I have been thinking a lot about microfinance recently. This volunteering has allowed me to spend more time researching about microfinance and other aspects of the world economy. I have now read over a dozen accounts of what happened in Andhra Pradesh and why the Indian microfinance sector is imploding on itself and I think I have a decent mental framework of the situation.
Andhra Pradesh was the initial hot bed of microfinance in India and expanded much faster than the rest of the country. The microfinance institutions (MFIs) generally followed Yunus’s example and his Grameen Bank in Bangladesh. One of the larger MFIs in Andhra Pradesh is known as SKS and is run by a man named Akula. He made a controversial move which apparently upset Yunus. He decided to make the MFI public and allow foreign investors in the picture. Yunus was against this because he thought allowing foreign investors to have a stake in an MFI would askew the essential mission of an MFI. To be clear, Grameen bank is also a for-profit MFI but there are some important differences. Grameen bank has a policy of forced savings and borrowers are forced to buy a share of the company, giving them partial ownership of the enterprise. The savings serve as equity to cushion against the risk of loans defaulting as well as allowing poor people access to saving as a financial service. The idea that the borrowers also own a part of the bank is a nice idea but I get the feelings that this is really just smoke and mirrors. I think that the vast majority of managerial decisions made at Grameen Bank are still made behind closed doors. The borrowers do occasionally get some return on the shares however which is definitely a good thing.
The regulatory environment in India is a completely different story. The MFI’s in India are not legally allowed to take any deposits as savings. I believe that this policy can be attributed to a legacy of Indira Gandhi and her program for nationalizing banks. At this point the government of India still has a grip over the financial industry; both macro and micro. It seems there was tension between the entrenched government authorities and the private MFIs; some kind of petty political fight over control. If MFIs could take deposits and thus operate like legitimate banks they would threaten the dominance of the state controlled banks.
Akula himself used to work for an NGO funded through development grants and philanthropy and he was apparently disillusioned by how little outreach his organization was able to accomplish. They had to continually turn people away because of lack of funds. He found this really frustrating and decided to try and develop his own for-profit, financially sustainable MFI. He thought that if it could expand on its own that it would grow much faster. I sympathize with this idea but the problem really came with the inability of private MFis to take savings. In order to maintain steady growth and keep up with growing demand he was pressured to open the doors to foreign capital. Once these doors were open he was subjected to even stronger pressure from these investors. Investors expect a return on their investment. Investors generally have a herd mentality and so if SKS would show signs of slowing down than some would jump ship which would pressure others to do the same. Some investors jumping ship would cause the shares to decrease in value and thus make the prospective lack of financial liquidity a self-fulfilling prophecy. The microfinance industry continued to boom in Andhra Pradesh and it became clear that there was a bubble forming. The market was getting saturated with MFIs. SKS in order to placate its weary investors was forced to become more aggressive in its loan collecting methods. They used much more coercive means to collect the money. There were around 300 suicides in India by microborrowers which ignited this crisis. At this point I believe there have around 13 suicides attributed to SKS’s “coercive techniques”. One story goes something like a microborrower was struggling to pay off her loan to SKS. She took out numerous loans from other MFIs but she could not get out of the spiral of debt. One of the loan collectors told her that if she could only get out her debt if she drowned herself. The next day she did.
The Indian government has been cracking down on MFIs and the entire industry has been collapsing. There are some lessons to be learned from the crisis in India. There is a difference between growth bubbles and actual development. Just because there was a lot of money circulating around the rural communities of Andhra Pradesh doesn’t mean that there was real wealth creation. The kind of financial bubble that occurred in Andhra Pradesh could prove to be more harmful than beneficial. Without a sustainable policy of savings/deposits MFIs could end up becoming mere pyramid schemes.
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