India's Microlending Loan Sharks

It looks as if microfinance in India is facing its first major crisis. Even though the crisis has been linked to recent farm suicides in Andhra Pradesh, it may not be far-fetched to connect it to the hugely successful IPO of SKS Microfinance, the nation's biggest micro-lender, and the prospect of lucrative profits.

Far from the promise of Grameen Bank-style microfinance, which earned its founder, Bangladeshi banker Mohammed Yunus, a Nobel Peace Prize, India's microfinance lenders have come in for increasing scrutiny in the wake of reports that high interest rates and coercive loan collection by some institutions have led to as many as 30 suicides in the impoverished far eastern province of Andhra Pradesh. A group of India's largest microfinanciers are suing to block strict new regulations by the state to rein in coercive practices.

Microfinance was designed by Yunus to free the poor from usurious rates by giving them small, affordable loans. But the Andhra Pradesh government, which accounts for nearly a third of all microfinance lending in India, has come in for increasing scrutiny because of what are akin to loan-sharking practices. The state's new regulations limit total interest payments to less than the total amount of the loan. They also ban taking security for loans and make offenders liable for up to three years in prison and fines of 100,000 rupees ($2,257).

Microfinance Institutions Network, an industry body with 44 leading microfinance institutions as members, Tuesday petitioned the Andhra Pradesh high court to block provisions of the ordinance which it says will severely disrupt business, chief executive Alok Prasad told the Associated Press in an interview, saying the new law would create an unwieldy bureaucracy and is unclear over how long a lender will have to suspend lending and collection activity while it waits for its registrations to be processed.

Indian microfinance lenders generally charge 24-36 percent annual interest. Although the rates compare favorably to village moneylenders, who demand 36 percent to 72 percent interest or higher, unsecured personal loans from commercial banks charge 16-17 percent. Microfinance lenders say they have to charge higher rates than commercial banks because of the added costs of serving large numbers of small customers in hard to reach places, the Associated Press reported.

Do we need better regulation of the microfinance lenders? In another, days after the SKS IPO, I expressed my reluctant, but eventual, capitulation to the concept of for-profit microfinance, as opposed to Mohammed Yunus' original philanthropic microfinance. Still, I never resolved one of the biggest questions in my mind: What is society to do if for-profit microfinance, in its quest for ever-higher profits, pushes the boundaries of usury and becomes exploitative?

The trigger for Andhra Pradesh's ordinance to regulate microfinance organizations in the state was not only the suicides but also complaints of abuse by some borrowers. The ordinance's details are not entirely clear and SKS has, in a filing with the securities watchdog SEBI, said it is seeking legal clarification to understand if the ordinance even applies to it.

One thing, though, is clear. The ordinance does not cap interest rates at which microfinance groups can lend. But that is a regulation separately being considered at multiple levels – by banks that lend money to microfinance groups and by governments.

Capping interest rates, many economists and editorials say, is a bad idea. But this is a simple free market idea that may or may not be desirable in the context of our society. Besides, the reasoning is not entirely persuasive. SKS founder Vikram Akula, for example, will only say that interest rates will eventually be driven down not by regulation but by competition. This is self-serving and maybe facetious, too. Given the extent of India's financial exclusion, serious competition that can lower interest rates will be a long time in coming. This should not mean usurious rates for the poor. It would be sad if what began as a revolutionary philanthropic movement is allowed to become exploitative.

I still believe for-profit microfinance can be a greater catalyst to society, compared with the philanthropic model, but will Akula and his big-name investors like Vinod Khosla and George Soros, not to mention other microfinance groups and investors, voluntarily accept lower margins, and not seek to maximize gains? If SKS does anything of the kind, could it be sued by shareholders for breach of fiduciary duties?

Akula has built the largest and most efficient microfinance company in India and he, more than anybody else, may have answers to these questions.

Bala Murala Krishna blogs for Asian Correspondent, with which Asia Sentinel has a content-sharing agreement, at Indian Century (http://asiancorrespondent.com/indian-century).