Why the vilification and collapse of microfinance in India is no less than a tragedy for society

The impact of microfinance on the poor has been tremendous; helping to empower individuals economically, socially and politically. According to a report released by the Microcredit Summit Campaign, by participating in microfinance schemes, nearly 9 million Indian households, including approximately 45 million family members, rose above the World Bank’s $1.25 a day poverty threshold between 1990 and 2010. Unfortunately, legislation passed by the Andrha Pradesh government, following arguably unjustified and vilifying allegations, has effectively caused the industry to shut down and the poor to continue to be poor. A huge loss to all of us who want to see the end of poverty.

Microfinance works by providing small loans to the poor who otherwise have no access to traditional means of credit. The loans are intended to allow the poor to invest in such things as tools, inventory and livestock in order to start or expand businesses and generate enough income to bring them out of poverty and create better lives for themselves and their families. As in any business, borrowers will require larger loans as they expand, so on repayment of their loan they become eligible for one. This ensures repayment for the microfinance institution (MFI) without holding any collateral from the borrowers or having to resort to coercion and gives the village more freedom to regulate itself. Many larger MFIs have also introduced insurance products such as for health and endowment as well as other key products to ensure security for borrowers’ families.

The rapid expansion of microfinance in India has been driven by NGOs using the aforementioned “Grameen” model pioneered by Nobel Prize winner, Muhammed Yunus in the seventies. This model has eclipsed government Self Help Groups which generally require individuals to first make savings before becoming eligible to borrow. Despite this extended reach, a 2008 World Bank Study “Access to Finance” estimated that in India only 10% of the $60 billion demand for such services had been met.

The results are truly phenomenal. A study was commissioned by the Small Industries Development Bank of India, an independent financial institution aimed to aid the growth and development of micro, small and medium-scale enterprises in India. It showed that borrowers benefitted significantly from microfinance. Amongst the findings were that 76% were able to increase their income through MFI assistance, 66% improved their food consumption, 56% could improve their housing conditions and 77% could provide better educational facilities. However, it is not until you witness the impact firsthand that you really understand how such loans are able to transform lives and entire communities. I recently visited several villages in Karnataka which have benefitted from loans distributed by SKS Microfinance, India’s largest MFI. When I asked the women (SKS only lend to women as part of their model) how their lives have been affected since taking loans, they all smiled and wiggled their heads. Some told me of how they were able to set up new businesses and others of how they can now afford to send their children to school. “This tin roof I purchased using my new savings. Before it was only made of straw” a new kirana (village) store owner told me. The more villagers I spoke to the more humbled I became as it was clear the benefits had extended beyond just the borrowers themselves. As I learnt more about their lives and their communities, I found that these women had grown in more ways than one. Their confidence had soared as they were now able to provide for their families and in turn, gained respect within their communities. SKS places great emphasis on this social empowerment aspect and I believe it is a huge stride forward for India.

Alarmingly however, in the past year, allegations have been spread, including claims that MFIs use excessive pressure to enforce payments, charge extortionate, non-transparent interest rates and overextend borrowers. Politicians such as V Vasant Kumar, Rural Development Minister of Andhra Pradesh (AP), in whose jurisdiction most of the major MFIs are based, also claim that MFIs are to blame for a series of suicides by borrowers. The reality is that in India, suicides unfortunately are not uncommon; for example, only recently forms of pesticides were banned after it was found some farmers had used them to poison themselves. The complex issues behind each suicide cannot be attributed to a single cause, especially when the accused has possibly helped others in similar situations actually pull away from further tragedies. If these loans have been shown to help the poor create better lives for their families, are MFIs not in fact helping stop suicides?

To quote Muhammad Yunus, “We never said microfinance was a silver bullet,” by no way do I suggest that microfinance neither is the perfect solution, nor do I believe that there is no malpractice within the industry. With tens of millions of customers, it is unrealistic and naive to believe that each and every customer is served in the fair and supportive way its founder envisaged. However, it is also clear that this is one of, if not the best, solutions we have to poverty right now and empirical evidence and borrowers’ testimonies tell us it is undeniably working. Is it not right then to promote, support and regulate such an industry?

In every part of society, policy should be shaped around incentivising people to do things beneficial to society and its development, whilst also punishing those who misuse such channels. As such, regulation of the MFI industry was necessary and strides have been taken by the central government and the industry to do so. In December 2009, the industry set up the MFI Network and adopted a self-regulatory Code of Conduct which includes limiting borrowers’ loans, sharing data with credit bureaus and enforcing a whistleblower policy on any violators. In order to establish formal regulation, the Malegam Committee set up by the Reserve Bank of India (RBI), made a series of recommendations in January 2011 and subsequent industry guidelines were released by the RBI in May 2011. These were widely well received by the industry and commentators alike. They place certain limitations on MFIs and give more security to borrowers through, for example, maximum loan sizes and interest rates. Importantly they recognise the importance of financial inclusion for all and the role of MFIs in reaching this goal. They also bring further legitimacy to the industry and in turn give MFIs further access to cheaper funding.

Unfortunately, following the spread of the earlier mentioned allegations by opinion leaders, premise was created for the government of AP to swiftly introduce their own legislation which consequentially placed huge restrictions on MFIs’ ability to collect repayments and disburse new loans. Each new loan application must now be authorised by a government agency, which given their disapproval of the industry and slow pace of operations, has all but stopped MFIs disbursing new loans. The damaging consequence of this is that now, with no prospect of receiving fresh loans, borrowers have no incentive to repay. Subsequently, this has caused many of the large MFI players to write off millions of dollars of debt and left many smaller players bankrupt. A subtle poison to the industry, rather than a less discrete shotgun.

It is the impact on the poor that really matters here and this is what is fuelling MFI leaders’ attempts to revive the industry. The reality is that millions of poor families have been forced back to traditional money lenders who have been far less beneficial, often charging over 50% interest and claiming collateral following defaults. Borrowers have little hope of pulling themselves out of poverty, instead facing potentially spiralling debt and increased social pressures. So it seems that instead of sharpening one end of the stick and blunting the other, policy has just thrown the stick in to the fire.