Microfinance in India: A case of development’s bull run

Image: Flickr User Vikram Walia
Image: Flickr User Vikram Walia

Talking to some friends who work in NGOs I have noticed an increased pace of activity in NGOs running microfinance programs. And some programs around the other buzz word ‘financial inclusion’. This made me think if microfinance really has the kind of emancipatory potential that many in the non-profit sector see. I dug up a few papers that were discussed as a part of microfinace module back at the university and found I could use them to make a case of a clear bull run that happened and which really isn’t anything better than retrofitting a market idea into a ‘non-profit’ space.

Whatever the motivations of microfinance as a service in the interest of development were, there is one thing that may be safely stated – that microfinance was a market based enterprise. An enterprise which affected a kind of financial engineering that could potentially help people in the poor and low income categories to get out of the poverty trap that they found themselves in. It may not have started with the motivation of making higher returns by extending credit at an interest to the poor but it certainly ended as that. By end, I imply the crashing of microfinance industry with the Andhra Pradesh crisis. On the thought that it was a market based enterprise it would not be difficult to find consensus, irrespective of which side of the debate one is positioned. What many contend is writing off microfinance as an approach in helping the poor and lower income people to get out of poverty.

If we look at microfinance industry’s performance in India during the period 2000-2010  it reflects what I allege as microfinance’s ‘bull run’ in the development sector. ‘Bull run’ is a term borrowed from stock markets where it is characterized by a sustained increase in share prices. Such an increase is based on positive investor confidence in the economy. For instance, the Bombay Stock Exchange had a bull run from April 2003 to January 2008, a period of five years when the sensex increased from 2,900 points to 21,000 points. This is a massive bull run which tends to pay off investors handsomely. During such a bull run there is a widespread confidence in the market which tends to obfuscate information, merits and overall sustainability of prices of a company’s shares. I argue that such a thing happened with the microfinance industry in India. The use of market terms in explaining the dynamics of an industry which was touted to be necessarily steeped into development sector is deliberate. It is deliberate because microfinance’s emergence as an industry received its most important impetus only when capital from the conventional or mainstream financial markets made its entry into the sector.

The origins of microfinance industry may have been out of concerns of poverty alleviation and genuine belief in the deliverance of microfinance as a tool to escape poverty but as it unfolded it can be seen that it was anything but that. This professor at the university notes that microfinance industry has done well in the last decade: has grown from a USD 400 million in 1996 to USD 200 billion industry, by 2010. In terms of market size it has indeed done well and is an indicator of the kind of growth that a necessarily development activity is capable of showing if it is left to market forces. This aligns with the bull run phase that is the subject of this article. He also explains the underlying reason for such a splendid rate of return that many of the microfinance companies saw during this period. There was also a growing thinking that subsidized credit has its own limitations. Lending should be done at rates which cover the costs: of capital, of delivery and of risk. While costing, cost of delivery of both financial and technical assistance and support services, at the doorstep of the poor household was also included. However, these services were often not delivered, leaving an extra-normal margin for the Micro-finance Institutions (MFI).

This extra-normal margin is well explained in a paper by this professor and his co-authors who happened to be a part of the early microfinance movement themselves. An extra normal margin was an attractive proposition for the mainstream finance companies which were already reeling under the ongoing crisis in the banking industry in India to channelize their capital and of course forces in to this emergent sector. The emergent patterns had all the making of a typical market space where the ruling order is capital and scale. This became evident in the course of growth that microfinance companies in many states later followed. A high capital investment which had to be responded to with strict performance in terms of return on investment which would then effect the earlier stated ‘development outcomes’ by the microfinance company.

There are several arguments made on the impact of microfinance on poverty alleviation, its role as an activity which brings access to finance by the poor who are not covered by mainstream banking etc. These arguments need empirical evidence. Presenting microfinance as a win-win solution that helps companies find that fortune at the ‘bottom of the pyramid’ as well as offers a value proposition to the poor in terms of access to low interest capital is incomplete. As a general proposition the vision is fully supported neither by logic nor by the available empirical evidence. Morduch’s example from Micro Banking Bulletin, 1998 speaks to the emotive argument made by others – that the most careful and comprehensive recent survey shows that the programs that target the poorest borrowers generate revenues sufficient to cover just 70% of their full costs. So why would such an inefficient program as microfinance should be run when in comparison by making lending to the poor a banking priority one could achieve similar results, theoretically. Now, one may argue that banking priorities gravitate towards those who are rich and not to the poor. Then this is where the argument that making access to finance to the poor a political priority will be necessary. If it can be a political priority then it will also get addressed by the banking sector. The reason for having a parallel industry where regulation and quality control has been rife with conflict is unexplained. It will be easier to achieve this outcome via the conventional banking industry given the same political and social conditions that are argued for by the microfinance proponents.

Mission drift argument about microfinance industry’s good intentions in the beginning which then get subjected to equity market’s pressures of return on investment and also to the emergence of microfinance as a ‘sunrise’ opportunity must also be examined in the reverse order. Why did the mission drift happen? 

The mission drift argument does not note that structurally finance industry is oriented towards capital flows, performance of capital, return on investment, scale and other typically market oriented structures. What was being attempted by the microfinance industry pioneers was a retrofitting of a market structure into the development sector and reorienting its goals from wealth creation to servicing the poor with access to finance and help them escape poverty. This reasoning is not pursued for a variety of reasons. First is that of admitting to this massive transplantation experiment. Second, is that of making mistakes and not acknowledging them. Third, that pushing microfinance as a solution the development practitioners have come so far that mission drift is the only convenient and saving argument that can be made. However, this reasoning must be driven in order to not make the same mistakes again.

A revision in the microfinance industry regulation and working is being proposed in the wake of Malegam Committee report and the other multiple crises like debt recovery methods of microfinance companies and borrower suicides. It should be questioned if watering down of a capital and market dominated industry like finance to suit development outcomes could be done like the way it was done starting from Grameen Bank to Basix and to SKS Microfinance.
It appeared to be a purely market opportunity which ran well for a period rising on investor confidence and sector wide optimist. During this time finer details were dispensed with. Every microfinance company responded to the lure of capital and the charm of ‘reaching out’ to a large number of ‘unreached’, ‘under-served’ constituency of poor.

The crash of the industry should serve a vital lesson to development sector – of not working in complete dispensation of the day’s reality that market forces are major influences. The development goals of equity, access and opportunity to a poverty free life cannot be situated in a world which discounts the market forces. The measures must work with them and try to negotiate around conflicting goals. Not in the way of retrofitting an idea from one space to the other. If the poor must escape poverty then structural adjustments in the political, governance and social spaces must be effected which then effects a conducive environment for the poor to rise up on the back of equal opportunities and on their own capabilities. The idea that enabling access to finance will achieve this outcome has been a flawed one not only incomplete.

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