Ramesh S. Arunachalam, 2011: The Journey of Indian Micro-Finance: Lessons for the Future. Chennai: Aapti Publications.

The microfinance crisis in India which broke out in fall 2010, first imperiling numerous borrowers and then an entire industry, is the most fundamental event in the world of microfinance since the Nobel Peace Prize in 2006. In hindsight, it may even turn out to be the defining moment of microfinance history – never before has the dark side of microfinance, and the vulnerability of the industry, been so brutally exposed to a global audience.

Naturally, these events have attracted a host of opinions and analyses ranging from simply blaming the Andhra government for bringing down a healthy microfinance industry, to accusing microfinance of having become worse than loan sharks. And yet, so far, we understand very little of why India’s vast microfinance sector went so far astray. Thankfully, people like Ramesh S. Arunachalam are out to change this.

Arunachalam has earned the respect of many a reader (me too) with his candid and incredibly well-researched blogging on the Indian microfinance sector. He posts prolifically, but despite (or perhaps because of) his over 20 years of work experience in development and rural finance, he has otherwise kept a low profile. He is not an outspoken critic.

Now Ramesh Arunachalam has applied his sharp analytical approach and evident knack for writing to publishing the first book about the Indian microfinance crisis. The result is a meticulous, evidence-based piece of research which brings clarity into what so far has mostly been an interest-driven and polemical battle of explanations.

In some ways what Arunachalam has produced is, in fact, more than a book; it is a dossier of evidence and analysis of how the Indian microfinance sector functions at the deepest levels, and where its errors lie. It is a biography of an industry in identity crisis, and also a handbook on how Indian microfinance might (perhaps) still be saved. Above all, as the book’s (wonderfully illustrative) cover implies, it is a search for the Faustian, troubled soul of Indian microfinance.

Close-up of the cover illustration

No review could adequately discuss the sheer wealth of information amassed in this book: 504 pages plus appendix can hardly be summarised. Here is only in very broad strokes an idea of what Arunachalam’s work does.

Naming the problem

The book begins by naming in no uncertain terms the problem which prompted it to be written:

Micro-finance, in the past, especially in the good old days, was widely regarded as a tool for poverty alleviation and MFIs were held in high esteem. However, in the light of the events of 2010, they began to be viewed as profiteers, who accumulated wealth at the expense of the poor. In fact, often times during the course of my interactions, in the latter half of 2010, I found the term “micro-finance” evoking sharp and negative reactions from civil society and the general public. … That micro-finance in India is in a macro mess today is a sad truth.

The book then delves into the events which predicated the crisis of 2010, starting with the localised crisis in the Krishna District of Andhra Pradesh in 2005/6 from which, as the author shows, lessons were never learned. After Krishna, the industry grew faster than before by focusing on the easily-accessible Andhra market and ignoring its internal weaknesses in order to offer high returns to equity investors, whose money poured in. Arunachalam even compiled an own database to track the equity capital flows, which increased more than four-fold from 2007 to 2008 alone – figures which, so far, were not being collected or tracked by anone. Original data-work like this is among the greatest delights of the book.

The author then tracks the build-up to the euphoric year of 2010, which saw the public share issue (IPO) of SKS Microfinance as well as the outbreak of the deepest microfinance crisis so far. Along the way, he engages in such useful exercises as mapping the financial marketplace for low-income people in India (which extends far beyond microfinance), exposing the inside dealings and misuse of funds which took place in SKS leading up to the IPO (which have received scant attention so far), and charting the conflicts of interest in the microfinance sector’s supervisory boards. He then tracks the development of the 2010 crisis and its fallout and implications.

Exposing the secret agents

The second part of the book more systematically evaluates the causes of the crisis, mainly from the perspective of weaknesses within MFIs’ internal systems and their corporate governance. Linking such issues as the rise in loan officer caseloads (using his field-level knowledge of the pitiable conditions which loan officers actually work in) with the growth in multiple lending/borrowing, Arunachalam makes the patterns at the ground level clear. In particular, he repeatedly discusses the implications of the “know your customer” principle being eroded to the point of practical non-existence.

Especially with regards to the sensitive issue of MFIs lending through “agents” or to “ringleaders”, Arunachalam plays the role of whistleblower for a problem which has fallen on deaf ears for years, but which he claims is a systemic ground-level reality. The widespread use of agents is a well-kept secret of the sector.

As we go along, we are bound to see the agent problem cropping up in more places and states. Therefore, it is about time that we stopped pretending that there are no agents. The truth of the matter is that there are large numbers of agents, who have been (and are being) used to turbo charge the growth of micro-finance, and they are now turning into Frankenstein like monsters, created by the MFIs themselves.

He notes two main types of microfinance agents: local grassroots politicians, using loans to add to their political clout; or centre leaders (the heads of groups of borrower groups) making an additional profit by controlling or appropriating the flow of loans. He goes into great detail about how these two systems function, how MFIs have benefited from using these agents, and how they have created entirely new risks for the sector. The widespread use of these agents may even in part explain how so many MFIs can claim innocence for the wrongdoings they are accused of – perpetrated, after all, only by their arms-length agents – while simultaneously having profited from these atrocities.

I see agents as the major cause of the present Indian micro-finance crisis. In my opinion, they are all pervading and powerful and they get clients for MFIs and they can make clients disappear from an MFI’s horizon and put these clients onto another set of MFIs. They (can) stop client repayments. They indulge in coercive collection practices as many of them have backing of thugs and criminals (locally).

Coming from as well-meaning a commentator as Arunachalam, sections like the one on agents are an urgent, stern call to action for an Indian microfinance sector for which it may perhaps already be too late. Furthermore, they are a warning to MFIs in other markets, and their backers.

Regulating and supervising the Indian Enrons

If Arunachalam is correct in the first two thirds of his book, the Indian microfinance industry is in a far greater mess than most people are aware, which MFIs are neither willing to admit to the public, nor to themselves. If he is correct in the last third of his book, not all is lost in Indian microfinance; but the changes required will be far more fundamental than those currently envisioned by the industry or its regulators.

The final third of the book makes extensive suggestions for the future regulation of the Indian microfinance sector, an issue which only since the crisis has been addressed with any seriousness. Drawing parallels (as he often does throughout the book) from microfinance’s crisis to the 2009 Satyam scandal (“India’s Enron“), Arunachalam pleads for serious and enforceable regulation – the kind which the microfinance sector for years has railed against and avoided; the kind that bites. While the practical recommendations he makes could be more detailed, they are at least the nuts and bolts of a regulatory framework. One very important point shines through clearly: regulation needs teeth in order to be actual regulation, to bite through such means as randomised unannounced field checks or portfolio audits.

It is worth appreciating finally that his conclusions emphasise the need for far more than microfinance if India wants to achieve “inclusive growth”. India absolutely needs policies which are “holistic, futuristic and yet practical” and a “truly bottom up and democratic process” for development, rather than a bigger (or even just a more stable/sustainable) microfinance sector. Microfinance may be India’s latest economic scandal, but the actual social scandal is why a country growing at 7 to 9 percent a year has left a majority of its population behind, at the mercy of a profiteering microfinance sector.

Transparency, but at the expense of handiness

From the great depth of the book The Journey of Indian Micro-Finance it is evident that nobody knows as much about the sector as Arunachalam does – or at least nobody who is willing to share their knowledge. But Arunachalam, thankfully, also admits where he doesn’t know something, and is frank about the margins of error in his estimations and evaluations.

In fact, the defining feature of the book – it’s greatest strength – is the total and meticulous transparency with which the author reports his findings. The chapters are riddled with excerpts of memos, e-mail exchanges, newspaper articles, balance sheets, data charts and graphs, and so on (in addition, there is a huge appendix). So if Arunachalam’s book treads on anyone’s feet, they can certainly not complain on the grounds of unsubstantiated claims. And despite the technical nature of many subjects he discusses, the author writes in a wholly accessible style – even if, at many times, he should have been more concise.

A book the size of an autorickshaw

On brevity, to make one thing really clear: this is probably the least handy book you will ever read (picture an A4 printing paper packet as a book). It weighs about as much as a full Hyderabad auto-rickshaw… but such is the price of comprehensiveness and transparency. Aside from its odd formatting, some further things are worthy of criticism. They have little to do with contents, and more to do with professional redacting.

The book occasionally suffers from poor structure; at times, chapters detour or get lost in detail, and the overall arrangement of the book – from history, to diagnosis, to recommendations – could have been improved through longer and more cohesive chapters. Hovering somewhere between a proper monograph and an analysis built around a scrapbook of documents and pieces of evidence, some patience is demanded from the reader. In my view, this mainly stems from a lack of professional editing, and not from the author’s writing skill.

While it is great that the book is “out there” and has been published quickly, a better-equipped publishing house with more resources and more time could have moulded Arunachalam’s material into a more solid and cohesive shape, making it accessible to a broader range of readers. An abridged and simplified version might be able solve this, in future.

Give it to me straight, doctor

My only critique with regards to substance is that the book retains a certain ambivalence with regards to underlying causes. It never becomes clear whether Arunachalam believes India’s microfinance sector was destined (after a certain point) for disaster, or whether it could have been averted if certain actors (regulators, supervisors, MFI chiefs and investors) had done a better job in the years before the crisis.

In fact, I fear that his business-like focus on corporate governance and intra-organisational issues places too much emphasis on the micro-mechanisms of “mission drift”, instead of asking how and why a sector which supposedly set out to do good could get so lost in as little as ten years. Frankly, given the type of knowledge which Arunachalam possesses, I would have liked some answers upstraight. From whom else should they come?

But in the author’s defense, it is clear that he has to walk a tightrope, which is visible in the delicate way he phrases some criticisms, and readers are advised to read well between the lines. Part-insider-part-observer, he would be ill-advised to pass harsh judgment, and at times it is tangible that he held back. Furthermore, as I expect this cannot be his last effort as a writer, future works may bring greater clarity.

The best parts of this larger-than-life book

To end this review on a critical note would be horribly wrong. The Journey of Indian Microfinance is truly an amazing book, and everyone who takes more than a lay interest in microfinance should read it. The inner workings of the most highly-developed microfinance market, which went completely astray, are exposed here in a meticulous, conscientious and transparent fashion. The book is full of original data and new perspectives. It is a treasure-trove, and development policy-makers, funders, aficionados and microfinance players around the world would learn much from studying the knowledge Ramesh S. Arunachalam has amassed. For this reason, it is a shame that he has gone with an obscure publisher, as the book deserves a much wider circulation.

Finally, at the risk of this being out-of-place in a review, I would suggest for readers to focus on certain sections in particular, if they find the entire length and breadth of this entire larger-than-life book difficult to slog through:

  • Chapters 1-12: introduction; an explanation of the Krishna crisis; the lessons which weren’t learned from it; how the sector recovered so quickly; the early signs of new trouble; the IPO of SKS (and the very dodgy dealings which marked it); who was (perhaps) responsible for the atrocities which caused the 2010 crisis.
  • Chapters 18, 21-24: the corporate governance failures in MFIs which allow(ed) abuses in microfinance; the problems with internal controls in MFIs; how regulators could fix them; the very sensitive issue of agents; how loan officers became burdened with more and more clients.
  • Chapters 34 & 35: the problems with consumer protection in Indian microfinance; detailed suggestions for a regulatory framework.
  • Chapter 37: what India needs beyond microfinance.

To conclude, I congratulate Ramesh S. Arunachalam on having written not only the first book on the events of 2010 which shook microfinance, but also one which brings great clarity into these events. I sincerely hope it finds the wide, attentive readership it deserves.