Bigger Troubles for Indian Micro Credit

More than six months after the Indian state government of Andhra Pradesh passed a law seeking to reform money-gouging microfinance institutions which had driven scores of the poor to suicide, the cure appears almost worse than the disease.

Defaults are mounting for the micro-lenders in Andhra Pradesh, a state that produced as much as a quarter of India’s US$5.1 billion microfinance industry. The loan recovery rate has fallen to as low as 15 to 20 percent since the state pushed through the reforms. Many borrowers even with the best repayment history have started to walk away from their loans because of the lack of accountability. In the first half of the current fiscal year, microfinance loans nosedived from US$1.1 billion to as low as US$1.9 million.

The microfinance institutions are now finding it difficult to meet the terms imposed by banks to restructure their own loans, furthering distressing the institutions, which are in desperate need of capital. The micro lenders, which offer tiny loans to poor farmers, shopkeepers and other small businessmen, borrow money from the commercial banks at 11-14 percent and lend at 25-30 percent.

Microlending has spread across 85,000 villages and 30 million Indian households. Andhra Pradesh led the country with millions of Telugu women taking loans. The borrowers theoretically improve their economic condition, leading to social empowerment.

The Reserve Bank of India recently announced national rules designed to regulate micro finance as a separate sector. The policymaking institution has ordered the micro lenders to fix interest rates below 26 percent. The guidelines also stipulate that collateral-free micro loans should be for rural people with an annual income of not more than Rs 60,000 and that the loan amount must exceed Rs 35,000 in the first lending cycle.

It also emphasized that household debt should not exceed Rs 50,000. The RBI governor D. Subba Rao insisted that the banks offer loans to microfinance institutions as a priority lending sector lending. The micro lenders would collect repayments from the borrowers by weekly, fortnightly or monthly installments according to their capacity and choice. Whether these regulations will dry up the lending industry nationwide, as it did in Andhra Pradesh, remains to be seen.

Certainly, in Andhra Pradesh and other areas, the practice, if not in fact the concept, of microfinance is in peril, not least because of what amounted to outright loan-sharking and strong-arm collection methods. The BBC reported in December that 80 people had taken their own lives in the last six months of 2010 in Andhra Pradesh out of desperation over their micro loan payments. There are additional questions over the effectiveness of collateral- free small loans in helping the poorest out of poverty.

The primary allegations revolve around the high interest rates, which run as high as 35 percent annually, and the practices micro lenders use against the borrowers, including offering new loans to borrowers to repay older ones with the aim of showing a fraudulent but excellent recovery rate. According to the BBC report, families who had taken micro-loans in Andhra Pradesh at that time had average annual debt of US$650 on annual incomes of US$1,060, meaning more than 60 percent of their incomes were spent paying off loans.

Muhammad Yunus, the 2006 Nobel Peace Prize winner for his creation of Grameen Bank and micro lending, said he is as worried at the sorry state of microfinance in India as he is about his own ouster from Grameen as the result of a political vendetta carried out by Sheik Haseena Wajed, Bangladesh’s prime minister.

"I founded Grameen Bank in 1983 to provide small loans to the poor people, especially the women, as a mission for poverty alleviation," Yunus told Asia Sentinel in a telephone interview from his office in Dhaka. "At that time, I never imagined that one day microcredit would give rise to its own breed of loan sharks."

Microcredit, he said, "should be an area for social business where one may want to help poor people get out of poverty by doing business. He or she neither loses money nor earns profit out of it. With that amount of money, he or she wants to serve the poor people to get out of poverty. That’s where the interest should be."

The situation for both microfinance institutions and borrowers got jittery when the Andhra Pradesh government issued the AP Microfinance Institutions regulations, formulated to prevent abusive practices. Even solvent borrowers, overly protected against abusive practices, soon developed the habit of not repaying their loans. SKS Microfinance, the country's largest micro-lender, reportedly lost nearly Rs700 million.

It isn’t as if India has been ignoring the problem of providing capital to its poorest. Micro-financing was in the Indian lexicon before Yunus and Grameen came along. The Reserve Bank of India has made concerted attempts since Independence in 1947 to help the poor get access to banking services. However, traditional commercial banks have insisted on collateral and discouraging red tape, driving the poor and the lower middle classes to money lenders who often charge usurious rates.

Borrowing the idea of microfinance from Yunus, India now is encouraging poor women to get the benefit of small loans. The country formulated the Swarnajayanti Gram Swarojgar Yojana ("golden jubilee rural self income generating scheme") a decade ago to encourage villagers and those in urban slums to go for income generation. Self Help Groups are an important component of the scheme, in which those below the poverty line are encouraged to form groups of 10 to 20 to start saving money in weekly or monthly installments to open accounts in local banks.

After six months of regular transactions that prove reliability, revolving non-refundable grants of Rs 10,000 are offered by the government to the self-help group. As the group continues to function and save, also getting personal loans from the corpus at around 20 percent interest rate, it becomes capable of getting bigger loans for community income generation. The half of the loan amount is non-refundable as the government sanctions this amount as a subsidy.

But because of corrupt practices of the government and bank officials, village women are still deprived of the benefits that the scheme could offer.

As the government initiative failed to cover the potential beneficiaries, local NGOs came into the picture working on microfinance. At first look, rural people found the micro-financing beneficial as it offered loans at lower interest rates than the village money-lenders. Moreover, the villagers get the money in their own localities and do not have to waste working time while going to banks.

Many times, the same group of people became beneficiaries to both the government scheme (as SHGs) and non-government organizations. That is the region why more people were engaged in micro-financing in those Indian states, where the self-help group movement was also successful. Andhra Pradesh, Karnataka, Tamil Nadu, Maharashtra, Kerala and Gujurat have been recognized as successful practitioners of the income generating schemes.

But the sudden increase in suicide cases among the farmers in many South Indian states drew the attention of authorities. Indian media started highlighting the pitiable condition of farmers in Maharashtra, Andhra Pradesh, Karnataka and Tamil Nadu, who were exposed to the seasonal crop damages that aggravated their financial condition. The result was a tragedy that keeps unfolding and imperiling one of the world’s most innovative financial advances.