Published February 23, 2011 in Arabic Knowledge@Wharton
The most recent crisis to hit microfinance began in India's southern state of Andhra Pradesh, where allegations of widespread over-indebtedness, heavy-handed collection tactics and borrower suicides have stirred a national debate about regulating the industry.
In October, the state government slapped restrictions on microfinance institutions that crippled lending and sent collection rates plummeting along with the share price of SKS Microfinance, India's largest for-profit microlender. On January 19, the Malegam Committee Report, released by the Reserve Bank of India, recommended a range of new regulations for India's microfinance institutions, including interest rate caps, loan limits and income ceilings for borrowers. Some observers welcomed the news; doomsayers predicted a credit crunch and industry collapse.
While it is too early to tell how the sector will respond, the crisis in Andhra Pradesh has sparked heated debate and soul-searching throughout the world's microfinance community. During a recent program for microfinance leaders at Wharton's Aresty Institute of Executive Education, discussion turned repeatedly to questions of over-indebtedness, rapid industry growth, and the fine line between profits and purpose.
The microfinance sector has experienced "a rude awakening" by "a delinquency earthquake," said one of the program's 26 international participants, Kamran Azim, during a general discussion about the growth and sustainability of the microfinance industry. Azim, head of operations at the Kashf Foundation, a microfinance organization established in 1996 in Lahore, Pakistan, pointed out that methods and methodologies in microfinance have changed little in the past 20 or 30 years. Now suddenly, the earth has moved.
Sponsored by the Women's World Banking Center for Microfinance Leadership, the Advanced Leadership Program at Wharton brought together microfinance leaders for a week of intensive study, brainstorming and networking to help prepare them for the challenges facing microfinance today. The goal of this year's cohort: to find innovative ways to confront the global economic crisis, new competition, increased regulation and relentless pressure to perform.
"During times of accelerated change, there is a tendency to rely on known ways of doing business," reads the introduction to one of the program's courses. "Yet it is at just these times that innovation is of heightened importance." At the same time, as several participants noted, the industry must find new ways to sustain growth without losing sight of clients' needs. For some microfinance institutions, that could require a crash course in business fundamentals such as due diligence, sustainable growth and customer care.
The Effects of Over-lending
The modern microfinance movement began in Bangladesh in 1977, as an experiment by economics professor Muhammad Yunus, who gave out small, no-collateral loans to groups of borrowers too poor to get credit from traditional banks. Over the next three decades, the model he established became widely accepted and replicated in other countries as a way to fight poverty. Microfinance spread around the world and earned Yunus a Nobel Prize in 2006.
But over the past few years, increasing competition among lenders and a weak global economy have strained borrowers and microfinance institutions alike. As an increasing number of banks and for-profit companies entered the market and contributions from investors increased, some markets became over-saturated and borrowers over-extended. Microfinance institutions are now seeking ways to continue growing with less risk.
"We are in a tension field between sustainability and ... social impact," said participant Carine Roenen, executive director of Fonkoze, a grass-roots microfinance organization based in Port-au-Prince, Haiti. "You take one of these two poles out of the equation and things go wrong."
Fonkoze, Haiti's largest microfinance institution, is used to operating under such tension. After hurricanes affected the lives of one-third of its clients in 2008, Fonkoze helped struggling borrowers by rescheduling existing loans. Since the earthquake in January 2010, it has distributed thousands of cash grants, and more than 10,000 new loans to clients, and has developed a catastrophe micro-insurance program.
"Microfinance, especially after Yunus received his [Nobel] prize, was branded as something that was good for the people," Roenen noted. "And now Andhra Pradesh comes with a story where it is bad.... We can probably learn what happened there. The public knows and expects from us that we provide social value. But we need to communicate about that much more than we do."
Over-indebtedness in Andhra Pradesh today has become "a fast-growing negative energizer which is really threatening the entire industry," said James D. Thompson, director of Wharton's Societal Wealth Program, during a class session on customer-centric innovation. He also advised microfinance institutions to focus on the customer -- "to reflect thoroughly about customer needs along every step of the consumption chain.... One of the single greatest challenges in beginning to think like this is [putting] the customer at the center, versus the natural reversion to talking about us and what we do," said Thompson, adding that building a mental map of how an organization operates from the customer's standpoint appears simple at first, but is actually quite difficult. One course participant agreed, noting that during a group exercise "several times [we] took the position of the institution and not that of the client."
Outside the classroom, microfinance institutions (MFIs) have also struggled to understand their customers' needs.
The last three years have witnessed a wave of events stemming from over-lending, said program participant Inez Murray, executive vice president of New York-based Women's World Banking. Among them: Nicaragua's microfinance industry suffered a crisis in 2008 when a "No Pago" (No Pay) movement led to widespread defaults and violent protests; Morocco's microfinance sector experienced a wave of defaults that led to the demise of one of the biggest MFIs; and Bosnia witnessed over-indebtedness after war recovery efforts spawned a large number of MFIs chasing too few customers. In each case, the root causes were complex: poor competitive practices -- for example, cherry picking each other's clients -- as well as relaxation of due diligence as MFIs sought to grow rapidly; manipulation of clients by local political forces; and macroeconomic shocks. Microfinance "works in an ecosystem," Murray said. "When it becomes too successful and money is involved, risk is created."
Program participant Mavsuda Vaisova saw the negative results of overlending in Tajikistan, where she works as general director for Humo and Partners, a micro-lending fund in Dushanbe. Started with a staff of just 19 in 2005, the microlending organization now has 11 branches, 260 employees, 10,000 clients and an active portfolio of US$5.5 million.
"Last year, during the crisis situation, we saw what happened. People were killing themselves because they could not repay five or six loans," Vaisova said. "These cases in Tajikistan happened so often [that we said] to all our creditors, 'Please don't push us because we cannot push people to kill themselves.'"
In some countries, the problem of over-indebtedness has been attributed to a lack of information: Without a system of credit bureaus or official identification cards for the poor, lenders could not determine a borrower's credit history or the presence of existing loans from other lenders. But that was not the case in Tajikistan, according to Vaisova. The country has a good information exchange about clients, so microfinance companies were able to see that borrowers were already in debt. "They can see that this client has two, three outstanding debts with other organizations. Still, they would like to have more outreach, so they provide another loan," she said. When given the choice, most borrowers gladly take advantage of the extra credit. "People cannot correctly evaluate their loan needs. They are just taking, taking, taking -- and then they cannot repay."
Traditional banks, too, have begun to woo the micro-borrower in many countries, increasing pressure on microfinance institutions to hold market share. "In this context of new competitors, of different competitors, bigger competitors than us, all this fight [means it can be] very easy to lose the mission," said participant Rafael Llosa, general manager of Mibanco, a private bank in Lima, Peru, that focuses on micro and small businesses. "Because you are fighting to be the leader in the market and you are fighting to survive, you start [focusing] on other things."
And yet, profits are essential if the microfinance institution wants to carry out its mission of poverty alleviation, participants said. "You have to charge interest to cover all expenses," said Marie Louise Nsabiyumva, CEO of Burundi-based savings and credit cooperative C.E.C.M. and vice chair of the Burundian Microfinance Network. "Otherwise, you would disappear. And that isn't useful for the client." Added Llosa: "If we are not profitable, we are not sustainable. For that reason, it's not an error to have profits."
But how much profit? In Andhra Pradesh, state government officials in October cited microlenders' quest for "hyper profits" as reason to clamp down on the industry.
Many microfinance companies in India seek investor capital, in part because of India's banking laws, noted participant Vikram Jetley, chief operating officer for Bangalore-based microfinance company Ujjivan's north region. According to the company's website, Ujjivan has completed four rounds of capital infusions and plans to offer an IPO after three years of profitable operations.
"We have two different kinds of investors," he noted: pure social investors and private equity investors. "As a part of our mission, we have clearly defined that our return on equity would be at best 15%. So someone who is looking for a really aggressive return on equity would never come with us."
Established in 2005, Ujjivan uses the Grameen model of lending to groups of women borrowers and focuses on urban microfinance. It currently boasts a 99.12% repayment rate from its more than 975,000 customers in 20 states.
Regulated by the Reserve Bank of India as "Non-Banking Financial Companies," microfinance institutions such as Ujjivan must maintain a minimum capital adequacy ratio but cannot take deposits, according to Jetley. "So we have to go to the capital markets. Otherwise we will never be able to scale up."
Before the crisis, Andhra Pradesh was awash in micro-investment: the state holds about one-third of India's microloans and hosts some of India's largest for-profit microlenders, including SKS Microfinance, which raised US$358 million in an initial public offering in August 2010. (SKS shares have since lost more than half their value after peaking at 1404.85 rupees on September 15.)
According to Narasimhan Srinivasan, author of "State of the Sector Microfinance India 2010," the number of microloans in Andhra Pradesh now amounts to almost 10 times the number of poor households in the state. But Srinivasan also reports that not all loans came from microfinance institutions. Borrowers in Andhra Pradesh can also get credit from the Self Help Group (SHG) program, a government poverty alleviation program funded in part by the World Bank that offers microloans at below-market rates. Srinivasan found that one-third of loans distributed in Andhra Pradesh were given out by microfinance institutions, while two-thirds were given to borrowers in the SHG program.
"The Andhra Pradesh crisis happened because the government has been going there and promising a 3% rate of interest while my rate of interest even on our debt funding is 12%," said Jetley. "How can you survive? This is not an India problem; it's one state's problem. It is not cascading to other states."
Oversimplifying the challenges in Andhra Pradesh and painting the entire microfinance industry with the same broad brush will not help find creative solutions going forward, said participant Georgette Jean-Louis, CFO of Fonkoze, the microfinance institution in Port-au-Prince, Haiti.
"I think the sector right now is at risk because everybody is trying to take what happened in one part [of the world] and say it is the same thing that is happening in Peru, in Haiti, in Taijikistan or in some part of Africa," Jean-Louis stated. "Yes, there is a problem [with] what happened in India. We have to learn from it, we have to study it, in order to prevent it from happening in every part of the world.... But at the same time, you have to look at the context. You have to look at the environment. You have to look at what happened and study it instead of globalizing [it and treating it as] the same monster that is happening to you."
Every country is different, she added, and solutions must account for the differences and involve everyone. "There are lots of stakeholders. Government has to play its role. Microfinance has to play its role. The investors have to play a role. And then we can find a solution."
The recent developments in Andhra Pradesh and other hotspots have brought industry leaders together to explore ways to limit the potential for overlending in the future, said Women's World Banking's Murray. "The sector has to do this and build coalitions. It must also engage in self-regulation. However, this will only work up to a point. Legal regulation will likely be required, but this needs to be done in a way that enables growth."
The industry is focusing heavily on finding ways to measure social impact, and setting industry standards by which microfinance institutions can self-regulate. Organizations are also pushing product diversification: After years of extending credit, many microfinance institutions argue that other types of financial services could have an even greater impact than loans. Savings accounts, for example, would give poor households a safe place to store emergency funds. Insurance products would help them manage risk.
In a study in Morocco, Women's World Banking found that women borrowers tended to set aside 40% of their incomes for health emergencies, Murray pointed out. "It's pretty easy to argue that spending 20% on an insurance premium and the other 20% on investing in business to get out of poverty" could be a better option long-term, she said.
And growth -- for both borrowers and lenders -- is what microfinance institutions say they want. "We believe there's a tremendous future for microfinance ... if you focus on having an impact at the client level and the household level, creating services that will enable poor people to make better choices for how to use their money," Murray added. "We're absolutely optimistic that the microfinance sector is here to stay." Problems in Andhra Pradesh and other hotspots are "essentially a lot of growing pains. The key is not to throw the baby out with the bath water."