Sunday, November 29, 2009

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.


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