There has been a lot of press (mostly negative) about microfinance in India. A recent New York Times article highlights concerns such as poor lending practices, increased rates of borrower suicide, and a movement against making loan payments. (You can read how one of our Causes, ACCION, responded to the article here.) Some people are suggesting that these problems could mean the end of the microfinance industry as a whole. But no story is ever “black and white”, and in the world of finance it’s often possible to connect one crisis to another.
Microfinance is one way of helping to alleviate poverty and empower individuals to do and have more. It involves providing financial services to people otherwise unable to access them. Microfinance includes a range of services (loans, savings, insurance), but the most common product is a loan. Some MFIs (microfinance institutions), view the loan as charity; others take a for-profit approach. These MFIs believe that making microfinance a profitable enterprise will increase competition (more organizations will want to do it), increase access for the poor (more MFIs mean more loans/products available to them), and ultimately lower interest rates for borrowers.
In India, the microfinance industry has grown astronomically. There are both independent MFIs, small money lenders and state-sponsored “Self Help Groups.” They have been supported (i.e. funded) by direct funding from the state (in the case of the self help groups), by bank loans, and by private investments. For-profit MFIs reach close to 30 million clients with $4 billion in outstanding loans. State banks reach approximately 50 million clients through Self Help Groups. MFI loans are only 11% of the total loans – so while they are getting a lot of attention (because of the press and the recent SKS IPO) they are not the only providers.
Today’s “crisis” is a result of several factors. One is that individuals are not paying back their loans, with support of politicians who claim MFI interest rates are unfair. As a result, the government is “capping” interest rates (limiting how much the MFIs can charge, which might make lending unprofitable for them), and making it difficult for MFIs to borrow the money they need to lend to their clients. Unlike most banks, MFIs can’t legally accept deposits from customers, so they depend on borrowing money from larger banks, lending it out to their clients, and then getting enough money back to 1) pay back their loans; 2) pay back the interest on their loans; and 3) make enough money to make the whole enterprise worth the trouble. In a way, the MFI is just like the farmer or seamstress it lends to (but on a much bigger scale). Big banks want the MFIs to succeed so they can pay back their loans – just like the MFIs want their clients to succeed so they can pay back their loans. It is a closely connected and sometimes vicious circle.
So what makes the microfinance industry too big to fail? Well, experts estimate that Indian banks have already lent almost to $900 million to MFIs. If the MFIs go out of business, guess who else loses? Not only potential MFI clients, but also the banks that kept those MFIs in business. Somehow this sounds familiar – it’s kind of like the mortgage crisis that shook the real estate industry in the U.S.
So what does this mean for the TILE Community? First, think about the fact that loans are loans – whether to you, a business, a farmer, a company, or another financial institution. When someone doesn’t pay back a loan, the damage can be widespread – all parts of the economy are undeniably interconnected. Second, like many new industries, microfinance has lots of supporters and its fair share of detractors. Decide for yourself whether you like the for-profit or non-profit model best. Which do you think will create more opportunities for people in the future? One place to go for information is the Center for Financial Inclusion, which represents industry issues and points of view. Finally, ask questions (asking TILE is a great place to start!) as you come across things like this that make you go “huh?”
- Amy