India's Microfinance Crisis is a Battle to Monopolize the Poor

A king had a trusted monkey that was trained to wield a sword. As the king's bodyguard, the monkey would go to any length to protect him. One day, while the king was sleeping, a fly started pestering him. The monkey tried to shoo the fly away but it always came back. Frustrated, the monkey decided to kill the fly. He struck the sword right where it stood — on the king's face.

India has a strong oral tradition. Children are raised on stories passed from generation to generation, and every story holds lessons. The above tale teaches that good intentions are not enough — an overzealous protector can actually cause harm to those it loves. For proof, we need only look to the microfinance crisis playing out in Andhra Pradesh.

Andhra Pradesh is the motherland of Indian microfinance largely due to the early and extraordinary work of its state government. In the late 1980s, it built the Self Help Group-Bank Linkage Programme (SHG-Bank Linkage) with support from the National Bank of Agriculture and Rural Development and World Bank Loans. It invested heavily in client education and, along with the not-for-profit sector, built up a robust microfinance portfolio.

But over the last two decades, many lenders that began as non-profit organizations have transformed into commercial microfinance institutions (MFIs) — among them, BASIX, SHARE, SKS, and Spandana. As compared to SHG-Bank Linkage, these institutions have posted faster growth rates and reached far more borrowers.

Last month, the state government put a halt to that with theAP Microfinance Ordinance, suspending operations of MFIs in the state and for all intents and purposes allowing borrowers to stop repaying their loans. The announcement of the Ordinance stressed the need to protect the poor — but the move might well, in the long term, leave them far worse off.

The government has complained that too many poor borrowers find themselves subject to coercive collection practices by MFIs. It knows that its SHG members sometimes "double-dip" by taking on additional loans from the commercial lenders, and it sees that they tend to repay MFIs faster. However, there are explanations other than coercion that might explain that. MFI loans are more expensive than SHG loans, so a customer with two loans outstanding might reasonably choose to repay the MFI loan first. The MFIs' disciplined system of doorstep loan management might also account for the greater customer responsiveness.

Now, the manager of the government program, SERP, has pushed the accusation of coercive practices to a new level, blaming the MFIs' attempts to recover loans for the suicides of 54 men and women. This is a serious allegation and, again, prompts the question of whether there might be alternative explanations. At the most basic level, note that according to the National Crime Records Bureau, suicides in India occur at the rate of 10.8 deaths per 100,000 people every year (based on 2008 data). If we apply this rate to the 6 million clients who are members of SKS Microfinance, we might expect that there would be 648 clients succumbing to suicide every year. This reasoning, of course, is rather absurd; but so is drawing a link from borrower suicides to MFIs without evidence. (For a far more subtle discussion of the drivers of suicide among Indian farmers, see these articlesby Palagummi Sainath, an editor at The Hindu.)

What we are really seeing in Andhra Pradesh is the fallout from a long-standing competition between MFIs and the state government, each of which believes it should be the source of financial services to the poor. The government feels that it has a mandate to alleviate poverty; indeed, it has a responsibility to disperse US$22.2bn to SHG members by 2014. MFIs believe that the poor are ideal customers who have the right to financial inclusion. The two clashed first in 2006, also in Andhra Pradesh, and that Krishna crisis left many large MFIs crippled. But that time, private equity investors stepped in, and with strong inflows of both debt and equity capital, timely access to skilled talent, and significant use of technology, MFIs in general managed to continue growing and even to vault past the government program.

Now, with the AP Ordinance, the government seems determined to remove borrowers' access to MFIs. As a piece of legislation, the AP Ordinance has more to do with helping the state government program enjoy a monopoly over the poor than with preventing strong-armed debt collection.

Clearly it would be better for the government to understand that the poor have the right to make choices — and that there are better ways to serve the poor than crippling its competition.

At the same time, the MFIs need to understand that social businesses are complex and that, as they scale and become part of the mainstream financial system, they need to be more careful managers, of both their operational reality and their external image. When the most substantial plank in your reputation platform is poverty alleviation, perceptions are all-important. In contrast to the Indian Information Technology Industry, which has done a good job of managing values and reputation without moving the focus from commercial objectives, the MFIs have allowed others to shape perceptions of them. They are perceived as lacking in transparency about their interest rates and unable to effectively manage external stakeholders such as the media and the State. This perception comes closer to the truth when a leading MFI allows a post-IPO spat among its own leaders to play out in front of the public.

The fight over the poor seems to be getting uglier, but microfinance is too good a tool for financial inclusion to be thwarted by poor positioning. If both sides do not look inwards and make adequate course corrections, their destructive competition has the potential to set us back by 10 years.

Vineet Rai is the Founder and Chairman of Intellecap, which has recently released a white paper on the 2010 microfinance crisis in Andhra Pradesh. He is also founder of Aavishkaar, an investor in commercially viable enterprises that also have a social impact.