Furthering Financial Inclusion through Financial Literacy and Credit Counselling

(Address by Dr. K.C.Chakrabarty, Deputy Governor, Reserve Bank of India at the launch of Federal Ashwas Trust on November 30, 2009 in Kochi, Kerala.)
I am happy to be here this morning and feel privileged to launch the Federal Ashwas Trust for running the Financial Literacy and Credit Counselling Centres (FLCC) of Federal Bank. At the outset, let me warmly congratulate my old friend and colleague Shri M. Venugopalan, MD and CEO, Federal Bank, and his team for bringing the FLCC of Federal Bank to fruition. Even though Kerala has the highest literacy rate amongst all States in the country, I am sure that centres such as these have a vital role to play in providing valuable services to the people in the district.

2. As our Hon’ble Finance Minister emphasized in his Budget speech, our approach to banking and financial sector has been to ensure robust oversight and regulation while expanding financial access and deepening markets. The merit of this balanced approach has been borne out in the recent experience as the turbulence in the world financial markets has left the Indian banking and financial sector relatively unaffected. The recent turmoil which engulfed the western world and its financial sector brought to even sharper focus the pressing need to protect the vulnerable from Ponzi schemes through safety nets of financial education, counselling and timely advice.
3. The establishment of FLCCs is an important milestone in furthering financial inclusion. As I have emphasised time and again, opening a no frills account is by itself not financial inclusion. That is just the beginning. Financial inclusion is a much broader term which can be construed as the process of ensuring fair, timely and adequate access to financial services, namely, saving, credit, payment and remittance facilities, and insurance services at an affordable cost in a fair and transparent manner by the mainstream institutional players. Educating people and making them financially literate thus becomes integral to achieving financial inclusion, which is why centres such as these are needed.
4. With the above perspective, I organize the rest of my remarks under the following sections. In Section 1, I propose to talk about the importance of financial education. In Section 2, I would briefly touch upon the need for credit counselling. Section 3 discusses the specific objectives of setting up the FLCCs. Section 4 covers the role of RBI and, finally, I shall share some of my thoughts on issues and challenges that we need to address.
I. Financial Education
5. Financial education can broadly be defined as the capacity to have familiarity with and understanding of the financial market products, especially rewards and risks in order to make informed choices. Viewed from this standpoint, financial education primarily relates to personal financial education to enable individuals to take effective actions to improve overall well-being and avoid distress in financial matters.
6. The financial markets offer a variety of both simple and complex financial products. It is difficult for the common person to grasp the downside risks associated with financial products especially if he or she is confronted by a blitz of clever advertising. Making wrong choices while choosing financial products becomes one of buying in haste and repenting at leisure. The focus of any discussion on financial education is thus primarily on the individual, who usually has limited resources and skills to appreciate the complexities of financial dealings with financial intermediaries on matters relating to personal finances on a day-today basis.
7. Lack of literacy in general and financial literacy in particular, are the main hurdles in expanding the coverage of financial services to the poorer segments of society. Notwithstanding the initiatives taken so far, given the large magnitude of the problem, concerted efforts need to be made in this direction. Banks should, therefore, come forward to set up literacy centres and guide their clients about the features, benefits and risk of various financial products. With no well established banking relationships, the un-banked poor are pushed towards expensive alternatives. These centres can educate the people about proper financial management tools, inculcate saving habits and generate demand for financial products and services which in turn will boost financial inclusion. This process of education could benefit the banks as the centres while interacting with customers would be in a much better position to understand their specific requirements, which could then be a critical input in appropriate product design.
8. Financial education is also an integral component of customer protection. Despiteconcerted efforts, the current levels of transparency coupled with the difficulty of consumers in identifying and understanding the fine print from the large volume of information, leads to an information asymmetry between the financial intermediary and the customer. For example, customers are often penalised for minor violations in repayments, although they have limited redressal mechanisms to rectify deficiencies in service by banks. In this context, financial education can greatly help the consumers.
II. Credit Counselling
9. Credit Counselling can be defined as 'counselling that explores the possibility of repaying debts outside bankruptcy and educates the debtor about credit, budgeting, and financial management’. It serves three purposes. First, it examines the ways to solve current financial problems. Second, by educating about the costs of misusing a credit, it improves financial management. Third, it encourages the distressed people to access the formal financial system.
10. As per the All India Debt and Investment Survey, 2003, nearly a fourth of the households were indebted in 2002. The per cent of indebtedness households in rural areas increased sharply from 23 in 1991 to 27 in 2003; the corresponding figures for urban areas during the same period were 19 and 18, respectively. As per the NSSO survey (2003), out of 89.35 million farmer households, 43.42 million (48.6%) were reported to be indebted. Farmer’s indebtedness was highest in Andhra Pradesh followed by Tamil Nadu and Punjab. The average outstanding loan per farmer household was highest in Punjab, followed by Kerala, Haryana, Andhra Pradesh and Tamil Nadu.
11. The report on the Situational Assessment of Farmers (NSS 59th round-2003) estimated that 64.4% farmer households are indebted in Kerala as against the national average of 48.6%. The major reasons for arrears in repayment reported include high cost of cultivation, fall in prices of agricultural produce and crop failures. Opening of credit counselling centres such as these can certainly benefit the people.
12. Earlier, there were reports of farmers committing suicides in some parts of the country due to their financial liabilities. Through the provision of timely and professional advice, common people can be helped to manage their debt, improve money management skills and gain access to the structured financial system. Counselling can help solve current financial problems, create awareness about the costs of misusing a credit, can improve financial management and help develop realistic spending plans. Debt counselling/credit counselling can be both preventive and curative. In case of preventive counselling, the centres could provide awareness regarding cost of credit, availability of backward and forward linkages, where warranted, etc. The clients could be encouraged to avail of credit on the basis of their repaying capacity. Preventive counselling can be through the media, workshops and seminars. In the case of curative counselling, the clients may approach the counselling centres to work out individual debt management plans for resolving their unmanageable debt portfolio. Here, the centres could work out effective debt restructuring plans that could include repayment of debt to informal sources, if necessary, in consultation with the bank branch.
III. Specific Objectives of FLCCs
13. With the above background, let me remark on the specific objectives of setting up FLCC. As you are aware, while the broad objective of the FLCCs will be to provide free financial literacy/education and credit counselling, the specific objectives of the FLCCs would be:
To provide financial counselling services through face-to-face interaction as well as through other available media like e-mail, fax, mobile, etc. as per convenience of the interested persons, including education on responsible borrowing, proactive and early savings, and offering debt counselling to individuals who are indebted to formal and/or informal financial sectors;
To educate the people in rural and urban areas with regard to various financial products and services available from the formal financial sector ;
To make the people aware of the advantages of being connected with the formal financial sector ;
To formulate debt restructuring plans for borrowers in distress and recommend the same to formal financial institutions, including cooperatives, for consideration ;
To take up any such activity that promotes financial literacy, awareness of the banking services, financial planning and amelioration of debt-related distress of an individual;
14. FLCCs are not expected to act as investment advice centres /marketing centres for products of any particular bank/banks. Counsellors may refrain from marketing / providing advice regarding investment in insurance policies, investment in securities, value of securities, purchase/ sale of securities, etc., or promoting investments only in bank’s own products.
IV. Role of the RBI
15. We, at the RBI, actively encourage these initiatives and one of the main reasons for my coming here to launch the trust is to demonstrate our commitment to this cause. RBI has completed 75 years and in our platinum jubilee year, we are making concerted efforts to expand the reach of formal finance through outreach initiatives. All the stakeholders are being encouraged to push aggressively for greater financial inclusion. The Banking Codes and Standards Board of India (BCSBI) has recently brought out an updated code to ensure that the banks formulate and adhere to their own comprehensive code of conduct for minimum standards of banking services, which individual customers can legitimately expect. And finally, the Banking Ombudsman Scheme has been instituted for redressal of grievances against deficient banking services, covering all the States and Union Territories.
V. Issues and Challenges
16. Since promoting awareness is one of the primary objectives, the FLCCs should give due emphasis to customers' rights under fair practices code and act as watch dogs. Our institutions must provide high quality public services to all citizens with transparency and accountability. To achieve this, there are several issues and challenges that come to my mind:
The first issue is that of treating the customers fairly. Transparent pricing, terms and conditions of financial products including interest charges, premia, fees and user friendly products made available in a form which is intelligible to borrowers would go a long way in reducing the need for having financial education centres in the first place. There is a need to sensitise the bank staff to engineer an attitudinal shift with empathy for the poor, strengthen and streamline systems to improve the efficiency of our distribution and delivery mechanisms.
The second issue for banks is to expand the range and reach of counselling and advisory services to vulnerable sections. For this a large number of such centres would be required. Up to end June 2009, banks have reported setting up 154 credit counselling centres in various States of the country. Obviously, there are many districts which still do not have such centres and we need to strive towards setting up more centres.
Third, banks need to facilitate the empowerment of credit counselling centres for them to be effectively liaising and negotiating on behalf of their customers. It must be understood that FLCCs are to facilitate responsible behaviour among financial institutions serving customers at the base-of-pyramid as part of their focus on equity and efficiency.
The fourth issue is that of enlisting committed and well trained personnel to man these centres. As quality of service is an important aspect, it is desirable to have appropriately bench-marked quality standards for credit counsellors and counselling agencies. A related issue is that whether there should be accreditation of credit counselors? If so, who should do it, industry associations or individual banks? These could be considered in due course.
The fifth issue that faces agencies is that of following a segmented approach vis-a-vis a broad-based generalized one. It is clear that banks may have to adopt a segmented approach specific to different categories of borrowers and different credit segments. Similarly, in respect of urban and rural areas, different approaches would be required. For instance, the centres in rural and semi urban areas could concentrate on financial literacy and counselling for farming communities and those engaged in allied activities. The centres in metro/urban areas could focus on individuals with overdues in credit cards, personal loans, housing loans, etc. Thus, the challenge is to tailor differential literacy and counselling mechanisms depending upon the need.
Sixth, an important issue from the financial literacy perspective is that of content design and appropriate delivery medium and mechanism suitable to the particular target group.
Lastly, as lack of awareness is major stumbling block in such initiatives, it is necessary to give wide publicity to the concept of credit counselling and the free availability of such services. Effectively utilizing the various mass communication channels and leveraging information technology would assume importance in this context.
VI. Conclusion
17. I hope the FLCC of Federal Bank would bring ‘Ashwas’ or relief to the common person. The bank, based on the experience gained, may like to consider opening more such centres in other districts of the State in due course as the benefits of such initiatives flow back to the banks. We need to collectively strive to deepen and broaden the agenda for inclusive development; and to ensure that no individual, community or region is denied the opportunity to participate in, and benefit from the development process.
I wish the Trust all the success.

http://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=450

DUBAI CRISIS: WHAT AILS DUBAI? AND WHY SHOULD WE CARE?

In order to transform its economy as a major tourist and financial hub, Dubai borrowed US$80bn. However, it suffered a massive property slump in last year’s credit crisis. Now, it is not able to repay its liabilities, and asking borrowers to postpone repayments. There were 53 lakh Indians in the Gulf, of which 31% were in the UAE, mostly employed by construction sector for Dubai’s real estate boom. The Gulf region accounts for over half the total inward remittances worth over USD 25 billion annually from expatriate Indians, out of which 10% of overall remittances to India could be from construction workers. If Dubai were to default, there would be repercussion in other parts of world, where banking would take a hit from lending to Dubai. Though the overall size of the liabilities are not very big compared to US banking problems, this could be a taken as an excuse for the markets to correct at lower levels.

The biggest debate on Indian Microfinance Sector: Why There's No Credit Crisis in Microfinance

by Vikram Akula
A recent article in the Wall Street Journal would have you believe there is a credit crisis brewing in Indian microfinance — that microfinance institutions are indiscriminately over-lending as they seek to maximize profits. But the article's assertion was based on a small sample of data that's not representative of the larger industry. An overload of debt among a few individuals, in one slum, in one city, in one state of India hardly constitutes a bubble. It also misrepresents the nature of microfinance in India today.
Here are just a few of the facts:
Repayment rates in India remain solid. Microfinance institutions in India, which serve 22 million clients, have consistent repayments rates of 95% and above — payments that clients could not make if they were not generating regular income, given the weekly collection schedules most microfinance institutions follow. The Microfinance Information Exchange (MIX), a Washington-based nonprofit, reports that the average repayment rate of leading MFIs in India — which have the largest share of clients — is 98%. My own institution, SKS, which serves more than five million clients spread across 70,000 villages and slums of India, has a 99% repayment rate. In tens of thousands of villages and slums across India, millions of microfinance customers are thriving and climbing steadily out of poverty — as shown by a number of independent studies. One in particular, by Karuna Krishnaswamy, suggests that borrowers from multiple microfinance organizations have an equal or lower arrears rate than single-borrowing peers in the same branches. The slum in Karnataka that the Journal article focused on is an aberration in the industry.
Microfinance borrowers go through a rigorous approval process. The process of approving microfinance loans is completely different from the lax system in the U.S. for approving the mortgages that led to the subprime crisis. Leading microfinance institutions like SKS follow a strict procedure to ensure loans can be comfortably repaid. We require potential members to take three hours of financial literacy training and pass a test indicating they understand interest rates, loan installments, and other product features. We also make small loans exclusively for income-generating activities, not for consumption. We lend only to women, who are known to be more careful with their use of loans than men, and who borrow in interdependent groups of five. Yes, some microfinance institutions — particularly new entrants — may violate these norms. But to extrapolate from the exceptions a sweeping generalization about the entire sector is at best unbalanced; at worst, irresponsible.
In lieu of credit scores, borrowers prove their reliability over time. The Journal article cites, as cause for concern, that the "average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27." But the piece failed to point out the underlying reason for this number surge: microfinance institutions deliberately start with small loan sizes and increase them year-on-year as a borrower demonstrates credit worthiness. This gradual increase in loans is a substitute for the lack of a credit score among the poor — something that this neglected and largely undocumented segment of the population does not have. It is a standard practice in the microfinance model pioneered by Nobel Prize winner Muhammad Yunus. Moreover, even at $135, microfinance institutions are still lending well below the typical credit need of a poor household in India, which is $400 (based on survey data from an independent study commissioned by the government's Small Industries Development Bank of India). These data suggest that, on average, there is no over-lending issue for the sector.
Microfinance isn't perfect, and like any fledgling, high-growth sector it's going to experience growing pains. But we're taking steps to ease those pains while upholding ethical and transparent lending practices. About 220 microfinance institutions that are members of the industry association Sa-Dhan have signed a voluntary code of conduct. The leading MFIs are also working to create a microfinance credit bureau that would help mitigate credit risk.
The sector's rapid growth has been fueled in part by commercial interests. But there's a lot of merit to the commercial approach. In a decade, SKS has reached millions of poor people at a pace unimaginable not long ago, and we're now pioneering other ways to use our extensive network to give people access to other products and services they need, such as water filters, solar lamps, and mobile phones. Such scale would have taken far longer if the industry were funded solely by more limited philanthropic funds and grants — and in the meantime, another generation would have slipped into the grinding cycle of poverty.
http://blogs.harvardbusiness.org/cs/

The biggest debate of Indian Microfinance Sector: Microfinance in India - In Stable Orbit

Original article published in Microfinance Insights
When the Wall Street Journal (WSJ) starts publishing poorly researched, sensationalized articles about Indian microfinance institutions (MFIs) and senior analysts from major investment banks begin to call Indian microfinance assets “sub-prime,” it is time to put things in perspective. In Hindi, there is a proverb, “Doodh ka jala chhach bhi phook phook kar peeta hai.” (“A person who has burnt his mouth drinking hot milk, tends to blow even at buttermilk,” or simply, “Once bitten, twice shy.”) Granted, the WSJ and investment banks have just emerged from an unprecedented financial meltdown. They are entitled to be cautious, even dark in their forecasts. In this case, however, they're jumping on the wrong bandwagon.
An August 13, 2009 WSJ article claimed that the growth rate of MFIs is abnormally high. However, when compared with other sectors in the Indian economy, microfinance is one of many industries that are growing at a searing pace. In a decade, the number of mobile phones has grown from zero to 400 million. The Indian mobile phone market continues to add more than 10 million new connections a month. The insurance sector has grown at 37% annually since doors were opened to private insurance companies. The microfinance sector's high rate of growth represents supply catching up with decades of unmet demand.
All big MFIs—the ones that are driving these strong growth rates—have mastered their methodology. Their systems in the areas of hiring and training staff, customer acquisition, portfolio tracking and fund mobilization are now managed by professionals with experience in the financial sector. Product diversification is becoming the norm, although most MFIs are still offering variants of the basic Grameen Bank weekly-repayment loan model. Most MFIs have started offering life insurance linked to loans while some also offer stand-alone life and health insurance products. These products protect borrowers, and in turn, MFIs.
Additionally, most big MFIs have now transformed into non-banking finance companies (NBFCs), registered with the Reserve Bank of India (RBI). They are subject to norms that include capital adequacy (10% at present, slated to go up to 12% in April 2010 and 15% in April 2011). As MFIs have had to raise capital from diverse sources, they now have boards quite involved with operational oversight— yet another check on MFIs and the sector at large.
Although some regions have seen mass default by a class of borrowers, such as the Kolar district in Karnataka, overall portfolio quality has remained strong, with only about 1% to 2% of loans overdue beyond 90 days. This number is now much more reliable, because almost all major MFIs have a computerized portfolio tracking system audited by reputed firms. The MFIs are also watched closely by banks since some of the MFIs’ portfolios are assigned to these banks.
What is partly true is that poor households are borrowing beyond their means because loans are easily available. This has been a cause for concern, mainly because most Indian MFIs (with some exceptions) use the Grameen Bank weekly repayment model. However, MFIs are learning quickly and, apart from changing internal policies and incentive structures for field staff, they’re also getting together to establish credit-information sharing forums.
Having said this, there are several actions stakeholders within the microfinance ecosystem need to take to move forward. It will take efforts by MFIs, investors, bankers, regulators and apex bodies, nationally and internationally to steer the sector in the right direction.
At the household level, there should be a push to build greater financial literacy, so customers know the consequences of overborrowing and the benefits of savings and insurance in adversity.
MFIs also need to review their staff incentive systems and attempt to prevent irresponsible lending.
The onus does not fall only on the MFIs. Lending banks also need to exercise discipline by insisting that MFIs incentivize staff to do responsible lending and follow consumer protection norms. Banks also need to strengthen their monitoring mechanisms.
As investors become more familiar with the sector, they are becoming more realistic in their return-on-investment(ROI) expectations. Investors on the boards of MFIs must play an institution-building role for their own long-term benefit.
On the regulatory front, the RBI has enhanced its supervision of larger microfinance NBFCs by seeking monthly returns from the “systemically important” ones and by conducting on-site inspections. The RBI needs to simultaneously enhance the protection of regulated microfinance NBFCs from arbitrary action by district and state government authorities.
Attention must also be focused on MFIs that have not yet transformed into NBFCs. The Micro Finance Bill drafted in 2007 covers only NGOs and needs to be redrafted. Loan waivers and interest subsidies tend to cause credit indiscipline and distort the market. Instead, the Indian government could offer support to MFIs working in the 300 districts with low financial inclusion.
To close where we began, CGAP and other organizations should educate the likes of the WSJ and the investment banks to stop sensationalizing small incidents and get on board with the one part of the financial sector that is working – microfinance in India.

The Biggest Debate on Indian Microfinance Sector: WSJ - A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum

By KETAKI GOKHALE
RAMANAGARAM, India -- A credit crisis is brewing in "microfinance," the business of making the tiniest loans in the world.
Microlending fights poverty by helping poor people finance small businesses -- snack stalls, fruit trees, milk-producing buffaloes -- in slums and other places where it's tough to get a normal loan. But what began as a social experiment to aid the world's poorest has also shown it can turn a profit.
That has attracted private-equity funds and other foreign investors, who've poured billions of dollars over the past few years into microfinance world-wide.
As WSJ's Ketaki Gokhale reports, India's booming micro-loan industry could be headed for trouble as more people seek the loans just to pay the bills -- not start businesses.
The result: Today in India, some poor neighborhoods are being "carpet-bombed" with loans, says Rajalaxmi Kamath, a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008, totaling $1.24 billion, according to Sa-Dhan, an industry association in New Delhi.
"We fear a bubble," says Jacques Grivel of the Luxembourg-based Finethic, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure to India. "Too much money is chasing too few good candidates."
Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more.
"I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts -- two for
At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams."
Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.
Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt overload is stirring up social tension. Many borrowers complain that the loans' effective interest rates -- which can vary from 24% to 39% annually -- fuel a cycle of indebtedness.
In July, town authorities asked India's central bank to either cap those rates or revoke lenders' licenses. "Otherwise, the present situation may lead to a law-and-order problem in the district," wrote K.G. Jagdeesh, deputy commissioner for the city of Ramanagaram, in a letter to the central bank.
Alpana Killawala, a spokeswoman for the Reserve Bank of India, said in an email that the central bank doesn't as a practice cap interest rates for microlenders but does press them not to charge "excessive" rates.
Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.
The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they're not about to comply with that.
The repayment revolt has spread to other communities, including the nearby city of Channapatna, and could reach further across India, observers say.
"We are very worried about this," says Vijayalakshmi Das of FWWB India, a company that connects microlenders with financing from mainstream banks. "Risk management is not a strong point for the majority" of local microfinance providers, she adds. "Microfinance needs to learn a lesson."
Nationwide, average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27 or so, according to a survey by Sa-Dhan, the industry association. These sums are obviously tiny by global standards. But in rural India, the poorest often subsist on just a few dollars a week.
Some observers blame a fundamental shift in the microfinance business for feeding the problem. Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.
This change opened the door to more private-equity money. Of the 54 private-equity deals (totaling $1.19 billion) in India's banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chennai-based private-equity research service.
The influx of private-equity cash is the latest sign of the global rise of microfinance, pioneered by Bangladeshi economist Muhammad Yunus decades ago. On Wednesday, Mr. Yunus, a 2006 Nobel Peace Prize winner, was one of 16 people honored by President Barack Obama with the Medal of Freedom.
"We've seen a major mission drift in microfinance, from being a social agency first," says Arnab Mukherji, a researcher at the Indian Institute of Management in Bangalore, to being "primarily a lending agency that wants to maximize its profit."
Making loans in poorest India sounds inherently risky. But investors argue that the rural developing world has remained largely insulated from the global economic slump.
International private-equity funds started taking notice of Indian microfinance in March 2007. That's when Sequoia Capital, a venture-capital firm in Silicon Valley, participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world's largest microlenders.
"SKS showed the industry how to tap private equity to scale up," said Arun Natarajan of Venture Intelligence.
Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, and SVB India Capital Partners, an affiliate of Silicon Valley Bank.
As of last December, there were over 100 microfinance-investment funds globally with total estimated assets under management of $6.5 billion, according to the Consultative Group to Assist the Poor, or CGAP, a research institute hosted at the World Bank.
Over the past year, investors have poured more than $1 billion into the largest microfinance funds managed by companies, a 30% increase. The extra financing will allow the industry to loan out 20% more this year than last, much of it to countries such as the Ukraine, Cambodia and Bosnia, CGAP says.
Here in Ramanagaram, Lalitha Sharma recalls when the first microfinance firm arrived seven years ago. Those were heady times for her fellow slum-dwellers: Money flowed freely. Field agents offered loans to people earning as little as $9 a month.
Lalitha Sharma, top, racked up 10 loans from the many microlenders who have set up shop in her slum over the past few years. Here she helps with her husband's snack stand. Like many of her neighbors in Ramanagaram, India, she can earn about $8 a week, on average, working in the city's silk factories, one of which is shown above.
They came to Ms. Sharma's door, too. She borrowed $126. Under the loan's terms, she said she would use it to finance a small business -- a snack stand she runs with her husband. Many microfinance providers require loans to be used to fund a business.
But Ms. Sharma, a 29-year-old mother of three, acknowledges she lied. "You have to mention a business to get a loan," she says. "There was no other way to get the money." She used it to pay overdue bills and to buy food for her family. Ms. Sharma earns $8 a week, on average, in a factory where she extracts silk thread from cocoons.
Over the next four years, she took nine more loans from three different lenders, in progressively larger sums of $209, $272, $335 and $390, according to lending records reviewed by The Wall Street Journal. A spokesman for BSS Microfinance Private Ltd. of Bangalore, another of her lenders, declined to comment on her borrowing history, citing central-bank privacy rules.
This year, she took another $314 loan to pay for her brother-in-law's wedding, again saying the money would be used for business purposes. She also juggled loans from two other microlenders -- $115, $167 and $251 from the Bangalore lender Ujjivan, and $230 from Asmitha Microfin Ltd.
Ujjivan confirmed it issued three loans. An Asmitha official said he had a record of a loan to a Ramanagaram resident named Lalitha, but at a different address.
"I understand that it is credit, that you have to pay interest, and your debt grows," Ms. Sharma says. "But sometimes the problems we have seem like they can only be solved by taking another loan. One problem solved, another created."
Many of the problems in Indian microlending might sound familiar to students of the U.S. mortgage crisis, which was worsened by so-called "no-documentation" loans and by commission-paid brokers. Similarly in India, microlenders' field officers are often paid on commission, giving them financial incentive to issue more loans, according to Ms. Kamath.
Lenders are aware that applicants often lie on their paperwork, says Ujjivan's founder, Samit Ghosh. In fact, he says, Ujjivan's field staffers often know the real story. But his organization maintained a policy of "relying on the information from the customer, rather than our own market intelligence."
He says that policy will now change because of the trouble in Ramanagaram. The lender will "learn from the situation, so it won't happen again," he says.
It's tough to monitor how borrowers spend their money. Ujjivan used to perform regular "loan utilization checks," but stopped because it was so costly. Now it only checks in with people borrowing more than $310, Mr. Ghosh says.
BSS checks how loans are being spent a week after disbursing the money, and makes random house visits, according to S. Panchakshari, its operations manager. The company doesn't have the power to insist that borrowers not take loans from multiple lenders, he said in an email.
Lenders also tend to set up shop where others have already paved the way, causing saturation. There is a "follow-the-herd mentality," says Mr. Ghosh at Ujjivan. Microlenders "often go into towns where they see one or two others operating. That leaves vast chunks of India underserved, "and then a huge concentration of microfinance in a few areas."
In Ramanagaram district, seven microfinance lenders serve 22,500 women (most microloans go to women because lenders consider them less likely to default than men). Loans outstanding here total $4.4 million, according to the Association of Karnataka Microfinance Institutions, a group of lenders.
Lenders in Ramanagaram say the loan-repayment revolt was instigated in part by Muslim clerics who oppose the empowerment of women through microfinance. Most lenders are still servicing loans to Hindu borrowers, but have stopped issuing fresh loans to Muslims. "We can't do business with Muslims there right now," says Mr. Ghosh. "Nobody wants to take that kind of risk."
The irony is that, for years, Indian microlenders have touted themselves as bankers to the nation's impoverished minority Muslim community, which has long been excluded from the formal banking sector.
A 2006 report commissioned by India's prime minister found that while Muslims represented 13% of India's population, they accounted for only 4.6% of total loans outstanding from public-sector banks.
Islam prohibits the paying of interest, but mosque officials don't cite that as the reason for the loan-payment strike. They stressed the overindebtedness of the community, and the strains it's putting on family life.
Ramanagaram's period of wild borrowing irks some residents, both Hindu and Muslim. Alamelamma, a 28-year-old vegetable seller, says that she has benefited from microfinancing and that the profligate borrowers "have ruined it for the rest of us."
One gully away, Ms. Sharma, the heavy debtor, has a different view: She would like to see the microlenders kicked out of the community entirely. "Not just for now, but forever," she says.
http://online.wsj.com/article/SB125012112518027581.html