Another Look at the Indian Microfinance Crisis: Causes and effects

In the last few months the microfinance crisis in India, also called by some critics “India’s asset bubble,” attracted much negative publicity to microfinance in general and forced many supporters to question the industry’s ability to alleviate poverty. Due to rising doubts about microfinance as a model, the crisis quickly spread beyond India.

In the BBC’s podcast on December 1, 2010 Dr. Qazi Kholiquzzaman Ahmad, who runs the PKSF Foundation in Bangladesh, stated that for a large majority of borrowers, the loans did not improve their financial lot. Dr. Ahmad even called microcredit a 'death-trap' for the poor which causes some people to end up destitute while others face threats and violence from lenders. To make the matters worse, 80 people in India committed suicides because they could not repay their loans. In such an environment, many experts and microfinance practitioners are worried that it is the beginning of the end of microfinance in India (and possibly the rest of developing countries) and a challenge to C. K. Prahalad’s famous claim that businesses can prosper while operating “at the bottom of the pyramid.”

The majority seems to agree that the crisis started because of rapid and uncontrolled growth of microfinance organizations in India. While profitability and sustainability should be every MFI’s goal, it should not come at the expense of the borrowers, and this is exactly what happens when loans officers try to give out as many loans as possible regardless to the clients’ ability to repay. Moreover, such behavior is often encouraged when an MFI wants to show larger portfolios and attract more funding and when management rewards officers for the size and not the quality of their portfolios. While such profit maximizing behavior at the clients’ expense is not acceptable and needs to be addressed, there are a number of other issues that receive much less attention in the media and that need to be understood in order to form a more comprehensive view of the “microfinance crisis”.

Even with diligent officers and management, MFIs can face clients’ over-indebtedness, which occurs when the clients take out too many loans that they cannot repay later. This issue can arise because there often is no integrated software that allows loan-tracking across multiple microfinance organizations and credit bureaus are rare (particularly in India) so loan officers cannot adequately analyze the clients’ credit history and ability to repay. In an attempt to address these issues, the Indian government put major restrictions on MFIs and is currently developing a regulatory body that will oversee the industry.

Considering high levels of corruption and red tape in India, many practitioners worry that the proposed bureaucratic systems will greatly affect MFIs’ ability to operate in India. Therefore, while these problems need to be addressed, creating a regulatory body might not be an optimal solution for the sector. In addition, in her most recent post in Huffington Post, Elizabeth Rhyne emphasized that in India MFIs are not authorized to take deposits, which makes them more reliant on external financing. The need to attract more investors might result in the aggressive and indiscriminate loan behavior that I described above.

While evaluating this problem, it is also important to consider political implications. According to the BBC’s podcast of January 18, 2011, many politicians have encouraged clients not to pay back their loans. SKS Microfinance reported 99% repayment rate last year, but since the beginning of the crisis this rate has dropped precipitously to 20%. Such low repayment rates and political instability in the sector will force investors to put their money elsewhere, harming India’s economy in the long run. Besides, it is interesting to note that according to SKS Microfinance, 17 of their clients that committed suicide were not in delinquency, which might imply that there could be other reasons for the unfortunate deaths.