Indian Microfinance: Confusing Scale with Impact

Here's my latest (Nov 26, 2010) for GOOD Magazine.

Rumors of the death of microfinance in India have been greatly exaggerated. Here's what's really happening.

Until recently, microfinance was the darling of poverty alleviation. A foolproof way to pull people out of $2-a-day poverty. But, now, the microfinance sector in India is in crisis, so much so, The New York Times announced last week that “Indian Microcredit Faces Collapse from Defaults.” Is this another sub-prime fiasco? What happened to take us from “putting poverty in a museum” to putting the kibosh on the whole model?

Well, we got a little ahead of ourselves for several reasons. But, before we go there, here’s a brief recap on what’s happening in Indian microfinance: Last month, the government of the state of Andhra Pradesh, India’s most saturated microfinance market, ordered microfinance institutions to stop lending, and told borrowers to stop repaying. A spate of suicides by men and women who were microfinance borrowers alarmed many, and the government felt that microlenders were to blame. Were they?

In AP, two dueling parties provide a financial service to the poor. It gets a little complicated, but in essence, there are two ways to get a microloan, from the government or from a microfinance institution. Through banks, the government lends to groups of 11 to 20 women in so-called self-help groups or SHGs. The government has a mandate to disperse $22 billion to SHGs by 2014. The other option is a commercial, for-profit microfinance lender. They are shooting to use profits to scale up and reach even more borrowers. To get commercial microfinance money you become a member of a "joint-liability group" for a loan supported by group collateral. Some choose the SHG, others the standard microfinance institutions, and some take advantage of both, receiving multiple loans from multiple sources.

The government is vexed by the fact that borrowers often take loans from MFIs, sometimes double-dipping when they already have a loan through an SHG. To top it off, borrowers seem to repay MFI loans faster. The government believes they do so because MFIs are coercive. The sad truth is that some of them may be. But MFIs arguably also provide a better service, by delivering timely loans, and offering convenient, scheduled repayment plans at the borrower’s doorstep each week.

While, it’s possible that a desperate borrower might end his life due to coercion, he might also do so because of family pressure, lack of opportunity, a bad harvest, or massive debt. It’s difficult to know the cause without further investigation. In fact, an impartial investigation into the allegations is necessary, and would probably best be carried out by some entity other than the state government, which is, unfortunately, biased. But, the government didn’t wait. It shut down the MFIs, and now they are on the brink of financial collapse which is bad for borrowers, MFIs, and the Indian government.

The accusation of suicides due to MFI pressure is a serious matter. How did we come to this?

The core of the issue in India comes from the confusion between growth and impact. At some point in time, we stopped equating progress with poverty alleviation, and started measuring progress based on numbers of poor people reached. At a time when metrics are highly valued, counting the number of borrowers is much easier than evaluating the borrowers themselves to determine actual poverty alleviation.

If we measure progress by numbers of people reached, success depends on horizontal growth. For the last five years in India, commercial MFIs have been in a race to grow. MFIs in other countries can grow organically because many are allowed to take deposits. However, Indian regulation currently prohibits that, so commercial Indian MFIs require upfront capital from external sources. That capital enables them to disperse loans. More loans means more interest payments. More interest means more profit. More profit means more investors. More investors means more capital. More capital means more loans. More loans means more borrowers reached (i.e, “progress”). And so the cycle goes.

Five or ten years ago, when we thought that financial inclusion was the end game, a new borrower meant that you could check the box as having accomplished something. We’re older and wiser now. We know that microcredit, alone, is not enough to pull someone out of poverty. We should never have expected it to.

Think back to your first experience with financial inclusion. Did your first credit card make you a millionaire? Did you start a business with it? Probably not. It probably enabled you to buy something you needed, or gave you a cushion in an emergency—or maybe got you into debt you didn't need. It does the same thing for the poor, just in smaller increments.

Merely offering credit to more people doesn’t lead to poverty alleviation. It is a service that the poor should have access to, just like the rest of us. But, it is not a game-changer; it is one tool in the poverty alleviation toolbox.

Microcredit is only impactful if we create a deep connection to a borrower by offering a suite of services: microinsurance, financial literacy, business development training, etc. Some MFIs are already offering these services, and doing it well (see BASIX, for one great example), accepting that they may not grow as fast. The sooner MFIs evolve beyond the growth mantra and commit to making a real impact, the sooner we’ll be on the right track.

Lindsay Clinton is the editor of Beyond Profit and an Associate Vice President at Intellecap, a social development advisory firm in India.