Indian microfinance, the definitive investigation: Part 3, Verdict

December 15, 2010 | Andhra Pradesh, David Roodman, Global news, India, Interest Rates, Microfinance, Regulation, Theory, Underwriting

[Continued from yesterday’s Part 2 and the preceding Part 1.]


By: David A. Smith


In the first two-thirds of his terrific post, When Indian Elephants Fight, David Roodman of the Center for Global Development has done first-rate work uncovering not only the market facts – bad behavior by microfinance institutions in Andhra Pradesh – but also the shockingly vindictive, ill-thought, and counterproductive ordinance the state rushed through in an infamous day, October 14.  Now Mr. Roodman seeks to give the legislators their due:


The Ordinance has some good features:


But he has his good points too, Mrs. Lincoln


·         A requirement for clear interest rate disclosure

·         A “fast track” court system to resolve disputes

·         A definition of coercion.


After this faintest of praise, Mr. Roodman then dismantles what’s left of the ordinance’s credibility:


Still, it “leaves a lot to be desired,” according to N. Srinivasan, author of the 2010 microfinance State of the Sector report.


I concur:


The statute’s flaws are legion:


1.  Its preamble refers specifically to the need to “[protect] the interests of the SHGs” which “are being exploited by private Micro Finance Institutions.”  And the provisions only apply to MFI lending to SHGs and SHG members. SHGs, moreover, are defined as ones that have registered with SERP or its urban counterpart, the Mission for Elimination of Urban Poverty in Municipal Areas (MEUPMA) (hat tip C.S. Reddy of APMAS).


A MEPMA pffice


But many SHGs predate these entities and have not registered with them. If women in unregistered SHGs are being driven to suicide by microcredit, that is apparently not a pressing concern for the government of Andhra Pradesh.  If women belonging to no SHG at all are being driven to suicide by microcredit, that too is apparently not a pressing concern for the government of Andhra Pradesh. What then is the true intent? Occam’s Razor says: protecting SERP’s programs.


It is a discouraging sign of an industry’s maturity when stakeholders or corporations feel sufficiently confident that they advocate for their group’s interests rather than promoting the sector as a whole.


2. The law includes several provisions that I expect would be unconstitutional in the U.S. and many other countries. For example, it makes it a crime to belong to more than one SHG. Imagine if the government of California jailed people for belonging to more than one book club.


Very suspicious


Yes, that would violate the First Amendment’s freedom of assembly clause (‘the right of the people peaceably to assemble“). 


It makes it a crime for an MFI to lend to someone with two or more existing loans “irrespective of the source,” which could include friends and family.  


That would not be Unconstitutional, but it’s bizarre since it requires the microlender to conduct an essentially never-ending forensic examination of the borrower (and her extended family, and friends, and associates). 


Me great regulator! 


Does the government not realize that 70% of households in rural AP already have three or more loans, most of those from informal sources?  


Evidently not.   


Meanwhile, MFIs must register with the governments of each district in which they operate, and those districts may revoke registrations at any time “after assigning sufficient reasons” even if they are only at the investigating stage.  


This almost certainly would violate the Constitution’s due process clause (“nor be deprived of life, liberty, or property, without due process of law”).  


Imagine a California law empowering county governments to immediately shut down supermarkets for “sufficient reasons” without every defining that phrase. Imagine how, in India, this empowers local officials to demand bribes. 


Every time I don’t shut someone down, I get more of these 


Yes, that’s a license to shake down. 


3. The law imposes other burdens on MFIs without equivalent demands on SHGs. MFIs, for example, must obtain permission from the district government to lend to SHG members—but not vice versa. 


The law sounds more and more like simple interest-group favoritism. 


4. It contains other strange provisions. It makes it illegal for MFIs to accept collateral even though that would soften the pressure for full repayment.  


Populism run amuck. 


Who you calling a populist? 


It limits interest to 100% of principal—which seems odd where rates tend to be in the 20s, 30s, and 40s. But as Srinivasan points out this rule could, as it were, make my mortgage illegal since I will pay more interest than principal on it over 30 years. 


As usual, a law written in great haste overlooks that its general applicability ensnares many other similar or ancillary activities the lawmakers had no intention of punishing. 


As Srinivasan says, “The objectives of the ordinance are laudable.”  


Anything on the road to hell can be so justified.  


But the execution reveals bias, and bias of a particular kind. The law does not merely view SHGs as better. It views MFIs as malevolent.  


Who, us? 


It does not outlaw MFIs but, one wonders, perhaps only because it cannot.  


That would have been too obvious. 


We cannot be … obvious, Mrs. Peel 


The presumption of guilt on the part of MFIs is clear in its draconian requirements. 


My bottom line, for now


While the government responded to a real problem, there are real problems in the response.  


Well said! 


It was hurried because of the media drumbeat (he referred to the TV news several times) and the associated political drumbeat. I believe the government acted in no small part for the best of reasons. Still, India is home to a million small tragedies a day. This is a country where low-level officials routinely steal food coupons meant for the indigent.  


Even if private companies are no saints, government is not pure either. 


Solicitousness for the poor does not suffice to explain why microcredit literally came to dominate the government agenda.  


Because it was populist, and media-borne, and a frenzy. 


My God, it’s a catastrophe! 


SERP’s list of alleged suicide cases (symbolizing a link I find plausible in principle) were verified, Rajsekhar said, by “third parties”: district revenue agents and certain local non-governmental groups. But causality in suicide cases is delicate, and I don’t know enough about these third parties to trust their judgment about the full causes of the suicides in such a politicized context. 


Agree – it’s all too easy to make every death a suicide, and every suicide a microfinance suicide.. 


The main problem in the response, as Vijay Mahajan put it to me, is that the government is an unfair referee. It’s a player and a referee.  


In high school, I had a sadistic gym teacher (is there ay other kind?), who for reasons best known to himself felt that when we were playing intramural soccer, he should not only referee but also play for one of the sides. 


Pain is part of the curriculum 


Of course he never committed a foul, and somehow the team he was playing committed more, and his team won 2-1.  I think everybody despised him, even the players on his team.  


While SERP is not technically part of the government, it is as a matter of political economy an extension of it. SERP felt its interests directly threatened by MFIs. 


Unfortunately, Indian microfinance got caught halfway between being a proven industry and an fledgling concept.  On the one hand competition, emergence of an industry, with all the attendant incumbency behaviors and inevitability effects – and on the other, an industry undergoing rapid expansion into uncharted waters. 


Clearly self-regulation for microfinance failed miserably in Andhra Pradesh. That calls for the government to step in. But this is this is not how regulation should be done.  


Nor is this 


Regulations should be written and enforced by disinterested parties and published in draft, with a public comment period.  


Hear, hear. 


I would tentatively suggest (not knowing enough about India to be sure) that this will contribute to the foreign perception of AP as a no longer such a good place to do business –  


Perception?  Try reality.  If I were a microfinance institution thinking of expanding, Andhra Pradesh would now be the last Indian state I would consider. 


– the government can slam the private sector at any time.  


Elected officials forget that just as companies compete with other companies, states compete with other states – and Andhra Pradesh has just put itself at the bottom. 


The Ordinance comes off as assuming that MFIs are devils—companies that act out of pure greed rather than a mix of that with the pursuit of growth and genuine commitment to the poor—and assuming that SHGs and district officials to whom MFIs must now pay obeisance are angels.  


Fractal morality as far as the eye can see 


It’s parochial. 


So, as is my wont as a child of divorce, I see some symmetry in the tragedy: the government people and the MFI people are both imperfect, acting out of a mix of motives. (Let’s not forget that greed – the interest in making new opportunities for bribes – could be playing a role in the political economy on the government side too.)  


Everybody dips in a little, don’t they? 


Neither respects the other. One could say that the MFIs deserve what they got, maybe even needed it in order to force them to act more responsibly.  


The MFI industry, having scaled, professionalized, and become profitable, needed to self-regulate – but tragedy, in this case a legislative tragedy, is always a precondition to fundamental financial reform. 


They blew their chance at self-regulation while exuding disrespect for the government. So they got smacked. 


You deserved that 


Yes, they did – and punishing them is politically fun, but unhelpful policy. 


But what’s [most – Ed.] important is not what’s fair to MFIs but what helps the poor most.  


We can quarrel about this statement some other time – do for-profit microfinance institutions have a duty to alleviate poverty that outweighs their pursuit of profit consistent with fair dealing and good value?  Banks that take deposits do – American banks have a Community Reinvestment Act duty to serve, Indian banks have a Priority Sector Lending requirement – but these derive from their deposit-taking activities.  Industries are given public-policy mandates only when they operate under a favorable licensing or support structure, and when they have grown large enough to bear the additional burden.  Microfinance is not there yet. 


The Ordinance may be better than nothing because it froze a situation that was spinning out of control for many; it may well have saved lives.  


Who will ever know?  And if the law kills microfinance in Andhra Pradesh, how many other lives will be harmed?  In saying this, I am not defending rapacious collection practices or reckless lending, just observing that every action has consequences. 


But it is far from ideal. Despite Rajshekar’s assertions to the contrary, it is not realistic to expect the SHG system, for all the good it does, to meet all the financial needs of the poor.  


If it had, then there would have been no space for the microfinance institutions to grow.  


The private sector can help fill that gap. My hope is that this brutal game will ultimately lead the industry to a better equilibrium than before. But mostly it seems that the government wants to get rid of the MFIs, and is pursuing that goal quite efficiently.  


Killing the goat that ate the golden eggs. 


I believe the SERP is about as committed to serving the poor as is Vikram Akula, founder of SKS; but that does not mean that SERP, any more than he, is acting perfectly in the interests of the poor. 


When you represent the poor, it’s easy to decide that what’s good for General Motors is good for the country. 


Isn’t it? 


These events should also be cause for introspection at the World Bank, which has financed both sides, but especially the government and SERP (with $1 billion or so). The SERP-administered SHG program may well be doing much good. But World Bank money has also beefed up a political economy hostile to private sector solutions. 


The World Bank cannot be happy with these development. (I haven’t asked my World Bank friends, not wishing to put them on the spot.) 


Still, the true bottom line is this: 


1. Credit 

2. The poor, and 

3. Business-like insistence on regular repayment 


are a dangerous combination.  


An excellent distillation – pick any two.  




Change any one those three elements, and it is safer: savings instead of credit (cf. Gates Foundation), the well-off instead of the poor, the flexible and somewhat subsidized communality of SHGs instead of the hard-nosed efficiency of MFIs. If microcredit is to safely serve the poor, it must soften its edges. There are many ways to do that.  


The scaling of microfinance was over-engineered and over-revved. 


Pushed too hard, credit can easily become a buzz saw.  


Just being efficient 


But probably all are harder with growth is rapid. Fast growth in credit to the poor is therefore dangerous, and often unworthy of the label “development.” 


Between profits and impact, let’s just cut both in half 





Comment from Daniel Rozas
Date: December 16, 2010, 8:13 am


thanks for this excellent 3-part look at the AP crisis. I can imagine it’s of some interest to many of your readers who may not be close followers of microfinance issues.

I would, however, emphasize one aspect of this. The nature of Indian politics was hardly unfamiliar to MFIs, and if they had been unaware at first (really?), then certainly the earlier crises in Krishna and Kolar should have been a wakeup call. They obviously weren’t. The lessons the MFIs took away were that they survived those crises, so they can simply go on doing more of the same.

Doing business in a politically sensitive environment calls for a lot of attention to be paid to public perceptions, maintaining ongoing contacts with government and media, insuring maximum transparency, and so on. Hardly any of this was pursued in a serious way. Instead, the approach that was widely adopted is what I term the Ostrich Risk Management System.

Perhaps the best example of this was the reaction of Spandana — the 2nd-largest MFI in India, and the largest in Andhra Pradhesh. When the crisis hit, one of their first responses was to SHUT DOWN THEIR WEBSITE. It remained “under construction” for some 3 weeks or more, though is back online now. I can’t imagine what course in public relations they attended… It’s just one of a great many examples, but in some ways it’s the most telling.

At the same time, the Indian MFIs’ pursuit of extraordinary growth and very high profits also caused them to lose sight of their core defense against government interference — the clients themselves. Some insiders have remarked that in earlier times, MFIs could protect themselves by calling upon their clients, who would assemble to demonstrate in front of the relevant party offices. This time around, those clients were nowhere to be seen. I suspect that for too many clients, the sudden opportunity of no longer having to repay their outstanding debts proved more beneficial than sticking their necks out to protect the benefits of future loans. In microfinance that is unsupported by collateral and client credit histories, such calculus can be a deathknell.