I thought this post would be a good follow-up to one I featured earlier regarding the debate on whether to cap interest rates on microloans. Generally, I believe that the standard of judging whether microloans are comparatively beneficial should be something sensible. For instance, in rural communities where commercial banking is scarce, a good basis of comparison would be with rates charged by local moneylenders (or worse, loan sharks). However, it now appears that microfinance is encountering more teething pains as mainstream financial concerns enter this area. Previous generation microfinance lenders were arguably more focused on social objectives and patterned themselves on Muhammad Yunus' Grameen Bank. Next generation microlenders, however, include more conventional financial services providers that want to explore the "fortune at the bottom of the pyramid" in the famous phrase of the late CK Prahalad.It is here where we encounter difficulties. Setting aside the social mission, it is of course understandable why the cost of administering a bunch of smaller loans to borrowers in often more remote areas is higher than servicing larger loans to borrowers who come to your bank's branch. In other words, while attracting larger pools of funding may be beneficial in broadening the reach of microfinance, the higher cost of capital that commercial entities generally take into consideration translates into concomitantly higher rates of interest. So, we are back to the old issue of whether interest rates on microfinance loans should be capped. As a growing backlash in India suggests, it's certainly a topic for discussion:
The microlending movement that was supposed to help lift millions of people in India out of poverty has in recent weeks fallen into chaos. Urged on by local government officials and politicians, thousands of borrowers have simply stopped paying lenders, even though they have the money. The government has begun ratcheting up restrictions, fearing that borrowers are being buried by usurious interest rates. In some cases, officials have even arrested lending agents for allegedly harassing borrowers.Troubles emerge as international capital enters the picture:
Local politicians, meanwhile, have blamed dozens of suicides on microlenders and are urging borrowers not to pay back what they owe. Though so far the backlash has been confined to a southern Indian state of Andhra Pradesh, what happens there is frequently a bellwether for microlending in India, and programs around the world. Hyderabad, the state capital, is home to some of the world's biggest microlenders, including SKS Microfinance Ltd., Spandana Sphoorty Financial, Basix & Share Microfin Ltd. The state accounts for about 30% of the loans for all of India, one of the world's biggest microfinance markets.
"This is potentially going to devastate lending to rural areas for a long time," said Vikram Akula, founder and chairman of SKS Microfinance, India's largest microlender by loan volume, which recently listed its shares in India. "We are confident that we will survive, but certainly this is going change how things could and should be done."
Microcredit is the lending of tiny amounts of money, usually less than $200, to entrepreneurs who use the loans to start or expand small businesses such as a vegetable stand or a bicycle repair shop. Most microcredit firms lend money through women's groups and reach out to borrowers who are either too far from or too poor to borrow from a bank. The repayment rate on the loans have tended to be better than that of richer borrowers. Interest rates, however, can be high, from 25% to 100% a year, mostly due to the cost of administering millions of tiny loans in remote areas...
As the microfinance industry has grown, it has attracted international capital that has greatly boosted the size of the industry, much as payday lending and subprime borrowing soared until two years ago in the U.S. In a significant move that showed international investors' interest in the industry, SKS recently sold $350 million of its shares on the Indian stock market.There is a hysteria fuelling restrictions in Andra Pradesh state about microfinance causing several defaulting to seek the suicide solution:
But along with that has come concern among politicians, regulators—and indeed some in the industry—that unfettered expansion was leading to poor lending practices, multiple loans to the same borrowers, and fears of widespread repayment problems. While they have been much in demand wherever they have been introduced as they provide a kinder, cheaper alternative to the village loan shark, some economists are skeptical about whether the small loans actually help lift people out of poverty.
And in regions where there are more than one microlender competing for clients, some experts are concerned that the poor are being encouraged to take on more debt than they can bear. So far, the repayment rate across the microlending industry has remained extremely high. But Andhra Pradesh's payment strike could presage a turn—and put the capital that has flooded into the industry at risk. Mainstream Indian and international banks have backed the microlending industry in India with more than $4 billion of loans this year, with private-equity funds pouring more than $250 million into the industry in India last year alone.
The repayment strike is a rare black mark for an industry that has long been viewed as a social benefit. One of the industry's leaders, Muhammad Yunus of Grameen Bank in Bangladesh, won the Nobel Peace Prize in 2006 for pioneering the system. The industry has spread across emerging Asia, Africa and South America. India, with its giant population and hundreds of millions of people living in poverty, is one of the most important markets...
Andhra Pradesh slapped new restrictions on the industry that effectively shut it down last week. While a state court order put the restrictions on hold and allowed the lenders back in the field this week, close to half of all borrowers are continuing to avoid payments, microlenders say. State officials say they are trying to protect the poor from usurious interest rates and heavy-handed practices, which they say have triggered more than 70 suicides in the state. Microlending companies say that often where they have investigated suicides attributed to their lending, they have found that microloans were among the smallest of the many problems of the people that have killed themselves.To alleviate this lending logjam, legislators in Andra Pradesh look set to go forward with laws aimed at regulating the industry by--get this--ensuring that microfinance institutions do not lend to the same groups over and over. The general thrust of this legislation is that these lenders are pushing loans that self-help groups keep taking due to the proliferation of lenders. Said end result? Overborrowing and a reduced capacity to pay:
In Sankarampet village about 2½ hours from Hyderabad, Satyama Ayrene is still in mourning over the death of her son who hanged himself. While local police say they have been told to investigate whether microdebt caused the death, Ms. Ayrene says it was the $2,200 he owed loan sharks that was bothering him, not the $220 his wife owed to a microlender. "He did not commit suicide because of the [microloan] companies," said Ms. Ayrene, 55 years old. "He was burdened with loans from the local moneylenders and didn't know how to pay them back."
Microlenders say they are being punished for the success at reaching the poor and that if the resistance continues, many of them will go out of business. Many have been taking steps to create good will to try to avert the situation from worsening. The biggest lenders who account for the majority of borrowing say they will cap their rates at around 24% and form a fund to help troubled borrowers reschedule their loan payments. They say they are ready to comply with more government restrictions as long as they are given time to meet new requirements. But in the meantime, the industry has ground to a halt.
Though the Bill is still being given the final touches, sources said the key elements of the ordinance will definitely be carried forward in the Bill. Registration will be mandatory for the MFIs keen to operate in the state will be mandatory and any MFI operating without such registration will face punitive action including punishment up to three years and Rs1 lakh fine. There is also a proposal for naming all the directors and the top management in case of violation of this rule, though the government is said to be seeking legal opinion on such a move.What to regulate? Multiple lenders chasing the same pool of customers--in which case shouldn't borrowers be made more cognizant of the troubles that could arise from overborrowing? Or, should interest rates be capped? There are also obvious costs in meeting all these new regulations that will be passed on to borrowers, possibly defeating the objective of lowering borrowing costs in the first place. It's interesting, and Andra Pradesh certainly is a litmus test for India--and after India, the world that has grown accustomed to microfinance.
With the preliminary information on the MFI activity in the state suggesting the borrowers are being pushed into a debt trap due to multiple lending by the companies, the government has decided to cap such lending.
The MFIs will be asked to apply to the registering authority before lending to a borrower or a self help group already covered by a bank. The authorities will then verify the repaying capacity of the borrowers. Only after ascertaining the repayment capacity will the MFIs be allowed to extend loans. Lending to SHGs with a bank linkage without seeking the prior approval of the authorities is also a punishable offence.
While coercion will be a crime of sorts, leading to a punishment of up to three years, the MFIs will also have to disclose the interest collected to the authorities on a monthly basis. The government will also set up fast track courts to try the violations of the MFIs. “The information available with the authorities so far indicates that the interest rates are higher than what is being claimed by the MFIs. The average rate is upwards of 30%. There is also proposal to make the MFIs start collecting the repayments on a monthly basis instead of weekly. There is no final decision on this yet,” the source said.
Industry officials fear the conditions being laid out by the government would have a significant negative impact on the MFI activity in the state initially, though the institutions will have to find ways to keep themselves afloat.
