data reflects healthy repayment rates.

I heartily agree with you when you say that Microfinance is still in a nascent stage and there are ample opportunities for improvement and I believe me and my readers are just talking about what all improvements can possibly be made. Surely you can understand and appreciate that.

Let me make it very clear to you that there never was any intention to sensationalize MFIs or Microfinance as a whole.

I would be grateful if you can criticize / comment without using aid of your (seemingly) hyperactive imagination fueled by your excitement. Could you please point out exactly where the hell have I called MFIs / MFI entrepreneurs profit mongers or any thing similar?? I welcome criticism, but only to the extent of what has been said in my post, and not on the basis of what one imagines is said in my post.

I would once again like to request you to try and not to over react. Only then can you understand what is being said in my post.
Gagan said…
@ Dark Temptation: Hey.. thanks for your comment. Microfinance is indeed a powerful tool, which not only empowers the BOP customers, but also enables corporates to increase their reach in rural areas. However, there are few problems that seems to be brewing below the surface, and thats what I have talked about :)
Madhu said…
haha.. No you have said it all.. With your comment on securitazation you not only show your knowledge of MFIs but also render your business degree useless. Didn't they teach you a bit about securitazation at your B school...but ya you might not have been allowed finance courses there. Thats why you read securitazation and started jumping the MFI loans are being securitized and sold in international markets.
It is rightly said "If you give a pen in the hands of a monkey he is not going to write a novel...he might actually end up blinding himself and others with it"

I do not need any response from you now and I am satisfied by your reply.

Note :
I was one of the people who where instrumental in securitization deal which you are referring to and believe me it is not what you are talking about.

Also one thing I was wondering ..when did you get the time to work in MFI and start one in Bihar when the last few years you have been at B school..may be you did it on phone ( My earlier comment was regarding that attitude only...Unless you spend time and I mean time in the field and atleast 6 months whatever you say is no different from someone sitting in US posh office and commenting on a village in Karnataka and AP and you are no different.
Gagan said…
@ Madhu: your comments do not merit a response

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