Thursday, December 16, 2010

Microfinance's Sub-prime Moment

The debate over whether microfinance does more harm than good has been raging long before Muhammad Yunus and Grameen Bank were awarded the Nobel Peace Prize in 2006 for their work extending micro-loans to the poor of Bangladesh. However, rather than settling the question, the award seems only to have increased skepticism in some that, given the opportunity, the poor are capable of managing their own financial affairs, while others scream more vehemently that microfinance institutions (MFIs) are nothing more than “blood sucking leaches” burdening the poor with inappropriate amounts of debt.

Then came the IPO for SKS Microfinance Ltd., India’s largest micro-lender by assets, that reaped millions for the company’s founder and early stage institutional investors. Some heralded the event as “an important step towards fully engaging mainstream capital markets in the fight against poverty,” while others, including Professor Yunus, decried it as profiting off the poor. Now there is a financial crisis in Andhra Pradesh, one of the largest micro-lending markets in the world which is being compared to the sub-prime crisis in the U.S. and is raising concerns for the survival of microfinance as a tool for alleviating poverty.

Last week the Center for Global Development hosted a timely panel discussion addressing the crisis and its implications for the global microfinance community. (You can view this discussion by clicking on the link.) Swaminathan Aiyar, a prominent Indian journalist and research fellow at the Cato Institute, made a compelling case for the underlying local political issues at the root of the crisis. He explained that in lending to the poor in India, “default is built into the system.” It is essentially a part of the political system politician use to get elected. He was not at all surprised by the crisis. “When you lend to people who are insolvent,” he claimed, “they will default no matter what interest rate they are charged.”

With the government of Andhra Pradesh giving the poor permission not to repay their loans to private sector MFIs, large scale defaults are almost certain. This will have a devastating effect on micro-lenders, many of which are likely to go under and default on their loans from Indian commercial banks. This has led a former governor of the Reserve Bank of India to call for a study of commercial bank lending to MFIs that are “profit seeking.”

In my opinion the “profit seeking” MFIs are at the heart of the problem in Andhra Pradesh and microfinance in general. As one particularly vehement, anti-microfinance blogger has pointed out “SKS Micro-Finance has become a proxy, hammer it, hammer the whole industry.” While it may be unfair to single out SKS in this way, its early success prompted a rush of for-profit micro-lenders into Andhra Pradesh leading to poor lending practices and inevitable abuses similar to what was seen in the sub-prime mortgage lending in the U.S.

As I argued in an earlier post, greed is not good for microfinance. When MFIs are under pressure to provide market rates of return to investors, loan volume and debt collection will trump collaborative efforts to assist the poor out of poverty. The participants in the Center for Global Development discussion had many good recommendations for improving the way microfinance works to help the poor including: greater consumer protection, better corporate governance, encouraging savings, establishing credit bureaus and avoiding over lending. All good suggestions but difficult to implement the face of profit maximization. Microfinance belongs in the realm of sustainable social enterprise where issues like consumer protection, savings, appropriate lending policies and transparency do not conflict with shareholder needs.

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