Microfinance Faces A Remade Future
New regulation challenges old norms in micro-lending.
Microfinance – or small-scale loans – has rapidly grown into an international business that connects investors with impoverished borrowers around the world. Currently, microfinance institutions (MFIs) operate in over 100 countries and fund more than 92 million borrowers, according to the Microfinance Information Exchange. For-profit firms like Stamford-based Developing World Markets (DWM) invest in MFIs in India, which in turn provide loans to poor entrepreneurs, primarily women.
The end of a dusty public road in Chennai is a weekly gathering place for 27 women, all neighbors and members of a microfinance-borrowing group at SMILE, an MFI funded by DWM. The meeting begins with a pledge to guarantee each other’s loans and a song about women’s financial empowerment.
The businesses are home-based. One woman makes vadai– a savory donut delicacy. Another sells pickles. Kumari is among the top earners in this group. She owns 25 bicycles, lined up under an open shed in front of her house, and rents them out for 10 cents an hour to kids in the neighborhood. Kumari says she earns as much as $55 a week. Her husband, a movie stuntman, gets called once a month for a three-day job, which pays about $80.
“This cycle shop provides for our daily food. And when my husband was injured doing stunts in a movie shoot, I was able to pay for his medical treatment from my savings,” she says.
Most people here don’t have health insurance and Kumari’s husband had to stay home after his injury. They managed, thanks to her business, and there’s even money left to educate their two children. Kumari says entrepreneurship has empowered the women.
“We’ve gained self-confidence. Earlier we used to ask our husbands for everything – we want this, we want that, a new sari for a festival, school fees for the children. Now we bravely take loans and are able to repay because we run a business,” she says.
In Bengaluru, Manjula Ranganath, a fourth-generation weaver, has taken out a further loan of about $1,000 from Ujjivan, another MFI that’s funded by DWM. She and her husband, also a weaver, earn about $700 a month. The couple and their two children live in a two-room rented house that’s also their workshop. It’s a tiny space, sparkling clean and filled with the aroma of flavored rice. The loan has given Ranganath more control over her business.
“Earlier, the shop owner determined the order quantity and also gave me the materials. This loan has enabled me to buy materials directly and sell the woven silk saris to many different shops,” she says.
Ranganath is one of more than a million borrowers from Ujjivan and she’s the kind of success story the industry likes to tout. But until recently, lenders commonly charged interest rates of up to 35 percent, and some borrowers took on multiple loans, overextending themselves. Then, two years ago, the image of microfinance took a staggering blow when a number of borrowers committed suicide, allegedly under coercion to pay up. The deaths occurred primarily in the state of Andhra Pradesh, which had the most MFI investments in India. This prompted the state government to restrict the recovery of outstanding loans while banks simultaneously contracted the flow of credit.
According to a report on the global microfinance industry by the Economist Intelligence Unit from the Economist Group, by mid 2012, MFIs were unable to recover as much as $2 billion in outstanding loans, and nearly 10 million borrowers have defaulted.
In efforts to address charges of exploitation by lenders and also to stabilize the sector, a microfinance regulatory bill is awaiting parliament approval to become law. The Reserve Bank of India, or RBI – has capped the interest rate that MFIs can charge, at 26 percent. By contrast, the interest rate in Mexico is around 100 percent and in Peru, it’s close to 70. The limit will squeeze lenders.
“Definitely MFIs had to revise their business plans and ensure that within the kind of regulations the RBI has put in, whether MFIs can operate viably,” says Sudha Suresh, the chief financial officer of Ujjivan.
She says despite regulation, the market can still be profitable.
“There has been a core push moving towards operating efficiencies and cost control. But definitely a good balance between growth and profitability can be maintained and a reasonable level of return can be expected by our investors.”
But the sector has contracted. During the crisis, loan portfolios shrunk from about $6 billion to $2 billion. Suresh says Ujjivan survived thanks to funding from overseas investors like Stamford’s DWM.
“We did a 40 crore transaction and the rate of interest was 10.4 percent; and we would say that at the time of crisis, this has been of immense value to us,” she says.
Earlier this year, Ujjivan raised $5.8 million in a second round of financing from DWM at an interest rate of 13.12 percent.
Despite the RBI interest rate cap and restrictions on loan size, Ujjivan posted a profit last year, and DWM is still making money. WNPR contacted DWM for comment on this story but the firm did not respond. The company has investments in more than 40 countries and its seven investments in India include a $10 million private equity stake in SMILE.
“The ultra-poor are bankable. The repayment rate of the loan obtained is in the order of 99.9 percent,” says M. Sathiyamoorthi, chairman of SMILE.
Microfinance has proven to be indispensible for many impoverished women. In some communities it’s the only source of credit for the poor. Banks require collateral, moneylenders can charge up to three times more, and Self Help Groups – managed by non-government agencies – while effective, have limitations.
But MFIs have their own set of limitations and are not the solution to abject poverty.
“Microfinance may provide a loan, but without sufficient and reliable social security, whatever little benefit that microfinance does to a household will be simply wiped out,” says D. Rajasekhar, economist at the Institute for Social and Economic Change in Bengaluru.
That’s because credit is a necessary condition, but not the only condition for poverty alleviation. In the absence of affordable health insurance and pension, borrowers will be forced to sell any asset acquired from business profits. Rajasekhar also says the microfinance model is limited by its lack of provision for other tools that determine business success: education and skills training, storage facilities, and market linkages.
At the broad level, critics say reducing poverty – not making profits – should be the goal of investors who finance the poor. But supporters of the microfinance model, like Yale University economist Dean Karlan, say you can do both.
“The basic idea of people who have money looking for returns and then there’s opportunities in developing countries that have high returns and that’s what capitalism does and that’s a good thing. So let’s compare it to just Coca-Cola going in and seeing an opportunity to expand its market in a particular country,” he says.
Karlan is quick to point out that microfinance is not a panacea that’s lifting millions out of poverty. What randomized trials in India and abroad have shown is that microfinance has enabled poor entrepreneurs to manage risks better and make small investments in their business, thereby improving their lives.
“We should look at health, education – not just micro credit as a direct tool for poverty alleviation,” he too says.
Karlan, who is also president of Innovations for Poverty Action, an organization he founded to determine, through field trials, which solutions work best for poverty alleviation, says money is starting to flow into the sector again. Some previous supporters of microfinance have lost faith in the model itself. But many are hoping the regulations will improve the quality of lending. Right now, no one knows for sure which way the industry will go.
For WNPR, I'm Sujata Srinivasan.