India's $5 billion microfinance industry faces backlash over profits

Critics say the surge in for-profit MFIs driven by equity investors has skewered the industry away from its pro-poor roots. M S Sriram, an independent scholar on microfinance in Bangalore, says there is an inherent contradiction between “people-oriented” schemes and MFIs that focus on quick returns. “The client is secondary. Therefore the tensions get heightened,” he says via e-mail.

Microfinance's lightning rod

India’s largest lender is Hyderabad-based SKS Microfinance, which raised $350 million in equity in August and has become a lightning rod for critics. Speaking Tuesday at the World Economic Forum in Delhi, its chairman, Vikram Akula, defended SKS and blamed “rogue” lenders for the backlash. “Do not destroy the entire industry because of the actions of a few rogue players,” he said.

Since the crisis began last month, SKS has voluntarily lowered its interest rate, currently around 24 percent. Commercial MFIs say they must cover the cost of making thousands of tiny loans, usually $200 or so, without accepting deposits, as banks do. Mr. Akula said its scale of operations allowed major lenders like SKS to charge progressively less for loans compared to Latin America.

Not everyone is convinced by this argument. Mr. Titus says that commercial lenders cut costs by poaching loan officers from their rivals and targeting the same borrowers. This allows them to collect a higher return on equity as they don’t have to invest in new communities, which normally require training and preparation in how to use microfinance.

Justin Oliver, executive director of the Center for Micro Finance at IITM University in Chennai, says the overlap in lending by competing lenders isn’t necessarily a problem. In a new report, the center found that 60 million Indians belong to financial self-help groups, while 26.7 million had loans from MFIs. It estimated that 16.3 million had borrowed from more than one source.

“It makes sense for people to want to be part of multiple groups at the same time to keep lines of credit open for when they need it in the future,” he says.

Backlash takes a political dimension

The backlash against MFIs in Andhra Pradesh has a political dimension. Many of the existing self-help groups are backed by public banks, which are in turn overseen by local politicians who use their largesse to build vote banks. By undercutting these lenders, commercial MFIs are threatening this patronage network.

Analysts point out that regulators appear focused solely on curbing commercial lenders, rather than tackling systematic risk. A ban on loan officers collecting weekly repayments, the normal practice in microfinance, is a major blow to these lenders.

This isn’t the first time that microfinance has run into trouble in Andhra Pradesh. In 2006, several suicides in one district led to the temporary closure of MFIs accused of coercive practices. The neighboring state of Karnataka also suffered a wave of defaults last year after local Muslim leaders objected to usury on loans, which Islam forbids.

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