Microfinance: Small loan, big snag
Amy Kazmin
Published: December 1 2010 20:30
Last updated: December 1 2010 20:30
With $52,000 raised from family, friends and others of Indian origin,
Vikram Akula, a graduate student from Schenectady, New York, arrived in
south India in 1998 to establish a microfinance programme.
Like many small rural development projects, he set up his Swayam Krishi
Sangham, or "farmers' self-help group", as a charitable trust. In eight
years, it built a base of around 200,000 rural borrowers, mainly women,
who received small loans to start enterprises that might help lift their
families out of poverty.
But Mr Akula's ambition was to ramp up that number at a faster pace than
a charity could typically manage. In 2006, he turned SKS into a
for-profit company, backed by investment from Vinod Khosla, founder of
Sun Microsystems, as well as the Silicon Valley-based Sequoia Capital
and others in the US west coast technology industry. All were confident
both in microfinance's transformative power and its commercial potential.
Since then, SKS Microfinance has expanded its client base to around 7.5m
rural and urban women, who borrow an average of $165 each. In August,
SKS raised $358m in an initial public offering that valued it at $1.5bn.
Within weeks, the shares had risen by half – providing affirmation for
Mr Akula and his backers of microfinance's ability to deliver "double
bottom line returns", allowing investors to "do well by doing good".
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Yet today, Mr Akula is on the defensive. SKS stock is 27 per cent below
the offer price, amid a backlash by Indian authorities, who accuse
microfinanciers of seeking "hyper-profits" from the poor through
over-lending and "coercive" collection tactics. Collections have plunged
below 20 per cent in Andhra Pradesh state, where officials intervened
after more than 50 suicides by borrowers, mostly women.
Pranab Mukherjee, the country's finance minister, has chided Indian
microlenders – who together have around $6.7bn in outstanding loans to
30m borrowers – for their high interest rates, which range from 27 per
cent to more than 30 per cent, and has promised tougher regulation.
Public opinion has soured, too. At last month's World Economic Forum in
New Delhi, Mr Akula, clad in his trademark orange cotton kurta, was
asked whether Indian microlenders were "too greedy". Though a moderator
tried to deflect the question, Mr Akula – who sold SKS shares worth $13m
before the IPO – insisted there was no trade-off between helping the
poor and earning handsome profits. "You can continually decrease your
price to your customer but at the same time increase shareholder value,"
he maintained.
Afterwards, the forum's burly foreign security guards hustled Mr Akula
away from a media throng. But the questions raised by India's
microfinance crisis – just how far doing well and doing good go hand in
hand – will not disappear so easily.
Once the slow-growing realm of development professionals funded mainly
by western aid, microfinance has been transformed since Bangladesh's
Muhammad Yunus, founder of Grameen Bank, won the 2006 Nobel peace prize
for his idea of giving small loans to businesses run by poor rural
women, whom he saw as more dedicated to their families' welfare than men.
Touted as a magic bullet that could in Mr Yunus's words "put poverty in
the museum", microfinance has turned into a global business that links
international finance with some of the world's poorest communities.
Amid the destructive excesses laid bare by the global financial crisis,
microfinance acquired even greater lustre as a sober, socially
responsible asset class: most microborrowers, in general self-employed
women less affected by the global market turmoil, kept up their
repayment rates of 95-98 per cent.
Yet India's experience is now threatening future capital flows to them,
by challenging the pillars of microfinance investment: that it is both
safe and beneficial to the poor.
Already in the past two years, Morocco, Bosnia, Nicaragua, and Pakistan
have all been hit by microloan repayment crises. The Consultative Group
to Assist the Poor, a World Bank-linked group seeking to improve
financial access for the disadvantaged, blames the upheavals on lending
that devoted inadequate attention to borrowers' ability to repay. In
Nicaragua and Pakistan, the problems were compounded when political and
religious leaders – like Andhra Pradesh politicians now – urged
non-repayment.
"To scale microfinance to its true potential – making it available to as
many poor people as exist in the world – it has to be sustainable, but
there is an element of responsibility," says Jennifer Meehan, of the
Grameen Foundation, which promotes Mr Yunus's ideals. "Certain parts of
the industry have lost sight of its purpose. Microfinance is a means to
an end: the end being reduction of poverty." But among India's biggest
microlenders, she sees a focus "on growth of the institution rather than
transformation of the client".
As microfinance evolved from niche activity to trendy asset class,
investors ranging from Sequoia in venture capital to pension funds such
as TIAA-Cref of the US and the Dutch PGGM poured money in. So did
sovereign wealth funds including Abu Dhabi's Aabar Investments and
individuals such as Pierre Omidyar, chairman of Ebay. Global banks offer
microfinance investments to private clients, while websites allow
person-to-person microlending. By the end of 2009, global microfinance
had around $12bn in cross-border investment, up from $4bn three years
ago, according to CGAP.
Coupled with a rising tide of direct bank lending to microfinance
institutions, these funds have fuelled a surge in microcredit
portfolios, integrating poor women into the global financial system as
never before. According to the Microfinance Information Exchange, a data
provider, more than 95m microborrowers together have around $65bn in
credit – with an average loan of $520 apiece – from some 1,800 lenders,
up from $24bn in 2006. Yet stories of indebted Indian women hounded into
suicide by aggressive collection agents – and the government crackdown
that followed – hardly fit the industry's typical promotional images of
beaming women next to their grocery stands, tea stalls or livestock.
Although SKS accepts that some of the suicides involved its borrowers,
it and other Indian microlenders deny responsibility, blaming "rogue
elements" – traditional moneylenders operating under the guise of modern
microfinance who also lent them money. But the regulatory backlash has
highlighted the political risks of pushing credit to poorly educated
borrowers of uncertain financial literacy and repayment capacity, while
microfinance executives and shareholders reap millions in salaries and
profits.
"India is so big and dynamic, and international eyes are on it so much,
so it will have an impact on investors," says Elisabeth Rhyne, of the
Washington-based Centre for Financial Inclusion, a proponent of
commercial microlending. "It changes the image of microfinance.
Everybody wants to make sure if they are putting their money into
microfinance institutions, they can trust their clients are not being
harmed."
Commercial, for-profit microfinance was supposed to be the answer to the
question of how to scale up access to funds by people otherwise reliant
on usurious traditional moneylenders. Nowhere did that seem more
relevant than India, where 42 per cent of the country's 1.2bn people
lack access to formal banking services.
The entrepreneur who led the rapid roll out of credit was Mr Akula, who
argued that the process of granting loans to the poor should be as
efficient as serving up a meal from McDonald's or a Starbucks coffee. He
claims fealty to the Grameen methodology – a system of group lending,
where women borrow together and take responsibility for each others'
repayment obligations if any is unable to meet their instalment. In
essence, group members – neighbours who know each better than any
outsider ever could – serve as credit committees by their willingness to
take liability for each others' loans.
At Grameen, group formation and pre-loan training is a painstaking
process. But SKS streamlined it to around four hours, helping it to
expand its loan book rapidly. In the year to March, profits doubled to
$38m on revenues of $212m. "The more profitable you are, the more
households you can reach, and that's what we try to pursue," Mr Akula
told a recent forum in New York.
But SKS was not the only enthusiastic lender to the poor. Other Indian
microfinanciers have also grown fast, encouraged by investors and
bankers, hoping to follow SKS's path to market. According to Rajiv Lall,
co-founder of Lok Capital, a fund that invests in social business,
"together, they became committed to the myth this sector is capable
delivering hyper-growth for the indefinite future".
Suddenly, women who had had limited access to credit were spoilt for
choice. Many borrowed from multiple lenders. Microfinance "developed its
lending methodologies at a time when it was tiny – nobody had to worry
about overlending", says Ms Rhyne. "It's like a car with no brakes."
Over the past year, Indian policymakers had repeatedly expressed concern
about microloans' high interest rates. Though the industry defended
these rates as necessary to cover the cost of reaching customers, unease
grew amid reports of executives being paid more than those who ran
India's biggest commercial banks. The sector's return on assets was also
well above those of banks. After the SKS IPO and reports of borrowers'
suicides, the official mood hardened.
"The Silicon Valley guys or financial investors seeking high growth,
high profitability couldn't see the political writing on the wall," says
Vijay Mahajan, president of India's Microfinance Institutions Network,
which represents 44 for-profit companies. "They thought they are doing
it for a good cause [and that they would] be able to carry public
opinion with them. But everybody in this world, even at a bus stop, has
an opinion of what is a fair interest rate. This is the one price in the
entire economy that everybody has a view on."
Today, as Indian microlenders trying to stabilise their business and
brace themselves for new regulations, the global microfinance sector is
drawing lessons from the crisis. Some argue that events in India
demonstrate the need to adopt consumer protection principles, including
complaints mechanisms. Others say lenders must do more to measure not
just their financial performance but their social impact.
"Investors must have more realistic expectations," says Lok Capital's Mr
Lall. "The company does not exist to serve their interests. The company
exists to serve clients, and they make money because they do that well."
Lessons for commercial banks keen to tap into a growing middle class
Dressed in a smart suit, Lynne Patterson looks like a banker and has the
energy of one. But as the co-founder of the 20-year-old, non-profit
organisation Pro Mujer, or "pro-woman", the former US schoolteacher
certainly does not talk like one, writes John Paul Rathbone.
Although her conversation is peppered with loan default statistics and
the "need for scale" to drive down lending costs, Ms Patterson cherishes
the belief that financial services are only one part of what
microfinance organisations (MFIs) such as hers should offer clients.
"Mostly, we have been advised to stick to finance and forget about
health, empowerment, business and financial literacy training," she
says. "But I think our day has come."
Many would disagree with such an approach, arguing that "financial
inclusion" is goal enough. But then the ecology of the Latin American
microfinance industry is diverse. Throughout the region, more than 700
institutions service 10.5m borrowers with a total loan portfolio that
the Inter-American Development Bank estimates grew 12 per cent in 2009
to about $12.5bn.
Mexico's Compartamos is one of the biggest. It began as a small
non-government organisation in 1990 and now has 1.7m clients and a
listing on the Mexican stock exchange. Interest rates are high, as with
all MFIs, but clients seem to prefer Compartamos' terms to the 100 per
cent-plus annualised rates offered by local loan sharks. "Going down
that route is to sell your soul to the devil," says María Ester
Hernández, who has a 6,000 peso ($478) Compartamos loan. "It's
affordable and I always know where I am with repayments."
Other MFIs have made a similar transition from quasi-charity to more
commercially driven operation – such as Edyficar, founded by Care, a
charity, and bought last year by Credicorp, Peru's biggest financial
group. "Lately, we've seen a lot of Brazilians coming to Peru to try and
poach our expertise," says Alvaro Correa, Credicorp's chief financial
officer.
That is not surprising. Peru is a recognised leader in microfinance;
and, in a continent where banks have traditionally been reluctant to
lend and credit penetration is low, commercial banks are seeking to
learn from microfinanciers to lend to the region's emerging middle
class. In Brazil, for example, Spain's Banco Santander is opening
branches in favelas to tap into a credit and consumption boom.
Still, if a competitive market is starting to deliver credit to people
who have never had access to it, that also places a greater emphasis on
the sector's social role. According to Luis Alberto Moreno, head of the
IADB, speaking at a recent regional forum on the industry: "In this new
stage – and this is one of the lessons from the recent crisis – there
will be growing concern over client welfare."
