In rural India, capital has been a scarce resource for the most deprived sections. On one hand, local money lenders charge exorbitant rates and on the other, traditional financial institutions hesitate to extend credit to these borrowers. It is this gap in the lending market that micro-finance institutions (MFIs) have bridged by introducing the innovative concept of disbursing small loan amounts to a large number of clients repayable at short intervals. There are mainly two variations of the MFI model:
SHGs typically start off as loosely-linked groups of 10-20 members who meet regularly and pool their savings and disburse micro-loans from these savings. After roughly 6 months of stable savings, banks or other MFIs start providing credit to these groups. Further disbursement of loans happens according to the criteria developed by the group.
In this model, each village has one or more centres with 6-8 groups of 5-6 members each. The groups are very tightly bound together, resulting in high social pressure to repay the loans. Any member who fails to pay, risks social exclusion, but additionally, his group still has to repay his loan, thus ensuring nearly 100% repayment rates. MFIs under this model have shown the fastest growth both geographically and in the number of customers. But, developing such self-regulating centres requires a lot of training and effort.
Untapped Market: The MFI model made it possible to extend credit at affordable rates to the deprived sections of the society. As there was a dire need for credit in this segment and they did not have other comparable alternatives, MFIs were a welcome relief for them and thus there was a huge influx of customers.
Government Policies: Favorable policy changes, namely the 2004 RBI decree that included lending to MFIs through intermediaries under the purview of priority sector lending, led to an exponential growth of the microfinance industry; currently a total of Rs. 60,000 crores has been sanctioned by banks for lending to MFIs.
The Beginning of the Crisis
Most of the phenomenal growth witnessed by the industry was concentrated in Andhra Pradesh. Some of the big players like SKS were alleged of charging exorbitant interest rates and employing unethical loan recovery practices. The interest rates charged by the MFIs seemed inelastic to the steep decline in primary lending rates. The industry in general and SKS in particular continued to grow tremendously. In order to raise more funds to widen its reach, SKS decided to go for an IPO and with the backing of big PE players, SKS pulled off a highly successful IPO despite widespread criticisms of commercialization of the industry. This was soon followed by stories of SKS employees cashing out their stock options, becoming instant millionaires and the then CEO being sacked, leading to questions about corporate governance at SKS.
The problems at SKS exposed just the tip of the iceberg of issues plaguing the Indian microfinance industry. PE investors, the financial backbone of the industry, were pressurizing the MFIs to focus on growth. Many issues arose as a result:
Lending for Consumption: The pressure from PE investors to focus on aggressive growth led MFIs to extend loans for purchase of lifestyle items and consequently created a debt trap for the poor by encouraging extravagance.
Deviation from the SHG concept: The relentless focus on growth led to spending little time and effort on developing mutual trust within SHGs that is required for timely repayments.
Multiple Lending: Faced with an inability to pay back earlier loans that were used for consumption, many customers took loans to repay them, thus falling into a vicious debt trap.
Suicide of Borrowers: Unable to pay their loans, many borrowers committed suicide and many regional political parties exploited this to cast the MFIs in an evil light, resulting in the drop of repayment levels from 99% to 20%.
To bring about changes in corporate governance of the MFIs and hoping to regulate the profit-motive of these institutions, the AP government passed the Microfinance Institutions Ordinance 2010. The salient features of the Ordinance were:
Registration of MFIs: MFIs have to be registered and have to furnish details such as interest rates charged, area of operations and methods used for loan recovery. They have to submit monthly reports of their operations which would be open to scrutiny.
Regulation of Interest Rates: a) Interest payable on a loan should not exceed the principal amount and this should be implemented with retrospective effect.
b) MFIs have to make the interest rates charged publicly available. And no costs other than the ones laid down in the application should be charged.
Curbing Multiple Lending: a) Second loan to be granted only on clearance of the first loan.
b) Membership only in one SHG and SHG members require permission of registering authority to take a second loan.
Directives for Loan Recovery: a) Only MFI personnel with identity cards to go for recovery, which would take place at Gram Panchayat offices and not at the borrowers’ residence.
b) Fast courts to be setup to handle grievances and loan sharks to face up to 3 years in jail and/or Rs.1 lakh fine.
Long- Term Implications
These measures are short-term fixes and have created a moral hazard problem for MFIs.The restrictions on multiple borrowings would mean non-renewal of a lot of current loans. And since most groups were made by MFIs and were not social groups that came together themselves, there is little social incentive to repay. Also due to the combined effect of political opportunism and the general anti-MFI environment, borrowers are exploiting the recovery laws to escape from repayment. If the trend continues, it would become increasingly difficult for the MFIs to get loans from banks for their operations. Thus, we see that the very laws which were meant to facilitate and regulate MFI activity in the state are now curbing all of MFI operations.
The authorities should realize that microfinance is in principle, capable of providing access to capital for the most deprived sections and the current failure was systemic, due to lack of regulation. This can be rectified by bringing proper policy changes through a regulator like RBI, which has a long history of good policy making. This would ensure that regulation of this sector is immune from political influences. Only then can the firms hope to survive through the current times and prosper and replicate the model in all parts of the country.