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Microfinance: Little loans, big trouble Add to ...

Microfinance was supposed to mean economic empowerment for the poorest of the poor, many of them female villagers living in India's southeastern state of Andhra Pradesh. Instead, the sector has spiralled into crisis in recent weeks, where the state is blaming 57 recent suicides on aggressive loan collectors.

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Television clips show weeping family members gathered around the latest victim, a 23-year-old father who hanged himself because his family was unable to pay back a 540-rupee ($12) weekly instalment. "They said you will face dire consequences if you don't repay on time," his widow says.

The state government alleges customers are being exploited by the sector through "usurious interest rates and coercive means." It has slapped on restrictions that have effectively frozen the sector. The institutions say stringent laws will force borrowers back into the hands of less scrupulous loan sharks.

The ripple effects have spread beyond Andhra Pradesh. Microlending activity across India is slowing as banks get nervous about lending and new loans dry up. This week, Bangladesh cracked down on the sector, imposing interest-rate caps on microfinance institutions - a move some experts worry will curb service for its poorest clients.

Microfinance has long been the darling of development circles. Big names including Bill Gates and George Soros have got religion on microfinance, and its popularity has soared since its top pioneer, Muhammad Yunus, won the 2006 Nobel Peace Prize.

A debate is raging between those like Dr. Yunus, who say the sector should remain non-profit with its focus fixed firmly on the very poorest of the poor (those living on less than $1 a day), and entrepreneurs who favour a faster-expanding, for-profit approach backed by investors who want to do good - and see returns.

As the recent chaos shows, the road to hell can be paved with good intentions. Huge growth has come at the expense of the people microfinance was meant to help: vulnerable borrowers.

The birth of microfinance

Dr. Yunus is widely credited with popularizing microfinance. But some trace its origins further back than that - to 19th century Europe, when Germany's Friedrich Wilhelm Raiffeisen started a village bank that granted small loans to rural farmers.

Its modern-day roots stem largely from Dr. Yunus, who handed a $27 loan to 42 poor basket weavers in rural Bangladesh in the 1970s. The idea was simple: giving impoverished rural women access to credit and training can help them move into self-employment, freeing them to generate an income that will eventually let them save, send a child to school or build better shelter. Repayment rates tend to be better than for rich borrowers, though interest rates are typically higher because the loans cost more to administer.

The idea has since exploded. Microcredit has evolved into microfinance: services for the poor ranging from health insurance to savings programs. The sector had 107 million poorest-of-the-poor borrowers globally at the end of 2007, a 14-fold increase in a decade, though academics are split over its effect on poverty rates.

It has also reached the developed world. Dr. Yunus opened Grameen Bank branches in New York in 2008, amid the recession. The U.S. now has 362 microfinance outfits, and loan applications have doubled this year.

In Canada, credit unions from Newfoundland's NLFC to Quebec's Desjardins to B.C.'s Vancity are offering microloans, particularly to immigrants who lack a credit history in this country. Vancity has dispersed almost 400 microloans in the past four years, growing about 10 per cent a year, and says need is outstripping its ability to supply the loans.

The sector heats up

India's microfinance market, with its booming but underserved population, is known as the world's hottest. Within India, that heat is centred squarely in Andhra Pradesh, the country's fifth-largest state by population.

In August, SKS Microfinance became India's first such company to list its shares, in a $350-million IPO. The core philosophy at SKS and many other new players is that turning a profit and alleviating poverty can go hand in hand.

The spate of suicides, however, has highlighted weaknesses in the system. Numerous borrowers took on debt from more than one institution, repayments became more difficult and some loan officers have reportedly threatened clients.

SKS now finds itself in the eye of the storm. Seventeen of the recent suicides are SKS clients, though the company maintains none were in default, and that the blame stems from multiple factors rather than just from its collectors, some of whom have been arrested for harassment.

"As the industry grew, the ability to temper the pursuit of growth with a sensible eye on customer needs and ability to repay began to deteriorate," said K Sree Kumar, chief executive of the Indian social business advisory firm Intellecap, who is based in Hyderabad.

For now, the sector is essentially frozen, says Vijay Mahajan, Hyderabad-based president of Microfinance Institutions Network, which has 44 members.

In their quest for growth, some microfinance institutions (or MFIs), contributed to high indebtedness by encouraging some clients to take out multiple loans, "which, in turn, may have led to suicides in some cases," he says. "It's hard to deny that we have contributed to some of this."

The government should also shoulder blame, some say. Public policies encouraged rapid expansion without credit checks, and forbade MFIs from taking deposits, which thwarted their ability to serve customers and promoted borrowing over saving.

Most experts saw the crisis in Andhra Pradesh confining itself to India - until this week, when Bangladesh announced plans to cap interest rates on microloans.

It may seem a reasonable move. But a proliferation of interest-rate caps "is the worst thing that could happen," says Mary Ellen Iskenderian, president of Women's World Banking in a phone interview from Mexico. "When an MFI's ability to recoup costs is circumscribed, all the other ancillary services - training, business development, health - go out the window. So you become only about financial services, without the financial education."

Time to put on the brakes

India isn't the only country where microcustomers have become overextended. Indebtedness has also been a problem in Bosnia, Nicaragua and Morocco, says Elisabeth Rhyne, managing director at the Centre for Financial Inclusion at the global microfinance non-profit ACCION.

Until lately, the sector has been all about growth, a goal made easier by a global economic boom. Now that some markets are getting saturated, the focus must shift to "putting the brakes on the industry … to look more at quality of what you're giving than just expanding the numbers," she says.

A number of measures may mend the situation in India: the start of credit bureaus, more transparency, closer co-operation between the government and the private sector, and a stronger ethical and regulatory framework. Some, like Ms. Rhyne, are spearheading efforts to create a global set of principles on how to treat microfinance clients.

It's tempting to compare Andhra Pradesh with closer-to-home payday lending, or the U.S. sub-prime crisis. Lending money to lower-income and sometimes less-educated clients attracts big investor money. Borrowing costs rise, and debtors get in over their heads. Some companies sink. In the end, the poor suffer the most.

Tavia Grant is a reporter with Report on Business.

 

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