Business Today

Poverty's new saviour

Microfinance in India  has grown fast. But has it also grown right?

Raijiv Rao        Print Edition: December 14, 2008

David Gibbons, Chairman, Cashpor
David Gibbons
Poverty has become big business in India. So much so that a slew of storied venture capital outfits and wealthy techies—such as Sequoia Capital, eBay Founder Pierre Omidyar and Michael Dell—who are more at home analysing enterprise software or semiconductor makers’ business models, have now decided to park some of their capital with some of India’s poorest people using microfinance institutions as intermediaries. These investors—and their MFI outfits— hope that handing out small loans that average 5,000 rupees at a 28 per cent interest rate to India’s impoverished, will not just help their for-profit microfinance portfolio companies such as SKS turn a tidy profit, but will also help reduce poverty in the country.

Billions of dollars have poured into poverty alleviation in India over the past decades—but with little effect. State sponsored initiatives in delivering social inputs like health care and education have proven to be profoundly inefficient. Today, literacy levels and health conditions in rural India are appalling. Infant mortality rates are high and malnutrition is rife. Consequently, average incomes in rural India have lagged severely behind urban ones during India’s last seven years of galloping growth, adding to increasing inequity between both segments of the population.

Jayshree Vyas, MD, SEWA Bank
Jayshree Vyas
Microfinance institutions say they want to fix this problem and are in a heated race to scarf up poor clients. Industry veterans, like David Gibbons, Chariman of MFI Cashpor and Nancy Barry, ex-Head of Women’s World Banking, are aghast at the nature of their activities. Microfinance institutions come in all sorts of shapes and sizes, but the main ones plying their trade in rural India are Self-Help Groups (SHGs) and for-profit MFIs. SHGs—numbering 3.4 million and servicing 45 million poor—are groups of up to 20 women who borrow directly from banks at a 12 per cent rate and then lend the money internally to members with additional percentage points tacked on. Interest income earned on each loan goes into a savings pool. In about five years, each individual from the group has a nice little nest egg of around Rs 25,000 to spend as they like. Forprofit MFIs like SKS and Spandana—only 25 of which serve 14 million people, but are the fastest growing outfits today in microfinance—have a different approach. They loan out money using the Grameen model, within groups of five women or so—but the loans are to individuals. The group exists as a collective guarantee for the loan and if someone defaults, the rest of the members have to come up with the cash.

A staggering 800 million of India’s poor are starved of formal credit and MFIs can be a godsend to their poor clients who use this cash injection to try and transform themselves into successful minientrepreneurs by rearing buffalos or selling vegetables and thereby improving the hold of a fellow, put Rs 5,000 in his pocket and moved on,” wonders Srinivasan.

It makes sense that reasonably priced credit can be a lifesaver for the desperately poor, especially women. With the purchase of an inexpensive buffalo, a poor mother can generate a little more cash income and send her children to school. However, is everyone borrowing for entrepreneurial purposes? “An increase in lending to people to pump numbers up has resulted in many borrowing to pay for marriages,”says Jayshree Vyas, Managing Director of SEWA, an organisation of poor, self-employed women workers in Gujarat. Pigeonholing the poor as wise, frugal spenders, who are impervious to consumerism is naive. “I’ve even seen people spending huge amounts on DJ parties in remote villages,” says Vyas. Also, many industry observers point out that often a poor person takes out one loan to pay for another, and, in effect climbs on to a “debt treadmill”. In fact, double counting clients is a widespread if under-reported phenomena amongst MFIs.

AY Caramba
Mexico’s MFIs have made a killing off its poor, using shady tactics, say many. India should learn from this experience.

Mexican microcredit institutions seem to be experts at profiting off the poor and have raised the hackles of industry veterans, like Grameen Founder Muhammad Yunus. Yunus feels that a bank like Compartamos is a blot on the industry and likens them to a loan shark thinly disguised as a microfinance firm. Compartamos, which has around a million clients and ironically apes the Grameen model of fund disbursement, made a shocking $80 million (Rs 400 crore) in profits last year. Moreover, when the bank sold 30 per cent of its shares in an IPO in 2007, it raked in a cool $458 million (Rs 2,290 crore), $150 million (Rs 750 crore) of which went into investors and senior management’s pockets.

In Mexico, rates that banks like Compartamos and Azteca charge are unusually high—upwards of 100 per cent compared to 28 per cent in India. These banks say that the costs of giving out loans is steep hence the pricy rates, but Indian MFIs in the business of servicing hard-to-reach rural clients levy a much lower fee. Perhaps the lack of competition enables Mexican banks to jack up the interest. There might be other countryspecific cultural or economic explanations. Still, the fact is that a hefty 24 per cent chunk of Compartamos’s interest income from lending activities went directly towards its profit numbers according to CGAP, a microfinance think tank at the World Bank versus a 7 per cent average for most Indian MFIs.

Here’s how Mexican banks supposedly make their money: Loan reps are promised 120 per cent of their salary based on loan growth, so there is a mad rush to sign people up regardless of need. Some sneakily tack on life insurance policies into a group’s weekly payments—commissions are handed out for doing this. Expensive consumer electronics are widely flogged where low weekly payments are emphasised in ads but the very high financing rate isn’t mentioned. Soon, some poor “clients” are so far behind in their ability to pay that they are forced to go back to a loan shark in order to pay the first loan off. While India is still eons behind Mexico in these kinds of shenanigans, the absence of any kind of regulatory framework or consumer watchdog group that can safeguard the poor doesn’t bode well for the future of Indian microfinance.

Rajiv Rao

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