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Under the Microscope: Microfinance's Latest Growing Pains
Published February 23, 2011 in Arabic Knowledge@Wharton
The most recent crisis to hit microfinance began in India's southern state of Andhra Pradesh, where allegations of widespread over-indebtedness, heavy-handed collection tactics and borrower suicides have stirred a national debate about regulating the industry.
In October, the state government slapped restrictions on microfinance institutions that crippled lending and sent collection rates plummeting along with the share price of SKS Microfinance, India's largest for-profit microlender. On January 19, the Malegam Committee Report, released by the Reserve Bank of India, recommended a range of new regulations for India's microfinance institutions, including interest rate caps, loan limits and income ceilings for borrowers. Some observers welcomed the news; doomsayers predicted a credit crunch and industry collapse.
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While it is too early to tell how the sector will respond, the crisis in Andhra Pradesh has sparked heated debate and soul-searching throughout the world's microfinance community. During a recent program for microfinance leaders at Wharton's Aresty Institute of Executive Education, discussion turned repeatedly to questions of over-indebtedness, rapid industry growth, and the fine line between profits and purpose. The microfinance sector has experienced "a rude awakening" by "a delinquency earthquake," said one of the program's 26 international participants, Kamran Azim, during a general discussion about the growth and sustainability of the microfinance industry. Azim, head of operations at the Kashf Foundation, a microfinance organization established in 1996 in Lahore, Pakistan, pointed out that methods and methodologies in microfinance have changed little in the past 20 or 30 years. Now suddenly, the earth has moved. Sponsored by the Women's World Banking Center for Microfinance Leadership, the Advanced Leadership Program at Wharton brought together microfinance leaders for a week of intensive study, brainstorming and networking to help prepare them for the challenges facing microfinance today. The goal of this year's cohort: to find innovative ways to confront the global economic crisis, new competition, increased regulation and relentless pressure to perform. "During times of accelerated change, there is a tendency to rely on known ways of doing business," reads the introduction to one of the program's courses. "Yet it is at just these times that innovation is of heightened importance." At the same time, as several participants noted, the industry must find new ways to sustain growth without losing sight of clients' needs. For some microfinance institutions, that could require a crash course in business fundamentals such as due diligence, sustainable growth and customer care. The Effects of Over-lending The modern microfinance movement began in Bangladesh in 1977, as an experiment by economics professor Muhammad Yunus, who gave out small, no-collateral loans to groups of borrowers too poor to get credit from traditional banks. Over the next three decades, the model he established became widely accepted and replicated in other countries as a way to fight poverty. Microfinance spread around the world and earned Yunus a Nobel Prize in 2006. But over the past few years, increasing competition among lenders and a weak global economy have strained borrowers and microfinance institutions alike. As an increasing number of banks and for-profit
All materials copyright of the Wharton School of the University of Pennsylvania. Page 1 of 4
The country has a good information exchange about clients." Outside the classroom. the problem of over-indebtedness has been attributed to a lack of information: Without a system of credit bureaus or official identification cards for the poor. director of Wharton's Societal Wealth Program. Since the earthquake in January 2010. Started with a staff of just 19 in 2005. When given the choice. But that was not the case in Tajikistan. executive vice president of New York-based Women's World Banking. a micro-lending fund in Dushanbe. We can probably learn what happened there. Page 2 of 4 . "You take one of these two poles out of the equation and things go wrong." Murray said. taking -. "Microfinance. "These cases in Tajikistan happened so often [that we said] to all our creditors. during a class session on customer-centric innovation. and more than 10." Vaisova said. so microfinance companies were able to see that borrowers were already in debt. "They can see that this client has two. 'Please don't push us because we cannot push people to kill themselves. and has developed a catastrophe micro-insurance program." Over-indebtedness in Andhra Pradesh today has become "a fast-growing negative energizer which is really threatening the entire industry. Haiti. They are just taking.Under the Microscope: Microfinance's Latest Growing Pains: Arabic Knowledge@Wharton ( http://knowledge.cfm?articleid=2623) companies entered the market and contributions from investors increased. a grass-roots microfinance organization based in Port-au-Prince.. taking. lenders could not determine a borrower's credit history or the presence of existing loans from other lenders. social impact.and then they cannot repay.upenn. After hurricanes affected the lives of one-third of its clients in 2008." All materials copyright of the Wharton School of the University of Pennsylvania.'" In some countries.." said Thompson.wharton.. where she works as general director for Humo and Partners.. 10. People were killing themselves because they could not repay five or six loans. and Bosnia witnessed over-indebtedness after war recovery efforts spawned a large number of MFIs chasing too few customers. Microfinance "works in an ecosystem. "Last year. three outstanding debts with other organizations. so they provide another loan. executive director of Fonkoze. according to Vaisova. Morocco's microfinance sector experienced a wave of defaults that led to the demise of one of the biggest MFIs. Haiti's largest microfinance institution. "We are in a tension field between sustainability and ." said participant Carine Roenen.. during the crisis situation. Thompson..000 new loans to clients. some markets became over-saturated and borrowers over-extended. He also advised microfinance institutions to focus on the customer -. The public knows and expects from us that we provide social value." Fonkoze. "And now Andhra Pradesh comes with a story where it is bad. the root causes were complex: poor competitive practices -. One of the single greatest challenges in beginning to think like this is [putting] the customer at the center. Fonkoze helped struggling borrowers by rescheduling existing loans." Program participant Mavsuda Vaisova saw the negative results of overlending in Tajikistan. In each case. is used to operating under such tension. Microfinance institutions are now seeking ways to continue growing with less risk. the microlending organization now has 11 branches. Still.000 clients and an active portfolio of US$5.as well as relaxation of due diligence as MFIs sought to grow rapidly. risk is created. The last three years have witnessed a wave of events stemming from over-lending. But we need to communicate about that much more than we do.. said program participant Inez Murray. "When it becomes too successful and money is involved. versus the natural reversion to talking about us and what we do."to reflect thoroughly about customer needs along every step of the consumption chain. One course participant agreed. was branded as something that was good for the people. they would like to have more outreach. 260 employees. but is actually quite difficult. we saw what happened. microfinance institutions (MFIs) have also struggled to understand their customers' needs. cherry picking each other's clients -.edu/arabic/article. especially after Yunus received his [Nobel] prize. most borrowers gladly take advantage of the extra credit. adding that building a mental map of how an organization operates from the customer's standpoint appears simple at first. noting that during a group exercise "several times [we] took the position of the institution and not that of the client.for example. and macroeconomic shocks.. it has distributed thousands of cash grants." said James D.5 million. "People cannot correctly evaluate their loan needs." Roenen noted." she said. Among them: Nicaragua's microfinance industry suffered a crisis in 2008 when a "No Pago" (No Pay) movement led to widespread defaults and violent protests. manipulation of clients by local political forces.
" said participant Rafael Llosa." microfinance institutions such as Ujjivan must maintain a minimum capital adequacy ratio but cannot take deposits." said Marie Louise Nsabiyumva. all this fight [means it can be] very easy to lose the mission. that focuses on micro and small businesses.12% repayment rate from its more than 975. "I think the sector right now is at risk because everybody is trying to take what happened in one part [of All materials copyright of the Wharton School of the University of Pennsylvania." Oversimplifying the challenges in Andhra Pradesh and painting the entire microfinance industry with the same broad brush will not help find creative solutions going forward.85 rupees on September 15. Page 3 of 4 . "You have to charge interest to cover all expenses. noted participant Vikram Jetley. Andhra Pradesh was awash in micro-investment: the state holds about one-third of India's microloans and hosts some of India's largest for-profit microlenders. "We have two different kinds of investors. "Otherwise.M. of different competitors. profits are essential if the microfinance institution wants to carry out its mission of poverty alleviation. taking -.and then they cannot repay. CEO of Burundi-based savings and credit cooperative C. It is not cascading to other states. and vice chair of the Burundian Microfinance Network. in part because of India's banking laws.upenn. bigger competitors than us. Regulated by the Reserve Bank of India as "Non-Banking Financial Companies. "The Andhra Pradesh crisis happened because the government has been going there and promising a 3% rate of interest while my rate of interest even on our debt funding is 12%. we are not sustainable." Building Coalitions But how much profit? In Andhra Pradesh." And yet. And that isn't useful for the client. author of "State of the Sector Microfinance India 2010. Srinivasan found that one-third of loans distributed in Andhra Pradesh were given out by microfinance institutions." Established in 2005.wharton." Added Llosa: "If we are not profitable." Before the crisis.E. the microfinance institution in Port-au-Prince. too.) According to Narasimhan Srinivasan. you start [focusing] on other things. "As a part of our mission. including SKS Microfinance. It currently boasts a 99. participants said. Haiti. CFO of Fonkoze. For that reason.Under the Microscope: Microfinance's Latest Growing Pains: Arabic Knowledge@Wharton ( http://knowledge. chief operating officer for Bangalore-based microfinance company Ujjivan's north region.edu/arabic/article.C. we have clearly defined that our return on equity would be at best 15%. Peru. "Because you are fighting to be the leader in the market and you are fighting to survive. said participant Georgette Jean-Louis. it's not an error to have profits." the number of microloans in Andhra Pradesh now amounts to almost 10 times the number of poor households in the state. it's one state's problem. According to the company's website. Ujjivan uses the Grameen model of lending to groups of women borrowers and focuses on urban microfinance. increasing pressure on microfinance institutions to hold market share. But Srinivasan also reports that not all loans came from microfinance institutions. (SKS shares have since lost more than half their value after peaking at 1404. while two-thirds were given to borrowers in the SHG program. state government officials in October cited microlenders' quest for "hyper profits" as reason to clamp down on the industry. a government poverty alleviation program funded in part by the World Bank that offers microloans at below-market rates. So someone who is looking for a really aggressive return on equity would never come with us. general manager of Mibanco. "How can you survive? This is not an India problem.000 customers in 20 states. have begun to woo the micro-borrower in many countries. a private bank in Lima. which raised US$358 million in an initial public offering in August 2010. Otherwise we will never be able to scale up." Traditional banks. Borrowers in Andhra Pradesh can also get credit from the Self Help Group (SHG) program. you would disappear.cfm?articleid=2623) taking. "So we have to go to the capital markets. Ujjivan has completed four rounds of capital infusions and plans to offer an IPO after three years of profitable operations. Many microfinance companies in India seek investor capital. according to Jetley. "In this context of new competitors." he noted: pure social investors and private equity investors." said Jetley.
"We believe there's a tremendous future for microfinance . but this needs to be done in a way that enables growth.Under the Microscope: Microfinance's Latest Growing Pains: Arabic Knowledge@Wharton ( http://knowledge.. For multiple copies." The industry is focusing heavily on finding ways to measure social impact. this will only work up to a point. for example." This is a single/personal use copy of Arabic Knowledge@Wharton. The key is not to throw the baby out with the bath water.com P.for both borrowers and lenders -. custom reprints. (212) 221-9595 x407. Organizations are also pushing product diversification: After years of extending credit.wharton. Women's World Banking found that women borrowers tended to set aside 40% of their incomes for health emergencies. But at the same time. e-prints. and solutions must account for the differences and involve everyone. "It's pretty easy to argue that spending 20% on an insurance premium and the other 20% on investing in business to get out of poverty" could be a better option long-term. Microfinance has to play its role." Every country is different. she added.cfm?articleid=2623) "I think the sector right now is at risk because everybody is trying to take what happened in one part [of the world] and say it is the same thing that is happening in Peru." Murray added. In a study in Morocco. The investors have to play a role." Problems in Andhra Pradesh and other hotspots are "essentially a lot of growing pains. said Women's World Banking's Murray.edu/arabic/article.is what microfinance institutions say they want." Jean-Louis stated.. Government has to play its role... would give poor households a safe place to store emergency funds. It must also engage in self-regulation. there is a problem [with] what happened in India." The recent developments in Andhra Pradesh and other hotspots have brought industry leaders together to explore ways to limit the potential for overlending in the future. in order to prevent it from happening in every part of the world.. All materials copyright of the Wharton School of the University of Pennsylvania. "We're absolutely optimistic that the microfinance sector is here to stay. And then we can find a solution. Murray pointed out. posters or plaques. and setting industry standards by which microfinance institutions can self-regulate. However. "There are lots of stakeholders. Insurance products would help them manage risk. if you focus on having an impact at the client level and the household level. Savings accounts. creating services that will enable poor people to make better choices for how to use their money. "Yes. please contact PARS International: reprints@parsintl. in Haiti. You have to look at the environment. we have to study it. she said. "The sector has to do this and build coalitions. in Taijikistan or in some part of Africa. you have to look at the context.upenn. And growth -. Legal regulation will likely be required. We have to learn from it. You have to look at what happened and study it instead of globalizing [it and treating it as] the same monster that is happening to you. Page 4 of 4 . many microfinance institutions argue that other types of financial services could have an even greater impact than loans.
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