Microfinance’s Macro Implications

Microfinance, the provision of financial services to low-income clients, is hailed by many as the savior of the poor. The banking model, which grants  some of the world’s poorest access to financial services while simultaneously freeing them from money-lender loan rates has recently been under attack in India and now faces imminent collapse.

Courtesy of Kuni Takahashi for The New York Times
Courtesy of Kuni Takahashi for The New York Times

Last month, the government of Andhra Pradesh, an Indian state which accounts for almost one third of micro-lending in India, investigated reports alleging that high interest rates and aggressive loan tactics by Micro Finance Institutions (MFIs) led to numerous suicides. The investigation resulted in an emergency ordinance by the government, which required MFIs to register with the state, banned loan collectors from visiting homes and capped loan rates, all of which caused lending and collections to halt.

Following this ordinance and spurred by politicians accusing the industry of making massive profits off the backs of the poor, virtually all borrowers have reneged on their loans, refusing to make payments. Reportedly, less than 10% of borrowers have made payments since the beginning of this crisis last month, leaving almost $2 billion in repayments reneged.

At a recent event hosted by the Center for Global Development, panelist David Roodman discussed the numerous causes which led to the catalytic ordinance by the government of Andhra Pradesh. In addition to a poor crop season, which led to decreased income for many farmers in the Andhra Pradesh state, Roodman also noted the socio-political climate as a factor that led to recent cataclysmal events.  According to Mr. Roodman, the government led “self-help” programs offer another important means of microlending to India’s poor.  Private firms offering microloans are perceived to hurt this government led microfinance initiative. When suicides linked to private MFIs were brought to light by the media, the government used these tragedies to rein in the competition, issuing the ordinance which proved to be catastrophic for the private microfinance sector.

India’s rapid MFI growth is viewed by many as irresponsible and unsustainable. In 2003, India had one million microloans outstanding; fast-forward to the summer of 2010, the number of outstanding microloans had grown to 27-29 million. Today, there is $4 billion in outstanding microloans in India, quarter of which reside in the state of Andhra Pradesh. Much like the mortgage crisis here in the United States, the industry expanded like a bubble, allowing many people to get credit too easily. MFIs are accused of seeking profit and growth by extending loans at exorbitant interest rates to poor villagers, with little or no regard for their ability to pay, often allowing individuals to take loans to cover prior outstanding debts.

Despite the massive profits the microfinance industry has seen over the past few years, with companies such as SKS Microfinance boasting annual revenue and profit growth at over 100%, the industry faces imminent collapse from defaults. As it crumbles, many fear a liquidity crisis in India’s $6.5 billion banking sector, which has almost $4 billion invested in microfinance initiatives. The crisis has reverberated to India’s national  banking sector which has frozen all new bank funding, and could in turn go global, effectively casting  a shadow over one of the world’s most popular anti-poverty strategy.

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