Microfinance: How AP govt Killed it .. An Detailed Analysis

What is Microfinance & How it all started?

It all started somewhere in Bangladesh when Muhammad Yunus during visits to the poorest households in the village of Jobra near Chittagong University, discovered that very small loans could make a disproportionate difference to a poor person. Traditional banks did not want to make tiny loans at reasonable interest to the poor due to high risk of default. But Yunus believed that, given the chance, the poor will repay the money and hence microcredit was a viable business models. In 2006 Yunus and Grameen Bank received the Nobel Peace Prize "for their efforts through microcredit to create economic and social development from below. Microfinance was able to do what none of the governments had been able to do that earlier, provide loans to the poorest of poor to earn their livelihood from their own savings and help them come out of the not‐so‐benevolent arms of moneylenders.

 

Microcredit in India and its journey in the state of Andhra Pradesh

What Yunus did in Bangladesh was something we in India also required to do to reach to the millions of people who were financially excluded from the formal financial system. From here microfinance made a beginning in India. In India AP was one of the states which took a lead on this form of finance for the poor and the industry flourished till brakes were put down on it in 2010.In 2010 AP govt brought an ordinance which changed the future of microfinance in India. There were several reasons why the govt brought such an ordinance but the knee jerk reaction to the ongoing crisis resulted in a totally breakdown of microfinance industry in Andhra and up to a certain degree had an impact on microfinance industry across India.

Reasons for the ordinance

• While the industry flourished in those years it started getting into unfair practices ,excessive lending by MFIs in the state of Andhra Pradesh lead to over‐indebtedness which caused distress to low income microfinance borrowers
• More than 200 poor, debt-ridden residents of Andhra Pradesh killed themselves in late 2010, according to media reports compiled by the State government
• Coercive behavior by MFI staff in collecting from these over‐indebted borrowers suffering from the stress of keeping up with their repayment obligations
• One woman drank pesticide and died a day after an SKS loan agent told her to prostitute her daughters to pay off her debt. She had been given Rs 1.5 lakh in loans but only made Rs 600 a week.
• Originally developed as a non-profit effort to lift society's most downtrodden, microfinance increasingly became a for-profit enterprise that serves investors as well as the poor. As India's market leader, SKS has pioneered a business model that many others hoped to emulate.

AP Ordinance

As a result of hundreds of deaths the State Government of Andhra Pradesh passed a sweeping Ordinance governing all lending activities in the state by banks as well as non-bank finance with stipulations that no collateral may be taken, repayments must be monthly, nobody must have more than one loan outstanding, all financial services business must be carried out in government offices and the permission of government agencies must be taken before any loans can be taken. This wrote the death knell for Microfinance industry in AP and had its impact in the country.

The Impact of the AP govt Ordinance on Microfinance Industry

In its annual report “M-CRIL Microfinance Review 2012: MFIs in a Regulated Environment” M-CRIL comes up with the financial and social analysis of this whole issue. Following are some of the points being observed.

 

People Stopped making payments for loans

 

The industry plunged into crisis when clients in AP stopped payments .The AP Government’s ordinance on lending by MFIs made it virtually impossible for them to continue their operations in the state.

 

The unspoken message to clients was that MFIs would not be allowed to operate and, therefore, there was no need for them to repay their MFI loans.

 

Given the populist nature of (particularly) local level politics in India, this message became “spoken” when politicians actually went around the state with the message that MFI borrowers no longer had to repay their loans.

 

Discouraging borrowers from repaying their loans is an irresponsible act since it makes clients ineligible from receiving further loans and thereby disrupts their lives and economic activities even as it de-stabilizes the financial market. There can be problems in the functioning of any market; concern about such problems should lead to corrective actions and reforms, not to the destabilization and total shut down of whole segments of economic activity.

 

Growth of the sector has been undermined

While MFI operations continue to be a significant component of the financial system in the country and its contribution to financial inclusion continues to rival, if no longer exceed, that of the rural banking system, the efficacy of that contribution has been undermined by the crisis and its aftermath.

 

 

 

Portfolio of MFI’s based in AP got a huge setback making the industry unattractive and risky.

Analysis of portfolio quality data from M‐CRIL’s sample of 56 MFIs indicates that the MFIs in India as a group have amongst the worst portfolio quality ratios in the world. The sample average of PAR30 at 23.7% is exceeded by the L‐10 group (at 29.5%) – of whom 4 have their main operations in AP. This is in sharp contrast to the reported portfolio quality ratio of 0.67% for end‐March 2010.The figure also shows how the ordinance impacted other MFI across country where political interference resulted in losing confidence in the future of this industry.

Analysis of portfolio quality data from M‐CRIL’s sample of 56 MFIs indicates that the MFIs in India as a group have amongst the worst portfolio quality ratios in the world. The sample average of PAR30 at 23.7% is exceeded by the L‐10 group (at 29.5%) – of whom 4 have their main operations in AP. This is in sharp contrast to the reported portfolio quality ratio of 0.67% for end‐March 2010.The figure also shows how the ordinance impacted other MFI across country where political interference resulted in losing confidence in the future of this industry.

• From a PAR of 0.67 in 2010 the PAR has increased to 29.5 % in the state of Andhra Pradesh, this makes it extremely risky portfolio which will act as a deterrent to any institutional lending to the sector
• Operating efficiency has been adversely affected as portfolio management issues and client protection compliance expenses have increased OER
• Cost per borrower has risen sharply as MFIs first pursued growth at all costs and now have to put considerable effort into client protection measures and follow up of repayments

 

Commercial banks pulled their hands out of MFI’s due to lack of Confidence in the sector

 It is apparent that the heavy handed October 2010 ordinance of the Government of Andhra Pradesh has resulted in a delinquency crisis of huge proportions. All banks and capital market participants have immediately stopped or reduced extending any funding to non-bank finance companies on a nationwide basis 

• During 2011‐12, the private sector banks were in full flight from the microfinance sector, dismayed at the prospect of huge losses on the AP portfolio.
• By end‐March 2012, institutional lending to MFIs had declined to Rs 15,136 crores ($2.97 billion), down by over 20% from the estimated peak of around Rs  18,000 crores in October 2010.    

 The resolution of the current crisis now awaits the restoration of confidence of the commercial banks and other investors in the microfinance industry 

Impact on Women

 

The relation between women and MFI can be understood from the fact that the overwhelming majority (98%) of Grameen’s borrowers are women. Women traditionally had less access to financial alternatives of ordinary credit lines and incomes. They were seen to have an inequitable share of power in household decision making. In fact the whole model of Microfinance revolves around women especially in rural areas and killing this source of finance means major unemployment in rural areas and talking away the opportunity from millions of rural women to earn their own livelihood and support the survival of their families.

With around 21 million borrower accounts the size of the microfinance sector more than matches’ significant parts of the Indian financial system in terms of the number of citizens affected a majority of them being women.

Future of MFI’s in Andhra Pradesh

 

A detailed report by “M-CRIL Microfinance Review 2012” shows the deep impact this crisis have taken on AP those MFIs that work extensively in Andhra Pradesh. By, November 2012, one medium‐sized MFI that worked exclusively in the state has effectively been taken over by its lenders through the conversion of a significant part of their debt into equity and some of the larger MFIs have negotiated a six‐year restructuring of their debt with their major lenders. Elsewhere, the shrinking portfolios some MFIs (in the absence of bank funding) have caused operational problems and led to the take‐over of at least three MFI managements by investors. More acquisitions of this type are likely to occur in the near future.

 

Future of Microfinance in India

Debate on the Dependency on commercial institutions

While this is an area of debate whether Indian Microfinance industry should be too dependent on commercial lending by financial institutions or should it follow the Grameen Bank model of Bangladesh. Unlike Indian model the Grameen model uses the deposits from the clients to finance their lending requirements 

 

The 1.5% savings orientation of Indian MFIs is clearly very low by global standards. The L‐10(top 10 MFI’s) – more visible and, therefore, more vulnerable – have a negligible savings ratio, down substantially from the 23.7% of the 2003 M‐CRIL sample. All Asian countries with flourishing microfinance sectors – Bangladesh, Indonesia and Philippines – have deposit ratios that account for substantial proportions of portfolio – see exhibit above. Also, the rural banking system in India undertakes all it’s lending from deposits (portfolio deposit ratios >100%).

 

Policy paralysis at the Center:

 

All microfinance stakeholders, whether within or outside Andhra Pradesh now await the passage of

“The Micro Finance Institutions (Development and Regulation) Bill, 2012” tabled in the national Parliament on 29 May 2012. It is generally thought that the bill has the following positive features

1 It specifies that the central bank, Reserve Bank of India, will be the regulator of MFIs

2 It provides for MFIs regulated by RBI to accept thrift from their borrowers – thus, no public deposits but the provision of a savings service to borrowers

3 It clearly removes microfinance from the ambit of state‐level money lending laws greatly reducing the risk of interference by state governments in the provision of financial services to low income families.

However the bill is stuck in parliament and with the central govt unable to come out of the firefighting mode due to spate of corruption scams by its ministers and therefore has been unable to get this bill passed. Hope the govt comes out of its policy paralysis to pass this bill in coming monsoon session.

In the meantime, the Government of Andhra Pradesh continues to challenge the constitutional validity of the bill on the grounds that in the Indian Constitution this despite the same party ruling at both center and the state. And if such a thing does happen it will be the end of road for the MFI in AP and those who will suffer will be millions of poor who will be denied a chance to earn their livelihood by their own efforts.

 

 

 

By: Saurabh Sinha

Twitter: @saurabhsinha10