Indian microfinance crisis: complexity and governance


The potential trade-off between commercial expansion and social goals is emphasised in comments of the current microcredit crisis in India –not least a well-informed FT article (subscription required) a few days ago. It has in fact been a recurrent theme in microfinance since the end of the 1990s. While consensus is that microfinance should strive to achieve both goals, some doubt this is doable. The debate re-heated last summer when SKS, a major Indian microfinance institution, went public: many, including Nobel Prize-winner Muhammad Yunus, saw the move as opposed to the interests of the poor.

Is the effort to reconcile commercial and social goals now collapsing in India? Is this crisis the final proof that the two goals are inconsistent with each other?

Well, I don’t think so. Although the issue of how to combine commercial and social goals remains crucial, it is still undecided. The Indian crisis is in fact more a subprime-like crisis, to the extent that the system has many layers and involves multiple actors, with a resulting great deal of uncertainty on where risk is and how it spreads. Microfinance is a network of partnerships and relationships: between the poor and the microfinance institutions (MFIs) that provide financial services to them; between MFIs and their funders, be they multilateral institutions, donor governments, non-governmental organisations (NGOs), for-profit companies, banks or cooperatives; between MFIs and regulators. The intrinsic complexity of the system makes it very difficult to track risk, an issue that in the case of India, is amplified by weaknesses in governance.

To monitor final clients’ overindebtedness –one of the alleged causes of the current crisis –instruments such as credit bureaus and more importantly, a national ID system are necessary. While SIDBI, the largest single funder of MFIs in India, has recently taken the laudable initiative to promote a credit bureau, David Roodman has stressed how an ID system would be much more expensive to set up (and,  in my view , would presumably require a coordinated donor initiative). Another problem is the so-called “priority sector lending” (PSL) according to which Indian banks must devote a portion of their income to weaker sectors of the economy –a requirement that they are usually happy to satisfy through wholesale loans to MFIs, less costly that direct efforts to reach out to remote, difficult-to-reach  or poorer communities.

The result has been an excess of easy credit from banks to MFIs, with unwanted consequences. MFIs have been under pressure to use these massive amounts of money quickly, but with little control on quality and integrity of their services; and incentives for them to seek funding from other bodies have weakened, with a sort of “reverse crowding out” favouring local banks over more socially-oriented investors. As a result, microcredit has swollen but has not been accompanied by comparable progress in the provision of training, preparation, and support services, so that the riskiness and fragility of poorer clients has eventually increased instead of diminishing.

And yet, Indian MFIs strongly believe in their social commitment and proudly show their anti-poverty credo on their websites –while somewhat ironically, their financial statements and other more technical documentation are more rarely available online.

The point is that despite all allegations, Indian MFIs are all genuinely keen about their social mission and unwilling to switch to a purely for-profit approach; but they need better regulation in order to pursue their goals. Industry-level coordination and forms of information-sharing (also including an ID system!) with involvement of all stakeholders are badly needed; so is a revision of PSL requirements, though certainly not in the short run, and ideally accompanied by government or donor-sponsored support to MFIs to enable them to access funds from a more diverse range of sources.

Let’s not blame the social-commercial goals tension: it will still be unresolved after the Indian crisis, and is here to stay.

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