Credit check: Ammamani (above) and Seshamma (foreground, top right) are typical micro borrowers, who have multiple loans, often more than their incomes. A dip in earnings, then, can send them hurtling into the debt trap

AUGUST 26, 2006
Mylavaram & Tadigadapa, Krishna District, Andhra Pradesh

From B. Seshamma's question, it is evident that trust isn't one of Tadigadapa's most abundant resources-at least of late. "Have you come for yourself or to do something for us?" she asks. "Are you from the government or from a newspaper?" questions her suspicious friend, Sivakumari, spotting the photographer by my side. If nerves are taut in this sleepy village in the Krishna district, 270 km from Hyderabad, it's because things look bleaker now than what they did five months ago. It was in March this year, that Mylavaram, its neighbouring nondescript village shot into national fame after the district's young collector, Navin Mittal, raided offices of microfinance institutions (MFIs) and ordered 30 of them shut, including those of better-known MFIs such as Share Microfin and Spandana.

What provoked Mittal's action were reports of alleged abuse in the microfinance business. There were three major complaints against the MFIs operating here: One, that they were charging usurious rates of interest, ranging from 40 to 60 per cent per annum; two, they were abusing human rights by detaining relatives of defaulters or suggesting to borrower's family that the borrower commit suicide for insurance money; and three, that they were creating large-scale rural indebtedness.

How do things look five months on? Not too good. There have been no fresh disbursements from the MFIs over the last five months and neither have the borrowers been paying their installments. Borrowers like G. Sarala, Seshamma and Mancham Ammamani are willing to repay-provided they get fresh loans. Therein lies the key to the microfinance muddle. Most of the borrowers have taken multiple loans, thereby piling up debt vastly more than their incomes. When their incomes drop for whatever reason, they quickly slip into a debt trap; to repay borrowings, they need to borrow some more. "It is now a people's movement, as they feel cheated," says Mittal. "In most cases, people are holding back and waiting for clarity on the issue."

A Decisive Battle

The direction the fight between the MFIs and the people/administration in Krishna district takes will likely determine the course of microfinance elsewhere in the country. For one, just four districts of Andhra (Krishna, West Godavari, Guntur and Prakasam) account for about 15 per cent of all micro loans in the country, says Mittal. For another, an adverse outcome here could force banks that lend through MFIs to rethink their foray into microfinance. "What I fear is that following this crisis, a lot of bankers will start getting nervous," says Nachiket Mor, Deputy Managing Director, ICICI Bank, who is closely watching the developments. "It took me some effort to convince my own colleagues that we should view this more as an aberration that will get corrected."

Mor has a point. Microfinance is a high-risk business, simply because there's no asset underlying the loan. Also, the cost of distributing and managing the loans is relatively high. The risks involved, therefore, show up in higher interest rates. For instance, Mittal says, before the March crackdown, the local MFIs were charging 40 to 60 per cent in annual interest rates. The MFIs, however, deny the charge, and say that the rate was 27 per cent that too on reducing balance, and has since been brought down to 15 per cent. Mittal, however, contends that the reduction was in reaction to the crackdown.

Some of the MFIs admit that the rates were reduced to coax out repayments, but add that the rates are unviable in the long term. Why? The argument is to do with the economics of microfinance. The cost of borrowing for MFIs is at around 11 per cent, meaning that at a lending rate of, say, 27 per cent, they get a spread of 16 per cent. But Udaia Kumar, Chairman and Managing Director of Share Microfin, says that defaults, operating costs and minimum expected return on investment eat up 13 percentage points of the spread. Says Kumar: "The loan size may be small, but the cost of providing the service is high."

Lifeline of the Poor

Angry Young Man: Navin Mittal, Collector, Krishna district, says that before he pulled the plug on microfinance institutions, they were charging usurious rates of interest

In a country where more than 300 million people earn less than a dollar a day, micro credit is literally a matter of life and death. It is estimated that the demand for micro credit in India is more than Rs 50,000 crore a year, not including Rs 10,000-crore demand for micro finance in housing. Apparently, 80 per cent of the demand is met by informal sources (local moneylenders, friends, relatives). Mittal says his administration will help fill the vacuum created by the lack of disbursements by MFIs in the recent months. Compared to Rs 43 crore in 2004-05 and Rs 90 crore in 2005-06, Mittal plans to increase institutional credit in the Krishna district to Rs 175 crore this year. "This is more than double of what the MFIs were lending," he says.

Noble intentions, but government or government-owned institutions alone cannot match the demand for microfinance. India needs a strong microfinance industry that is both profitable and beneficial. "Why were people suddenly so willing to believe that the MFIs that had brought eight lakh people out of poverty were corrupt and doing all the bad things?" asks ICICI's Mor.

Clearly, not all MFIs are scamsters. With newer players planning entry into the sector, better governance of the microfinance industry is the need of the hour. No microfinance is not an option.