This Will Make You Understand Why Microfinance Is Not Lifting People Out Of Poverty (3/5)

MICROFINANCE, A LOVE STORY PART 3: THE FIRST FIGHT

In part 2 of the third article of the ‘Developing India: from the Bottom-Up’ series, we showed that Muhammad Yunus, the modern founder of microfinance, came up with quite a few ways to efficiently lend to the poor by mitigating the problems of traditional banks while also eliminating high-interest rates money lenders charged. Group lending was an innovative way of lending to individual entrepreneurs. However, microfinance became very infamous around 2010 and we will see why in this instalment.

Fruit seller in the market of Salaiya, a block in the Indian state Jharkhand. He buys his fruit on the daily market indirectly from farmers (source: own source).

Growth in the microfinance sector

Muhammad Yunus’ idea saw successful implementation on such a scale that seven years after his initial lending project in 1976, his endeavours were fully translated into the setup of the Grameen bank (meaning the Village Bank) — a real bank which focuses on lending to the poor. It was the very first Microfinance Institute (MFI) of its kind and originated in Bangladesh. He won the Nobel Peace Prize in 2006 for it.

Many similar initiatives followed in the same region and spread globally. For example, India now has more than 50 institutes that cover among themselves, about 90% of the microloan sector in the subcontinent.

Due to its promise and potential for lifting people out of poverty by means of loans, the microfinance concept, and thus MFIs, became very popular garnering global support. My very own Dutch Queen Maxima herself has been actively promoting it as a Special Advocate for Inclusive Finance for Development at the United Nations.

Igniting the Fire

In 2010 however, events that occurred in Andhra Pradesh, a large state in India sparked large debates on the role of MFIs. The practice of coercive money collection and confiscation of personal possessions from the MFI’s defaulting clients became the news du jour. One of the MFIs SKS Microfinance were also linked to villagers committing suicide.

On top of everything that transpired, Compartamos (a Mexican MFI), and SKS Microfinance (the Indian MFI) had their Initial Public Offerings (IPO). An IPO happens when a company goes public for the first time and sells shares of the company to the public to raise money. An IPO is an indication of high profitability.

The timing of this could not have been worse. Given the debt suicides in India, the IPO thus inadvertently signalled their wealth and high profitability, fuelling the already raging fire.

Fuelling the Fire

As if that wasn’t enough, our microfinance hero Muhammad Yunus added to the controversy by further venting his frustration in the New York Times among others, by calling the IPO outrageous, and blaming all other MFIs who turned their status from that of a Not-For-Profit to a For-Profit business entity where profit and growth mattered immensely.

The fact that these more commercial MFIs needed to raise money from risky international financial markets instead of using wholesale funds (as Mr.Yunus did with Grameen Bank), transferred more risk to the poor thus resulting in higher interests rates.

Spreading the raging Fire

Emotional reactions from Indian politicians on the suicides and negative vibes resulted in implementing panic regulations that almost killed the whole sector. One such regulation was to cap the interest rates — an MFI can only charge between 24–30% these days — meaning that MFIs unable to meet this would soon be out of business.

Way more pressing was the fact that a lot of people also stopped paying back their loans once the Indian government initiated a regulation where district authorities could decide to cancel the outstanding loan at once. MFIs incurred massive constraints in cash flow and capital losses since a lot of people used this regulation to “fly away with the money”. The negative vibe spread across the world and at some point, almost everyone, practitioner or not, was a critic of microcredit.

During these turbulent times, microfinance’s popularity rocketed thanks to the emphasis on the tragic suicide cases in Andhra Pradesh. SKS was so focused on growth that the loan officers barely bothered with due diligence and establishing a relationship with the borrower.

Instead of using the group-lending models, loan officers increasingly used more and more individual pressure techniques. They felt the need for this because of the arrested repayments and defaults owing to bad background checks. While this was tragic, it does not wholly write off microfinance in itself as a bad idea.

An overstated promise

The same time, an influential study conducted with a large Indian MFI, Spandana, concluded that microfinance, while a useful tool, is not that effective (yet) in eradicating poverty.

More striking than the negative connotation of the suicide tragedies was that the microfinance practitioners feared that microfinance was perceived as “just another tool” in the fight against poverty, and not the magic bullet that could miraculously transform the poor’s lives.

Upcoming: Part 4 — Really getting to know each other

Microfinance became a very popular concept to eradicate poverty once and for all until it hit some rocky shores. On top of that, initial research showed that microfinance is probably not THE solution for lifting people out of poverty. To look at this claim better, Part 4 focuses on recent research performed at the ground level.

Many thanks to Ramyaa Bommareddy, Shahzeb Yamin, Supriya Krishnan,and Sabine Kleve for their valuable input and patience in developing this series on microfinance.