82562 focus note Andhra Pradesh 2010: Global Implications of the Crisis in Indian Microfinance T he crisis that erupted in the Indian State of Andhra Pradesh in early October 2010 hit at the epicenter of microfinance in India and has The SHG movement received considerable national policy support led by the National Bank for Agricultural and Rural Development (NABARD). The implications there, across the country, and globally. role of NABARD combined with priority sector lending As events continue to unfold in Andhra Pradesh, policies stimulated the banking system to lend to this note provides background and context on the SHGs. This approach became widely embraced and situation, which raises important questions about grew much larger in the 1990s. The Indian SHG model the evolution of microfinance markets more broadly. remains unique for its sheer size and reach to poor people, though with varied levels of sustainability. Financial Inclusion in India Some SHG–bank linkage programs are low cost and financially sustainable1 while other SHG programs do India has a population of 1.2 billion, with less than not cover all costs, have low repayment rates, or rely one-quarter of adults having access to basic formal on ongoing subsidies. SHGs continue to offer a range financial services. Financial inclusion initiatives are of livelihoods and empowerment services that go well not new to India. Over the past century, a range beyond financial services. of innovative approaches to expanding access to finance for poor people has been pursued. Early The Rise of MFIs in the 20th Century laws were passed to create cooperative financial institutions to serve people By the 1990s economic reforms in India opened living in rural areas. Following independence in 1947, up space for the private sector to play a larger much of India’s financial sector was nationalized. role in the banking system. Amid these reforms Part of the rationale was to ensure access to finance a new breed of private microfinance provider to a much larger number of Indians, especially those emerged: microfinance institutions (MFIs), which living in rural areas. As a further effort to reach originally operated as nonprofits (societies and rural areas, India established a specialized class of other ownerless legal forms), but soon transferred regional rural banks in the 1970s. And in the 1980s their operations into for-profit nonbank finance social entrepreneurs created the self-help group companies (NBFCs). The transformation from (SHG)–bank linkage program, whereby commercial nonprofit to for-profit NBFCs was complicated, banks were encouraged to lend funds to groups of often leaving the nonprofits and other often newly 10 to 20 women. formed entities (such as mutual benefit trusts for the benefit of clients) with unclear voting rights No. 67 Indian SHGs were initially formed as a means to or influence over the newly formed NBFCs. Most November 2010 extend training and other nonfinancial services to often influence was concentrated in the hands of rural areas; some also mobilized savings and made the original founders (Sriram 2010). In more recent loans to members. But through the bank linkages years the dominant practice has been to form program, the SHG model began to incorporate start-up MFIs as NBFCs from the outset, obviating credit from the banks thus allowing for much the need for transformations. larger lending volumes. Today there are 4.5 million SHGs receiving credit nationwide, with 58 million By 2010 there were at least 30 MFIs operating as members. NBFCs, many with substantial growth trajectories. 1 See Isern et al. (2007). 2 This new breed of NBFC MFI has been supported government programs) has a significant presence, by government policies and direct investment. The directly working with 9.5 million of these SHG state-owned Small Industries Development Bank clients.3 The federal government is looking to of India (SIDBI) has steadily increased its lending expand this approach to other states, most notably to MFIs as a part of its mission to support small to Bihar, a state with a less developed microfinance enterprises. Loans by commercial banks to MFIs market than the one in Andhra Pradesh and also count toward priority sector lending quotas. significantly less outreach. In the last few years MFIs were also capitalized by equity investments from specialized microfinance One reason households have large amounts investment vehicles (MIVs) and, more recently, of credit from the SHG–bank linkage program mainstream private equity funds. supported by SERP is the “total financial inclusion program” the Andhra Pradesh Government began By 2010 these new MFIs were expanding at an three years ago. Traditionally SHGs were based annual rate of 80 percent, and had reached 27 million on member savings, and rules generally capped borrowers across India (Srinivasan 2010), nearly all this bank loans to the SHGs at three to four times this outreach achieved through a standard group-based savings base, effectively limiting borrowings to loan product common to South Asia. Importantly, Rs. 100,000 or less. But under the new program, these MFIs are effectively barred by regulation from banks began to lend up to Rs. 500,000 to targeted taking any deposits and instead rely heavily on debt SHGs. Additionally some loans to SHGs had a five- with commercial banks to fuel their growth.2 year repayment period, up from one year, and any amount of interest paid by SHGs above 3 percent The Capital of Microfinance: would be reimbursed to the SHG by the Andhra Andhra Pradesh Pradesh Government if the group did not default on its bank loan. SERP encouraged SHG members Andhra Pradesh in southeast India is the fifth to repay moneylender and MFI loans, but evidence most populous of India’s 28 states, with 75 million suggests that instead members kept multiple loans inhabitants. Recent state governments in Andhra from multiple sources. Pradesh have invested in progressive policies and programs focused on growth and building a sizeable In the late 1990s some of India’s first MFIs got information technology industry around the city of their start in Andhra Pradesh. Today, five of India’s Hyderabad. Andhra Pradesh has also undertaken a largest NBFC MFIs are headquartered in Andhra series of large-scale projects to fight poverty, the Pradesh making it the epicenter of the microfinance most prominent being the Society to Eliminate Rural industry in India. Over the last five years MFIs in Poverty (SERP). Andhra Pradesh were among the first to attract significant investment from specialized MIVs as SERP is a service delivery program under the Rural well as mainstream private equity players. These Development arm of the state government that capital injections have provided the equity capital offers far reaching livelihood promotion programs, for growth but they have also created strong including employment generation, vocational incentives for continued levels of high growth and training, and access to savings and credit through profitability to drive higher valuations. All of this SHGs. SHGs have a long and important history has fostered a perception of MFIs as being primarily in Andhra Pradesh and have deeper penetration profit-oriented organizations. While most MFIs have there than in any other state, with a total of 1.47 acted responsibly, a few have generated unusually million SHGs reaching 17.1 million clients statewide high returns on assets, compensated executives (Srinivasan 2010). Within the broader SHG approach lavishly, and remained nontransparent in ways that in Andhra Pradesh, SERP (and other Andhra Pradesh only furthered a negative stereotype of MFIs. 2 Indian banks have an exposure of around Rs. 270,000 million to MFIs in Andhra Pradesh, according to the microfinance industry body, MFIN. 3 MFI Registration Data November 2010, Rural Development Department, Government of Andhra Pradesh. 3 In recent years MFIs across India have diversified in any other state in India. Reports also suggest that geographic coverage, and Andhra Pradesh’s share many households have multiple loans significantly of the total national MFI outreach has dropped increasing their overall debt. to less than one-third. Nevertheless, a few of the largest MFIs remain heavily focused in Andhra This current supply side penetration data are partly Pradesh where growth has been rapid. corroborated by a demand side survey conducted nearly a year and a half ago by IFMR’s Center for The combined presence of the large and well-funded Microfinance. Johnson and Meka (2010) show that state-backed SHG program and five of India’s largest 83 percent of households had loans from more than and fastest growing MFIs has resulted in a rapid one source, including from moneylenders, with proliferation of credit across Andhra Pradesh and many households managing as many as four loans wide use of multiple loans by borrowers. And levels at a time.5 of household debt are high. In Andhra Pradesh, the average debt outstanding per household is Rs. 65,000 The study found high levels of penetration of as compared to a national average of Rs. 7,700 of SHGs into rural households, with just 11 percent outstanding microfinance debt per poor household.4 of households borrowing from MFIs. However, sampling covered all rural households (rather The parallel growth of two approaches to delivering than just poor households) in Andhra Pradesh. credit has expanded the reach of credit substantially With the growth since the time of the survey and over the past several years, as has competition some sampling distortion, it is likely that the 11 between the state-supported SHGs and private MFIs. percent figure significantly understates the level of SHG lending reaches 17.1 million SHG members penetration of MFI loans, though no current demand with Rs. 117 billion outstanding (Srinivasan 2010). side survey data exist to offer an exact figure. By November 2010, MFIs were reaching 9.7 million borrowers with Rs. 72 billion outstanding, according In sum, there is much higher penetration of to the government. But MFIs, while still somewhat microfinance in Andhra Pradesh than in any other smaller in total outreach than SHGs, had been state in India. Household dept comes from several growing more rapidly over the past 18 to 24 months sources, not just MFIs. The picture that emerges as SHG disbursements were slowing. Also, the from the data suggests that households in Andhra repayment tenor of many SHG loans is considerably Pradesh have too many loans and too much debt longer and often more flexible than those of MFIs, than seem to be supportable considering their reducing the size of repayment installments and income levels and ability to repay. thereby the debt servicing burdens on borrowers. Nonetheless, the combined outreach and continued October 2010—A Crisis growth has meant that the borrower accounts of Emerges SHGs and MFIs together on a per capita basis is over four times the median of Indian states. Srinivasan In 2005–2006 one of Andhra Pradesh’s 23 (2010) compares five Indian states with high levels of administrative districts experienced a crisis when the microfinance penetration and finds that the average district government closed 50 branches of four MFIs loan amounts per poor household in Andhra Pradesh following allegations of unethical collections, illegal is triple the size for the next largest state. By any of operational practices (such as taking savings), poor these measures the provision of credit in Andhra governance, high interest rates, and profiteering.6 Pradesh has reached much greater proportions than On that occasion, the dispute was calmed by the 4 Srinivasan (2010) estimates the total number of microfinance clients in Andhra Pradesh at 25.36 million (19.11 million SHG members and 6.25 million MFI customers), with a total debt of Rs. 165 billion. 5 Data from a study conducted by the Centre for Microfinance in 2009. The study, which included 1,922 rural households, gathered information on use of informal and formal financial products within these households. Data sets can be found under “Access to Finance Data” at http://ifmr.ac.in/cmf/resources.html. See also, CGAP Microfinance Blog at http://microfinance.cgap.org/2010/11/11/who%e2%80%99s- the-culprit-accessing-finance-in-andhra-pradesh. 6 For further information, see Ghate (2007). 4 MFIs agreeing to abide by a Code of Conduct their growth elsewhere. It is possible that a few MFIs alongside support from the national government and might have to close or dramatically downscale their the Reserve Bank of India (RBI), which recognized operations in Andhra Pradesh. And the result could the useful role MFIs played in providing credit for be the removal of a credit service that poor people low-income households. have come to view as reliable in their otherwise uncertain lives. But a rivalry between competing MFI and SHG models for serving the poor, often reaching into The nonrepayment of loans by clients has gained the same villages, has been simmering ever since. momentum as politicians at the state level have The SKS initial public offering (IPO) earlier this year seized upon the opportunity to make populist highlighted both the enormous scale potential of pronouncements, while MFI staff are still intimidated the MFI model and the considerable opportunity it and are not resuming normal operations in many provides to improve financial inclusion, while at the parts of Andhra Pradesh. 8 This environment is same time highlighting potential high profits and encouraging clients to question their obligations to lavish executive compensation. 7 repay, with potentially far reaching consequences for both MFI and SHG repayment rates. The press picked up on the SKS IPO, with different media outlets taking different angles on the story. Stakeholders outside Andhra Pradesh have also Further reports over the summer cited links between reacted to the conflict between the state government MFI practices and some suicides in Andhra Pradesh. and MFIs, and the intense media coverage. Though The situation came to a head in early October it has not made any public statements to date, when Andhra Pradesh’s chief minister passed “An RBI, the regulator of NBFC MFIs, has formed Ordinance to protect the women Self Help Groups a subcommittee tasked with looking into a wide from exploitation by the Micro Finance Institutions range of microfinance issues nationally, including in the State of Andhra Pradesh,” which sought to a re-examination of MFI loans’ classification as place a range of new conditions on MFIs, including priority sector lending. The Ministry of Finance district-by-district registration, requirements to has supported the continued presence and value make collections near local government premises, of MFIs while at the same time it has pushed for a shift to monthly repayment schedules, and other improved MFI practices, lower interest rates, and measures that affect how MFIs operate. This stricter regulation. The financial markets have taken ordinance has contributed to a general environment notice, SKS’s share price dropped steeply, and it is where MFI ground-level operations are impeded, unlikely there will be follow-on MFI IPOs very soon and loan collections for MFIs in Andhra Pradesh in the current environment.9 dropped dramatically. In recent years, the levels of profitability and private In the face of low loan collections, MFIs with gain have caused political concerns and have exposed proportionally larger exposures in Andhra Pradesh issues of reputation management for an industry could find it difficult to refinance their loans with whose very existence is based on doing good by commercial banks or to raise new equity. MFIs serving poor people. The potential for large returns unable to effectively negotiate their financing could made by the promoters of MFIs and their investors— become illiquid and insolvent. Even MFIs that are vividly illustrated by the headlines about the SKS IPO well capitalized and have a geographically diversified from late July onwards—has served to exacerbate portfolio beyond Andhra Pradesh might have to the issue of interest rate levels, which are a chronic absorb large losses in Andhra Pradesh, impacting political and public relations flashpoint.10 7 See Chen, Rasmussen, Reille, and Rozas (2010). 8 According to Sa-Dhan, Andhra Pradesh accounts for more than a quarter of the total loans outstanding of MFIs in the country, with Rs. 52351.4 million. DNA India (2010) reports that the unrecovered loans are anywhere between Rs. 500 million and Rs. 750 million. 9 According to the Deccan Chronicle (2010) banks have already stopped the disbursal of around Rs. 1750 million to Rs. 2000 million to around 44 MFIs. See The Economist (2010a). 10  5 As we write this, the microfinance industry and we see huge progress on that front. Across the various stakeholders are negotiating first ways to globe, including in India, the microcredit movement ensure the viability of the microfinance industry in has proved that it is possible to deliver financial Andhra Pradesh and then ways for a constructive services to poor people living in rural areas at a path forward. As part of the ongoing dialogue with large scale, free from any reliance on subsidies. As the state government, MFIs have offered to lower a result, millions of poor households today have interest rates and restructure debt. Negotiations access to credit, and also increasingly to savings, have enabled MFIs to resume some disbursement insurance, and money transfer services that they and collection operations, but staff are still largely use to manage household finances more effectively. unable to carry out usual loan collection activities. And yet there are still 2.7 billion people in the world without access to formal financial services that are Finding a speedy resolution is of paramount less expensive and safer than informal alternatives. importance so that the important work of ensuring It remains a priority to ensure that previously that poor people have access to responsible unreached low-income population segments gain financial services can continue. It is critical for poor access to these services, including in large swathes people that the financial services infrastructure of India. survive, which entails the resumption of collecting and disbursing loans throughout Andhra Pradesh Even within this wider context, though, we see as well as banks continuing to provide liquidity to important limitations of the microcredit-only delivery microfinance providers of all kinds. model and the ramifications of the strains caused by very rapid growth. Developments in Andhra Pradesh Going forward, the microfinance industry as a shine the spotlight on some of the same issues that whole needs to be serious about implementing a have emerged in other high-growth microfinance responsible finance agenda, including transparency markets in recent years.12 about interest rates charged to clients. Before the In India, investors’ emphasis on growth and the higher crisis, the MFIs had already begun a process that valuations generated from high growth rates have will lead them to report their interest rates publicly created strong incentives for fast expansion. These early next year through a third party, Microfinance incentives are transmitted from the top managers Transparency.11 In 2009 the MFIs had decided of MFIs down through middle management to the to invest in a credit bureau. Though it might frontline loan officers. These cascading incentives take some time to be fully functional, the credit can drive behavior that distorts basic good banking bureau will be important to help MFIs lend more principles and can lead to vulnerabilities that need responsibly. Serious discussion is underway about to be addressed: new regulations for the microfinance industry, both to help ensure that acceptable standards are met but also to create regulatory certainty for MFIs, and • Rapid expansion of credit in highly concentrated about deepening MFI relationships with clients by markets and loss of credit discipline can lead to providing a range of financial products instead of much greater risk of stress from higher levels of relying heavily on small-group loans. indebtedness. Growth can undermine credit discipline, driving unhealthy rises in loan amounts, The Way Forward cutting corners in the underwriting process, and resulting in an excessive supply of credit. A decade ago, the central preoccupation of the Incentives at the field level are often based solely microfinance industry was the search for scalable on disbursements and collection volumes, with and financially sustainable models for delivering insufficient incentives for sound underwriting or financial services to low-income people. Today, customer care. 11 http://www.mftransparency.org 12 See Chen, Rasmussen, and Reille (2010). 6 • Growth that outpaces the internal controls of making? How should policy makers balance financial service providers makes them more ensuring broad-based access to finance and vulnerable to inadequate technology and safeguarding client interests? systems and unhealthy rates of staff attrition and turnover. These questions speak to the bigger issue of how to • Relying on credit-only services makes Indian deliver high-quality services to more people while MFIs particularly vulnerable on asset quality since ensuring appropriate safeguards for clients. A vision borrowers have no deposit relationship to the MFI. of financial inclusion that truly addresses the needs And the MFIs’ heavy reliance on basic bank debt of poor clients dictates that responsibility lies not (plus a mix of capital markets instruments) leaves just with the providers, but also with policy makers, Indian MFIs vulnerable to refinance risks in times donors and investors, and the global microfinance of market stress. community to ensure appropriate governance, operational policies, and incentive structures at all All of this raise key issues for the microfinance levels, with appropriate client safeguards, to offer community to address. First, at the institutional level: high-quality services. As local markets mature, the delivery model for financial services for the poor • How do we assess financial service providers’ must evolve to support healthy outreach and the shareholders, management, and staff incentives growth of a broad range of products that poor to ensure long-term viability, understanding that people need. viability comes not just from shareholder value, but from a strong value proposition to clients? References and • How sustainable is the specialized microcredit Recommended Reading institution model? • What can investors and institutions do to ensure Bellman, Eric, and Arlene Chang. 2010. “India’s Major sustainable growth and avoid market saturation Crisis in Microlending.” Wall Street Journal, 28 October. or clients’ over-indebtedness? How can socially motivated investors be encouraged to redirect Chen, Greg, Stephen Rasmussen, and Xavier Reille. 2010. investments from the few, but high-profile “Growth and Vulnerabilities in Microfinance.” Focus saturated markets, to the many financial services Note 61. Washington, D.C.: CGAP, February. http:// “deserts” worldwide? www.cgap.org/gm/document-1.9.42393/FN61.pdf Then at the market level: Chen, Greg, Stephen Rasmussen, Xavier Reille, and Daniel Rozas. 2010. “Indian Microfinance Goes • Can self-regulation work when it comes to sharing Public: The SKS Initial Public Offering.” Focus Note credit information and establishing codes of 65. Washington, D.C.: CGAP, September. http://www. conduct on issues around culturally acceptable cgap.org/gm/document-1.9.47613/FN65_Rev.pdf collection systems, dispute settlement systems, etc.? Deccan Chronicle. 2010. “MFIs face music, banks stop • What kind of formal market infrastructure is needed loans.” 22 October. to support growing providers and protect clients? What are reasonable levels of productive debt for Dichter, Thomas, and Malcolm Harper, eds. 2007. poor people to carry? What’s Wrong with Microfinance? Rugby. • How can the focus be shifted to credit crisis prevention? What will it take to increase focus Economist. 2010a. “Microfinance in India: on understanding clients’ financial service needs? Discredited.” The Economist, 4 November. What is the role of regulators and policy makers to ensure client protection and consumer financial Economist. 2010. “Microfinance: Leave Well capability that leads to better household decision Alone.” The Economist, 18 November. http://www. 7 economist.com/node/17522606?story_id=17522606 NABARD. 2010. Status of Microfinance in India 2009–10, &CFID=154065457&CFTOKEN=91590038 NABARD. Ghate, Prabhu. 2007. “Learning from the Andhra Nath, Shloka. 2010. “The Indian Microfinance Lending Pradesh crisis.” In Thomas Dichter and Malcolm Machine.” Forbes, 28 October. Harper, eds., What’s Wrong with Microfinance? Rugby. Oliver, Justin. 2010. “Who’s the Culprit? Government of Andhra Pradesh. 2010. MFI Accessing Finance in Andhra Pradesh.” Blog Registration Data November 2010. Rural Development post on CGAP Microfinance Blog, 11 November. Department, Government of Andhra Pradesh. http://microfinance.cgap.org/2010/11/11/ who%e2%80%99s-the-culprit-accessing-finance-in- Intellecap. 2010. “Indian Microfinance Crisis of 2010: andhra-pradesh/ Turf War or a Battle of Intentions?” An Intellecap White Paper, October. Ramana, K. V. 2010. “Fate of SKS loans still hangs in balance.” DNA India, 5 November. Isern, Jennifer, et al. 2007. “Sustainability of Self-Help Groups in India: Two Analyses.” Occasional Paper 12. Srinivasan, N. 2009. Microfinance State of the Washington, D.C.: CGAP, April. http://www.cgap. Sector in India. New Delhi: Access Development org/gm/document-1.9.2706/OP12.pdf Services, Sage Publications, October. http://www. microfinancegateway.org/gm/document-1.9.46247/ Johnson, Doug, and Sushmita Meka. 2010. Access to State%20of%20the%20Sector%20Report%202009. Finance in Andhra Pradesh. IFMR Research. October. pdf Kazmin, Amy. 2010. “Debt trap leads to despair for Srinivasan, N. 2010. Microfinance State of the Sector rural poor.” Financial Times, 29 October. in India. New Delhi: Access Development Services, Sage Publications, October. Kinetz, Erika. 2110. “Indian Microfinance warns of crisis after suicides.” Associated Press, 28 Octo- Sriram, M. S. 2010. “Commercialization of ber. http://indiamicrofinance.com/microfinance- Microfinance In India: A Discussion of the Emperor’s ordinance-ap-comments-apmas-37923401.html Apparel.” Economic & Political Weekly, 12 June. No. 67 November 2010 Please share this Focus Note with your colleagues or request extra copies of this paper or others in this series. CGAP welcomes your comments on this paper. All CGAP publications are available on the CGAP Web site at www.cgap.org. CGAP 1818 H Street, NW MSN P3-300 Washington, DC 20433 USA Tel: 202-473-9594 Fax: 202-522-3744 Email: cgap@worldbank.org © CGAP, 2010 The suggested citation for this Focus Note is as follows: CGAP. “Andhra Pradesh 2010: Global Implications of the Crisis in Indian Microfinance.” Focus Note 67. Washington, D.C.: CGAP, November.