Andhra Pradesh Microfinance crisis: what went wrong
Microfinance has been one of the most successful tools to spread financial inclusion among the poor in developing countries. The idea behind microfinance lies on building specific financial products tailored for low income people, to allow them to access capital to improve their life and their family’s condition. The concept is much different from aid or social transfer, it is an empowerment tool which enables people to find a solution on their own and invest in their own future. The success of microfinance has been celebrated since its first inception in Bangladesh, in the 1970s, and its pioneer Muhammad Yunus was awarded the Nobel Peace prize in 2006. This is why it is so important to understand the causes of the crisis that hit the microfinance market in Andhra Pradesh in 2010.
In the fall of 2010, in the south eastern Indian region of Andhra Pradesh 57 microcredit debtors committed suicide. This dramatic incident has been the symptom of a crisis in the microfinance sector in the area which can be seen by the drop of stock value of one of the biggest microfinance institutions, publicly traded SKS Microfinance Ltd.
Stories about the victims help us understand the reasons why coming to such drastic decisions: shame, desperation and external stress. Families blamed the strong pressures of collecting agents, who suggested that life insurance would have covered the debt. These dramatic episodes draw attention to the lending practices of Microfinance Institutions (MFIs) and the Indian government. But who is to blame? There is certainly plenty of blame to go around! Blame falls on the MFIs that failed to restrain aggressive growth as the market became saturated; on the investors, who pushed ever-faster growth to make their investments to pay off; but mostly the blame falls on the government itself, which created a banking sector unable to respond to the needs of poorer consumers, and did not care to regulate such fast-paced growing sector to secure a successful relationship between the government and financial sectors.
Microfinance institutions in India became very important because they succeeded where the public sector had failed; they were an answer to poor people’s lack of financial opportunities. MFIs acted like a surrogate of development policy, since the government was not acting. And to make matters worse, instead of using the tool to promote development and financial inclusion, the government decided to create a new government development program, Self Help Groups, to compete with the new sector.
Most importantly, the sector was not given true direction. For example, although some Microfinance NGOs were allowed to go public and become commercial banks, they were not given the right to hold deposits. Allowing MFIs to hold deposit and become solid banking institutions would have helped them to raise funds locally and allow them to produce a balanced portfolio, instead of relying solely on micro loan products. In addition, a bank that holds deposits is also able to promote savings among its clients, they are more likely to repay and less likely to fall into debt-traps.
In India, banking policy tends to be constructed with banks in mind – a special relationship between the Indian banking authority and the public-sector banks. This relationship comes from the nationalization of the financial sector of 1969 (14 banks were nationalized in 1969 and six more in 1980). Although at the end of the nineties India allowed the privatization of the financial sector, the banking regulations that accompanied this reform were tailored for the public sector. The microfinance sector was not promoted in an open environment, but in a protectionist one.
The causes of the microfinance crisis and its consequences were therefore a blend of over- indebtedness of the clients, a lack of control in the lending process of the MFIs themselves, and the protectionist nature of India’s financial sector. The MFIs sector was not able to grow as true competition to government self-help groups, and its preferred relations with the financial sector did not allow for MFIs to truly prove their potential as a financial inclusion tool. The situation is still unstable for MFIs in India, and suicides caused by excessive pressure on clients are still reported nowadays. The failure of government intervention and the excessive competition on its side led the MFIs in Andhra Pradesh to create a self-regulatory group in order to promote client protection and ensure a robust development of the microfinance sector, an issue I will touch on in my next blog. Self-regulation can therefore be the answer to the protectionist nature of the Indian government.