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December 01, 2010
Microfinance in India Faces a Crisis
    by Robert Kropp

Amid charges of unsustainable interest rates and overly aggressive collections practices, the state of Andhra Pradesh has issued an ordinance that would regulate microfinance institutions at a regional level.

Microfinance is still a relatively new member of the financial industries sector. Its mission of providing banking services to the world's poor can be traced back to the founding in 1983 of the Grameen Bank in Bangladesh by Muhammad Yunus, who subsequently won the Nobel Peace Prize for his efforts.

Despite the relative youth of the industry, microfinance institutions (MFIs) have grown at a remarkable pace. In India alone, it has grown to be a $5 billion industry, serving 25 million of India's unbanked poor. However, the industry there now faces a well-publicized crisis, as charges of unsustainable interest rates and overly aggressive collections practices has led to a confrontation between MFIs and the government of the Indian state of Andhra Pradesh.

Despite the fact that the microfinance industry is regulated at the federal level, by the Reserve Bank of India, the government of Andhra Pradesh issued an
ordinance in October that would effectively regulate MFIs at the state level. According to Vatti Vasantha Kumar, Minister for Rural Development of Andhra Pradesh, "The interest rate declared by the MFIs is different from the actual and indirect rate that includes hidden charges. If you take the hidden charges into consideration, the interest rate ranges from 50% to 84%."

However, as Elisabeth Rhyne, Managing Director of the
Center for Financial Inclusion, told, the state government has its own self-interest informing its actions. Rhyne said, "It's very important to recognize the political side, which is the result of a rivalry between the state government of Andhra Pradesh, which runs a self-help group program, and the microfinance institutions, which target the same population. The Andhra Pradesh government has been antagonistic toward microfinance for year, because it gets millions of dollars from the World Bank to run the self-help group program."

"Normally, you would not see the state government get involved in this sort of thing, because microfinance is regulated by the Reserve Bank at the national level," she continued.

"The Center for Financial Inclusion was created by
ACCION International two years ago," Rhyne told "It differs from ACCION in that ACCION is an on-the-ground, practical builder of institutions. The Center addresses challenges that face the industry as a whole."

"Between ACCION and the Center we have a clear mission to pursue financial inclusion, but we use different tools. We use convening, publication, research, and training, while ACCION's main role is investment management services," Rhyne said.

In a recent
letter to the New York Times, Rhyne wrote of the crisis, "The blame for this unfortunate situation falls most squarely on the microfinance organizations (MFIs) that failed to restrain aggressive growth even as the market became increasingly saturated."

"The growth of microfinance in Andhra Pradesh was so astonishing, with growth rates of over 100% a year for some of the faster-growing organizations," Rhyne told "The microfinance industry has viewed growth as the Holy Grail."

Regarding reports that MFIs in Andhra Pradesh have engaged in overly aggressive collections practices—the Times referred to "growing reports of suicides among people unable to pay mounting debts" in its coverage—Rhyne described an initiative by the Center for Financial Inclusion called the
Smart campaign, which, she said, "Is a global consumer protection campaign with six principles of consumer protection that we're trying to get into the microfinance industry."

One of the principles espoused by the campaign states, "Debt collection practices of providers will be neither abusive nor coercive."

The crisis has intensified to such an extent that state representatives are telling recipients of microfinance loans not to repay their loans, and loan payments have dropped to a fraction of what they had been. In addition, "The ordinance made it much harder for clients to pay back their loans," Rhyne said.

"In Andhra Pradesh, where payments have fallen to about 50%, when they had always been quite high in the past, the ordinance has been challenging for investors," she continued. "For investors, the biggest thing right now is turning around the rate of repayment."

Yet in her letter, Rhyne wrote, "Investors must also swallow a big spoonful of blame. Because they paid dearly for shares in the MFIs, they need fast growth to make their investments pay off. Microfinance leaders in India are now working intensively to put measures in place that would hold back multiple lending."

The phenomenon of multiple lending—where loan recipients apply for loans at several institutions, thereby compounding their debt—is one factor of the crisis that Rhyne believes could be addressed by the formation of a credit bureau. "The crisis pointed the need to improve the infrastructure around microfinance, with credit bureaus being a huge priority," she told "At present there is an inability to know how much multiple borrowing is going on."

Rhyne's letter also stated, "Regulators share some responsibility…(MFIs) have not been licensed to take deposits. Deposit-taking, properly supervised, would have allowed the MFIs to raise funds locally and create a balanced portfolio of products and revenue sources."

"If the federal government had wanted microfinance institutions to be part of the evolving financial sector, they could have set up a regulatory framework that wouldn't have been so lopsided," Rhyne said. "When they're only lenders, the regulators don't spend much time overseeing them. With deposit taking would come stronger supervision. And clients need both savings and credit."

"The ideal outcome," Rhyne continued, "Would be a regulatory framework for MFIs that would allow them to begin taking deposits and have stronger supervision by the regulatory authorities."


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