The Andhra Pradesh crisis has been something of a turning point in public assessment of microfinance, with a suicide wave caused by widespread overindebtedness badly tarnishing the sector’s image in India as well as abroad. Some Indian politicians are now beginning to identify the idea of alleviating poverty with microfinance as “crap“.

Crilex

Source: M‐CRIL Microfinance Review 2012 (vii)

Microfinance in India remains in protracted decline since 2010 (see graph), although talk of “green shoots” and catharsis after “near-death experience” has been around for some time. The industry’s stance for the past two years has been to deny responsibility for any wrongdoings, downplay its role in precipitating the dozens of suicides, and claim that the AP government’s October 2010 legislation was a surprising and unjust crackdown on healthy practices. I have claimed otherwise.

Yet, fairly surprisingly, my new paper investigating the causes of the crisis, and a recent interview with SKS Microfinance senior managers come to some similar conclusions about the causes. In particular, both versions see the unregulated hyper-competitive market as a significant cause of the tragedy which led to microfinanciers’ troubles. How can this be?

The paper, written for a special issue on microfinance in the business journal Strategic Change, embeds the national and transnational processes which drove the Indian microfinance industry’s unsustainable growth into an analysis of the larger political economy of India. The industry was anything but healthy, digging its own grave by overlending as it was proudly reporting 99+ per cent repayment rates.

Although critical voices had questioned the soundness of the growth pattern and aspirations starting from the mid-2000s, the evident overvaluation and overcapitalization bubble was ignored by players and regulators alike. The 2010 crisis was what Srinivasan, author of several State of the Sector reports, called a “crisis by invitation”. (p. 52)

Overindebtedness, not government predation, caused the downfall

Starting with co-operative credit introduced by the British, India (like neighbouring Bangladesh) built up a legacy of credit-based social policy interventions through the 20th century. What drove many farmers and urban poor into the hands of the growing microfinance industry from the 1990s onward wasn’t any particularly good use for a loan, but rather the effects of the ambitious neoliberal reforms of AP, linked with population pressure and agricultural change, which eroded farmers’ and other vulnerable groups’ economic base (see in particular Taylor 2011). The microfinance industry profited from this toxic combination by feeding debt to an imperiled population in a system that was unstable and produced crises in 2005 and 2009, finally toppling in 2010.

Add the structural deficiencies of the Indian microfinance sector into the picture, and we recognise a hyper-competitive environment devoid of regulation, with microfinance institutions (MFIs) chasing market shares by lending to anyone who will take a loan. Interest rates remained unnecessarily high, generating abnormal returns which fed the rat-race between MFIs for success on the capital markets. External “agents” were often used to recruit new clients, internal controls hollowed out, and huge pressure exerted on clients. Before the crisis each one of the top six MFIs added 2,389 new active clients or 479 new joint loan groups (JLGs) every day,

so that by March 2010 statistically 35.9% of all households in AP had an MFI loan. The fact that the growth witnessed in AP was impossible on a “know your customer” basis is illuminated by SKS Microfinance — the sector leader — adding 4.17 million clients from April 2008 to March 2010, pushing its loans to 488 loans per loan officer by 2009. Also in the same period, the average borrower’s debt balance (toward each MFI) more than doubled; a debt accumulation compounded by multiple borrowing. (pp. 51-52)

Competition was driven by a seemingly unending supply of capital naively (and sometimes unscrupulously) seeking high returns, buttressed by Indian priority sector lending quotas. The stock market issue of shares in SKS Microfinance, the largest MFI at the time, which made founder Vikram Akula a multi-millionaire just months before the suicide wave, exemplified how the fish was rotting from the head down (various intransparencies and shady deals). At the same time it demonstrated the riches to be made from the tiny loans. The system was bound to collapse sooner rather than later, and finally did when the AP government pulled the plug to stop the suicides.

The competitive market was at fault, says SKS

In racing, “straight from the horse’s mouth” refers to information from a source so close to what’s going on, it may as well be the racehorse itself. Funnily enough, just as my paper goes to print, senior managers of the former sector leader SKS Microfinance have confirmed many of the above points in a rare press interview; straight from the horse indeed.

The managers portray the crisis as a “supply-side shock”, and in doing so confirm that the blistering prior growth wasn’t driven by genuine demand from borrowers, but rather by an ample supply of capital which only subsided after the government intervention spooked investors. Asked whether SKS would soon be applying for a banking license, the managers demonstrated a newfound recognition of the benefits from sensible and stable regulation, as opposed to their prior work to uphold a regulatory vacuum with facetious exercises in self-regulation.

While the crisis itself is still overall dutifully ascribed by SKS’ management to “political risk”…

The AP crisis was definitely an external event. It was a state intervention but this is not to say that everything was alright with the sector in 2010. (source)

… there is at least now an admission that the industry’s practices had become (self-)destructive.

The first mistake was all of us started as non-profit organizations and we embraced for-profit model for good reasons—to achieve scalability and sustainability. […] But when we embraced the for-profit model, we should have discarded the larger-than-life claims and mission statements like empowering the poor and eradication of poverty. The for-profit model doesn’t go with this.

When we had our initial public offer, people looked at our numbers, portfolio size and, most importantly, the individual incentive system like the ESOPS (employees stock options) and the salary levels. They were all relevant for a for-profit mainstream operation but the claim of eradicating poverty did not gel with that.

(… So it seems an open admission that microfinance is not about helping the poor is better than – perhaps – trying to reverse the mission drift; anyway…)

The second mistake at the sector level was that in 2009 and 2010, there was intense competition. There were 400-600 companies and even smaller firms were getting funds—be it debt or equity. If we go by the text book definition, intense competition should result in a price war but we had intense competition and no price war. Everyone was charging 31-32%.

The trouble was in the absence of playing the price card, process dilution became the selling proposition. Everyone was in the bar and all were drinking.

The customers also started playing one against the other on the processes and forced us to dilute them.

While this rhetorical shift of blame to the customers is baffling, the key admission from SKS’ management here – which underscores my paper’s analysis – is that the AP government’s legislative act only laid bare what was a set of pre-existing, fundamental problems in the industry. Much of its lending should never have been done, SKS now acknowledges. Better late than never.

Credit as an unsustainable surrogate

This is certainly far from a full-scale admission of responsibility for recklessly overindebting and exploiting clients to the point of suicide, but nonetheless a clear departure from the prior industry line that it was a government pouncing on a healthy industry which created the distress.

However, my paper and the SKS execs still differ on the ultimate legitimacy of the microfinance business in India; even though  the latter may have admitted more than they intended in their interview. Where CFO Dilli Raj explains that his company’s recent troubles in the state of Gujarat arose because it “is a very progressive state and has a pro-business government but microfinance works better in markets where there is a density of rural poor”, this sounds very much as if microfinance in India thrives on dysfunction and desperation – which in fact is the conclusion of the paper. Microfinance in India acted only as a surrogate for developmental policy, rather than as part of a package for positive economic transformation.

In conclusion:

The proximate causes of the AP crisis were largely home-made, and the AP government’s intervention was at most an enabling factor. Warning signs that Indian MFIs’ spectacular growth and profitability rested on overwhelming indebtedness of clients – the industry’s success in fact being merely a giant debt bubble – were amply present long before the crisis, but were blissfully ignored and later quietly forgotten. […]

In the Andhra boom, the music played until a sufficient number of suicides forced the government to intervene. But the fundamental causes of the crisis lay with India’s historical tradition of (ab)using debt as a tool of social policy. If there is one key lesson to be learnt from this more contextualized account of the Andhra Pradesh microfinance crisis, it is that deeper-seated social problems cannot be resolved with an infusion of debt, and that industries built on that premise are bound to fail eventually. (pp. 60-61)

Or, to summarise in the words of the above-mentioned politician, the entire premise may be “crap”.

Mader, Philip (2013): Rise and Fall of Microfinance in India: The Andhra Pradesh Crisis in Perspective. Strategic Change 22, 1-2, 47–66.

(phil)