The Macro Side of Microfinance
“Microcredit has given rise to its own breed of loan sharks,” groused Muhammed Yunus, Nobel Prize winner and the father of microfinance. These comments came in January, 2011 after the revelation that about 20 farmers in the Indian state of Andhra Pradesh had committed suicide due to over indebtedness and ruthless loan collection methods. An investigation by Associated Press (AP), identified Swayam Krishi Sangam (SKS) Microfinance, once the biggest microfinance company in India, as one of the main causes of these suicides, including sordid details of how their loan collection officers had allegedly driven their clients to death. SKS has refuted these allegations, having been exonerated from 14 out of 15 alleged suicide cases.
In order to stem the number of suicides, the Andhra Pradesh government issued the Andhra Pradesh Microfinance Institutions Act (Regulation of Moneylending Act) in October 2010. The act stated that every microfinance institution was required to report their purpose of business, loan interest rates, management system, collection rates and persons in charge of loan underwriting and collection to the government within 30 days of the issuance of the Act. If private sectors MFIs failed to comply with these regulations, the government would have the authority to bar these MFIs from doing business. However, as the state government began to regulate the private MFIs, they failed to consider the impact that government actions could have on the rest of the clients who had benefitted from the presence of the MFIs. Loan repayment rates for SKS plummeted from 99% to 42%, and MFIs suffered extreme losses and a hike in their operating costs. The only way the MFIs could cover their losses were by raising interest rates, which hurt the already vulnerable population who relied on these MFIs as their main source of credit.
Microfinance practitioners have long agreed on the limited role the state should play in microfinance operations. However, from the case of Andhra Pradesh, there are also reasons why the state should not assume the role of an observer. Drawing from successful examples, how else could the state and private microfinance institutions cooperate to develop the industry?
Firstly, to ensure clients do not get over indebted, the state could cooperate with private microfinance institutions to set up credit bureaus, which monitor the borrowing activities and credit history of clients. Risk of overindebtedness is reduced for both the microfinance institution and the clients when loan officers are more concerned with the creditworthiness of the potential client. Clients are also incentivized to make timely repayments keep their credit ratings high. In Guatemala, there have been attempts to link credit bureaus with the Ministry of Economy, to promote the sharing of credit information in order to reduce risk in the credit portfolios of the microfinance institutions. One such credit bureau in Guatemala, the West Central Credit Risk Station, has helped microfinance institutions reduce their loan default rates from 50% to 6%. India has also set up credit bureaus; however, the largest, Credit Information Bureau (India) Limited (CIBIL), has managed to cover only 44 million consumers, a fraction of India’s population.
Secondly, while the state can assume a rather important role in regulation, it is important that its presence does not hinder the operations of microfinance institutions. A possible measure would be the establishment of an external agency that monitors the activities of MFIs. The constant vigilance of the state would reduce chances of financial insolvency while protecting clients. Although third-party monitoring has not proven to be a fail-safe method, a good example of how they have managed to regulate microfinance institutions is the case of Banco Solidario (BancoSol), the world’s first private commercial bank specializing in microcredit. BancoSol is monitored by the Superintendency of Banks, with capital and financial reporting requirements similar to traditional banks. By having a third-party monitor their financials, a more objective light is cast on the monetary situation of that bank, with particular attention to the state of their assets. Another such example is the Microcredit Regulatory Authority in Bangladesh, whose work has been publicly endorsed by Muhammed Yunnus himself.
Although microfinance has been receiving some bad press recently, there is room in the industry for public-private cooperation. The strengthening of this relationship only serves to open safer and more financially responsible avenues of credit to the poor, while ensuring a conducive and profitable environment for microfinance institutions to thrive in.