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Intellecap Micro Finance White Paper (Oct 2010)

Intellecap Micro Finance White Paper (Oct 2010)

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Published by Fountainhead
Oct-2010 Whitepaper by Intellecap on Microfinance
Oct-2010 Whitepaper by Intellecap on Microfinance

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Published by: Fountainhead on Nov 02, 2010
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Indian Microfinance Crisis of 2010: Turf War or a Battle of Intentions?
An Intellecap White Paper
Indian Microfinance Crisis of 2010: Turf War or a Battle of Intentions?
An Intellecap White Paper
October 2010
Setting the Context – The Family Squabble
Microfinance in India originated in government programs thatprecede the Grameen model
, with a very distinct difference.While the Grameen model was being conceptualized inBangladesh, the National Bank for Agriculture and RuralDevelopment (NABARD) in India, and Aloysius Fernandez,the conceiver of Self Help Group (SHG) initiatives, werescripting another low-cost and effective technique of providing banking access to the poor, through a programnow widely known as the SHG-Bank Linkage Program
.The SHG programs allow people (mostly women) to formgroups of 11-20 members, develop savings and creditdiscipline and be formally linked to a bank for opening a bankaccount and accessing loans.
The hope behind the SHGprogram was to build a credit history for the individualsthrough the group process of on-lending, so that over timeeach individual would have her own bank account andaccess to financial services thereby contributing to the visionof total financial inclusion. In the long term, the benefits tothe borrower, and cheaper cost of capital allow SHGprograms to outscore all other models in the field of microfinance, with a single but critical flaw:There are no clear margins built into the program to takecare of the cost of building, managing, and scaling theprogram, except through grants, subsidies and other provisions made by government. The SHG model, despitebeing a brilliant tool for financial inclusion and receiving thebacking of the central government, NABARD, and PublicSector Banks, has not entirely succeeded in retainingborrowers and providing universal financial inclusion.The Indian government programs, despite being well-intentioned, had neither the discipline needed for long-termsustainability nor a business model that could be scaled upeffectively. The more recent model adopted by Indianmicrofinance is that of the Joint Liability Group (JLG),adapted from the Grameen model. It has been widelyembraced by Indian development professionals, and over time has become the major alternative to the SHG model.The JLG is not linked with a bank but is intermediated by theloan officer of a MFI who is responsible for formation andmanagement of the group. Unlike the SHG model whereinthe loan is given to the group and the bank does not trackindividuals’ credit history, in the Grameen-inspired JLGmodel the loan is given to the individual (usually by the MFI),backed by the group guarantee; and an individual credithistory is created, even though it may be skewed by thegroup guarantee scheme.If we may be permitted a whimsical moment, the Indianmicrofinance story offers an irresistible parallel to a familiar Bollywood plot: in the Indian microfinance potboiler, the SHGmodel is the elder brother in an Indian joint family while theMFIs play the part of an aggressive younger brother. Theelder brother struggles to uphold tradition and retain hisleadership position, while the maverick younger brother triesto break free (using new financial and technology tools),
Social businesses like microfinance, due to their sensitive client base, need to walk a fine line to balance their commercial interests with the social and moral expectations of a wide variety of stakeholders. The range of stakeholders may include the State, investors, and the public at large, besides clients and regulators. Indianmicrofinance institutions (MFIs) have done an admirable job of managing the commercial side of their business; yet they have often struggled to manage the inherent contradictions of running such businesses atscale while satisfying non-commercial stakeholders, and have often run afoul of the media and thegovernment. Recent allegations against MFIs by the media and the State include coercive practices, lack of transparency, and “usurious” interest rates. These accusations have resulted in the passage of an Ordinanceby the State Government of Andhra Pradesh (AP). This white paper by Intellecap, an India-based socialbusiness advisory firm, analyzes the buildup to the crisis in AP, attempts to revisit some fundamentals of thebusiness, and questions the effectiveness of 
approaches to multiple bottom-line business by the Stateand the media.
Indian Microfinance Crisis of 2010: Turf War or a Battle of Intentions?
An Intellecap White Paper
often overenthusiastically, and sometimes recklessly, inpursuit of the same goals.This script bears many similarities to a classic Bollywoodfamily drama. Unfortunately, the conflict between the twobrothers often leaves the family destitute. As the APmicrofinance drama plays out in the national media and theworld watches, it is mainly the poor, forced into choices notof their making, who will suffer.
 Andhra Pradesh: The Mother Land of IndianMicrofinance
The state of Andhra Pradesh (AP) has a unique leadershipposition within Indian microfinance. The state governmenthas not only made significant investments in subsidizingfinancial inclusion through SHG programs, but has, at leasttill now, also allowed the Grameen/JLG model to flourish. Itis thus not surprising that the four largest MFIs in India arebased in AP, alongside numerous other mid-sized MFIs.The MFIs and the government-led SHG program have co-existed for many years. However, the first signs of conflictbecame visible in the period from 2005-7 when, buoyed bycapital from a partnership model launched initially by ICICIBank
, MFIs started to finance customers more aggressivelythan before. A large number of these customers weremembers of existing SHGs, and the first sign of tensionappeared during what is now referred to as the “KrishnaCrisis.”
Customer-centric, but …!
The Krishna Crisis demonstrated the potential for conflictbetween a well-intentioned but self-righteous stategovernment, and ambitious commercial entities, as co-starsin the development sphere. The State believed that it wasserving its poor by providing them low-cost loans in anorganized manner. Yet they saw that the more organizedcommercial microfinance lenders, despite charging higher interest rates, were able to attract clients and achieve abetter repayment rate.In this view, over time the State began to believe that theMFIs must be following coercive business practices toachieve such success. The State believed that it had abetter product and lower costs, and refused to see anylogical or business reason why poor people still borrowedfrom MFIs.In 2006, the conflict between the State and the MFIs reacheda fever pitch, and district authorities closed down dozens of branches of two major MFIs, after allegations of usuriousinterest rates and coercive loan collection
 The Krishna Crisis was resolved largely throughcompromises made by the MFIs in Krishna district.However, the resolution may in fact have sowed the seeds of a larger conflict that has shades of a turf war.
The Scale Phenomenon: Private Equity,Professionalization and Commercialization
 Between 2005 and 2007, while some regions experiencedmoments of crisis, the larger Indian microfinance sector wasseeing a period of commercial renaissance. Private equityentered microfinance in a big way. Large equity infusions inMFIs such as SKS, Share, and Spandana provided them thecapital to scale up, and fueled their ambitions to movebeyond state boundaries. The period also saw theemergence of new talent, local and global, trained and willingto try fresh approaches, new technology and innovativefinancial transactions.Commercial MFIs started to compete with each other andsoon out-paced government-backed programs in terms of reach. Along with commercialization came stiffer competitionfor client ownership between the state and private players.With many of the largest, fastest-growing, commercial MFIsbased in AP, it might have been possible to predict thebeginning of a potentially wider conflict.
Making of the Crisis: Text and Sub-Text
The AP Microfinance Ordinance
was promulgated onOctober 15, 2010 by the Andhra Pradesh Government. Theordinance was built on the basis of four premises:a)
MFIs charge usurious interest rates;b)
If clients fail to pay on time, MFIs use coercive methodsto collect the interest;c)
These practices are forcing the poor to commit suicide;d)
MFIs make huge profits and have no social mission tohelp the poor.Through its allegations, in the extraordinarily-phrasedPreamble, the Ordinance strongly suggests governmentdissatisfaction with, and even broad antipathy towards, theentire MFI industry. However, these premises may not tellthe whole story. With the fullest respect, it is possible to readinto these allegations signs of a state government unhappythat its programs (and perhaps the individual influences of some members of government) are being undercut by theMFIs.The Andhra Pradesh government believes that the loans itprovides to SHGs serves the needs of the poor adequately;
Indian Microfinance Crisis of 2010: Turf War or a Battle of Intentions?
An Intellecap White Paper
indeed, it has a mandate to disburse INR100,000 Crores(US$ 22.2b) bank loans to SHG women members by 2014 tobring 10 million families out of poverty
. And yet, the growthand reach of MFIs seems unstoppable. The MFIs’combination of door-step service, easy credit, frequent small-value repayments and the group guarantee is attractingborrowers – who are no longer so naïve that they cannotweigh the attractions of these factors against the lower ratesof government programs. Is it presuming too much, toconclude that the government feels the need to save theseborrowers for themselves?We do believe the government has the best of intentions.But in promulgating this Ordinance, it has challenged thefundamental right of an individual to make choices – andperhaps even the rights of law-abiding MFIs to runbusinesses.
 Andhra Pradesh MFI (Regulation of MoneyLending) Ordinance
 The ordinance issued by the Government of AP is ostensiblyintended “to protect the women Self Help Groups”, who, thepreamble states, “are being exploited by private microfinanceinstitutions through usurious interest rates and coercivemeans resulting in their impoverishment and in some casesleading to suicides.” The Ordinance makes it mandatory for all private institutions engaged in micro-lending to register with the district Registering Authority, the Project Director (PD) of District Rural Development Agency (DRDA) for ruralareas, and the PD of MEMPA for urban areas by November 15, 2010 (one month from the issuance of the ordinance).MFIs have to specify their areas of operations, the rate of interest, and their system of operation and recovery. Further,they cannot seek security from a borrower by way of pawn or any other means. The Registering Authority may, at anytime, either 
suo moto
or upon receipt of complaints by SHGsor the general public, cancel the registration after assigningsufficient reasons. All repayment collections will take place atthe
Offices.The microfinance sector responded by submitting petitions tothe state High Court (one of which resulted in an interimgrant of relief on October 22)
, and is also in ongoingdiscussions with the Central Government.
 Analyzing the Ordinance
The Ordinance explicitly states that its objectives to rein inMFIs that are exploiting SHGs. The preamble of theOrdinance appears to presume guilt on the part of the MFIsuntil proven innocent.
No MFIs, operating at the commencement of thisOrdinance or intending to start the business of lendingmoney to SHGs, after the commencement of this Ordinance,shall grant any loans or recover any loans without obtainingregistration under this Ordinance from the Registering Authority.
This administrative step gives the state powersto severely restrict microfinance operations. While a time limithas been set for MFI registration, the state has no obligationto complete the registration within a given time frame
All MFIs operating in the State of AndhraPradesh as on the of MFIs date of the commencement of thisOrdinance, shall within thirty days from the date of commencement of this Ordinance, apply for Registrationbefore the Registering Authority of the district specifyingtherein the villages or towns in which they have beenoperating or propose to operate, the rate of interest beingcharged or proposed to be charged, system of conductingdue diligence and system of effecting recovery and list of persons authorized for conducting the activity of lending or recovery of money which has been lent.
: Procedures have been drafted and have nowbeen published; there is a view that they are somewhatonerous however High Court judgment on October 22permits MFIs to continue operating on an interim basis.
'Registering Authority' means the Project Director District Rural Development Agency for the rural areas andProject Director MEPMA for urban areas; or any other personappointed by the District Collector to perform the functions of a registering authority under this Ordinance for such District.
The Customer is king, but only nominally. TheOrdinance requires that MFIs must, in effect, register with thegovernment at district level, which is the same level of government which administers the government’s SERP andMEPMA programs. Is it only conspiracy theorists who mightconclude that this appears to protect the interest of SERPmore than it seems to be interested in protecting the poor?Also in the Ordinance NBFCs are defined as those formedunder Section 58A of the RBI Act which also is not the casewith most MFIs.
All loans in respect of which an MFI has realizedfrom the borrower, whether before or after commencement of this Ordinance, an amount equal to twice the amount of theprincipal, shall stand discharged and the borrower shall beentitled to obtain refund and the MFI shall be bound to refundthe excess amount paid by the borrower.
: Provision 9(2) includes stipulations that areretroactive in nature. This is likely to cause concern beyondthe microfinance sector, as it suggests to investors that

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