If one wants to understand Microfinance space, it’s important to know the Microfinance Crisis in Andhra Pradesh. It’s important to study failures and the reasons.
A SHG (self help group) is a community based group with 10-20 members. They are usually A SHG (self help group) is a community based group with 10-20 members. They are usually women from similar social and economic backgrounds, all voluntarily coming together to save small sums of money, on a regular basis. In the 1980s, Government started the SHG-Bank Linkage program whereby Banks were asked to provide credit to SHGs.
After the liberalisation in the 1990s, a lot of non-profit (Societies and other owner less legal forms) converted to for-profit NBFCs. MFI NBFCs aren’t allowed to raise retail public deposits, they relied majorly on bank borrowing to fund their operations.
Andhra Pradesh was already a leading state as far as SHG penetration was concerned. The state government was already running a state financed scheme to provide finance to SHGs. The state became the epicenter of Micro-Finance in India. Two of the biggest MFIs – SKS and Spandana were based out of Andhra Pradesh.
Traditionally SHG-Bank Linkage program had a cap on lending amount, limiting it to 3-4 times this savings base effectively limiting to Rs.1,00,000 or less per SHG.
But later the Andhra Pradesh government introduced a new scheme where the limit was increased to 5,00,000. A 5 year repayment instead of 1 year. Also any interest above 3% will be reimbursed by the Government. The idea behind the move was to encourage SHGs to give back loans to moneylenders & MFI but they kept multiple loans from multiple sources.
For Profit MFIs – Strong incentive and funds to go for exponential growth:
Banks have priority sector lending targets (they are suppose to lend a certain percentage of total loans as mandated by RBI to specified sectors). The yields ideally in priority sector lending were low. Microfinance offered better yields but banks didn’t have the capability to disburse and collect sizeable amount of these loans. So the Banks instead of directly lending through SHGs, decided to go through for profit MFIs as intermediaries. Large inflow of funds from banks helped MFIs to grow 70-80%.
Enter Private Equity and Venture Capital:
MFIs started attracting investments from private equity and venture capital firms. This created a strong incentive for growth and profitability for MFIs to drive the valuations higher.
According to reports, MFIs borrowed from banks at around 12% and spent around 8-9% in delivering the loan but charged as high as 60% from borrowers. They generated very good return on capital. Moreover, there was a large market as a very big section of population had no access to formal credit.
Combination of state funded SHGs and well funded MFIs saw rapid proliferation of credit across Andhra Pradesh. Borrowers started taking multiple loans. In 2010, average outstanding microfinance debt per household was Rs.65,000 as compared to national average of Rs. 7700
SKS Microfinance one of the leading MFIs had received 11.5 Million $ investment from Sequoia Capital – a leading venture capital fund. Muhammad Yunus, pioneer in the field of Microfinance, founder of Grameen Bank and Nobel Prize winner, was against the idea of venture capitalists funding MFIs.
From 2006 to 2010, Microfinance loans increased at a CAGR of 89%. Assets grew by 2.7 billion$.
The top five MFIs grew at close to 140 per cent in loan disbursal between 2008 and 2009. SKS and Spandana distributed 214 per cent more money in 2009 than in the preceding year. Their client base increased at 87 percent and 104 per cent.
Accident waiting to happen:
“Growth for the sake of growth is the ideology of the cancer cell.”
Thus the for-profit MFIs were flush with funds with incentives and targets to lend more and more. They had to keep on lending to justify their valuations. Money from the market had led to dangerous competition.
They lowered their lending prudence. This created a credit bubble. Pushing credit to vulnerable section of the population resulted in unsustainable indebtedness. The borrowers were borrowing from multiple entities using funds from one to pay the other.
This was an accident waiting to happen. There were media reports of suicides and heavy handed collection practices of MFIs. The state government brought an ordinance to put curbs on Microfinance institutions. There were large scale defaults by borrowers.
If anything is unsustainable, it is unsustainable.