In India, warnings of a microfinance bubble

Lending to the poor has proved so profitable in India that microfinance institutions saw their loan portfolio jump from $252 million to $2.5 billion in two years, raising fears of a subprime-like microfinance bubble.

When Gajendra and his wife Marigamala want a loan, they are spoiled for choice in this village six hours from Bangalore.

Five microfinance institutions offering small loans to the poor have set up shop here in the past five years, and at least two smaller unregistered ones offer money as well. The couple has taken loans from four of them, totaling 50,000 rupees ($1,000). With private microcredit lenders, unlike a bank or savings group, says Gajendra, “you just need a ration card and a photograph.”

Never has credit been so easy for some in the villages of Andhra Pradesh. The southern Indian state is at the epicenter of a decade-long boom in microfinance lending, a system of small loans so successful in aiding the poor that its pioneer, Muhammad Yunus, won the Nobel Peace Prize in 2006. That boom has intensified in India in recent years, transforming a largely nonprofit sector into a destination for private equity investors drawn by high returns and resilience despite recession.

Microfinance institutions (MFIs) watched their loan portfolio in India jump from $252 million to $2.5 billion between 2005 and 2009, according to data compiled by Sa-Dhan, an umbrella group for the sector. Last year alone the number of borrowers jumped 59 percent to more than 22 million people, and loan portfolio grew 56 percent. When including government-supported microcredit programs, the sector overall grew to more than 70 million borrowers and a $7.5 billion market.

But the spectacular growth and the rush of private capital into private MFIs – microfinance comprised 40 percent of equity deals in India last year – have some experts worried about a subprimelike bubble. The expansion has been too large, too fast, and too geographically concentrated, critics say, pointing to incidents of mass default in pockets of the country.

“Once irrational exuberance takes hold, it is difficult to puncture it until it is punctured,” says Sanjay Sinha, managing director of Micro-Credit Ratings International Limited in New Delhi, referring to the subprime housing crisis that triggered the US recession. A March report from the Consultative Group to Assist the Poor (CGAP) found private equity valuations for Indian microfinance were six times book value, and three times the global median. Excess capital flows were driving overvaluation, the report said.

Last year, overheated microfinance markets led to repayment crises in Bosnia, Nicaragua, Morocco, and Pakistan, Mr. Sinha notes, which forced some MFIs to close shop. “There is a global exuberance about microfinance – a flood of money without the infrastructure to distribute that money.”

A vast microfinance market

With an estimated 400 million people lacking access to formal banking services, according to the central bank, India is considered one of the world's largest microfinance markets. By providing small loans at interest rates lower than moneylenders’, though higher than banks, microfinance enables the poor to access credit to make larger purchases or set up enterprises.

In India microfinance falls into two categories: an older system of “self-help groups” that save money and jointly take out a loan usually from a public-sector bank, and a newer model in which microfinance institutions lend directly to groups or even individuals. Both types have grown, though the self-help groups still hold the bulk of the market with $5 billion in loans.

It is the MFIs, however, with their quicker processes, larger loans, and more aggressive repayment policies, that have propelled much of the recent expansion. Some have transformed into for-profits as they scaled up in size and profitability.

India's largest MFIs – about 27 of 230 analyzed in the 2009 State of the Sector Report issued by Access Development Services – cover 88 percent of the MFI market. India's biggest MFI, SKS Microfinance, which self-reported 5.3 million borrowers and a return on equity of 19 percent last year, will become India's first MFI to issue a public offering next month.

Most of the sector's growth, however, has been concentrated in a few regions. More than 50 percent of microfinance clients live in the four southern states, which are home to 15 percent of the country’s poor households. By contrast, the states in the central region host 32 percent of poor households but less than 9 percent of clients. 

This skewed growth is most startling in Andhra Pradesh, where average household microfinance debt is eight times the national average. The state of 16 million households had 20 million microfinance clients last year, according to an annual report on the sector.

Some areas in this region have already seen a repayment crisis. In 2006, several suicides in Krishna district led local officials to temporarily shut 50 microfinance offices on charges of usurious interest rates and aggressive repayment policies. In Kolar, in the neighboring state of Karnataka, a slump in the local silk industry and a directive from local Muslim leaders (Islam bans usury) led to mass defaults last year. One inquiry concluded that, although local economic and political factors triggered the crisis, there were underlying issues of multiple lending, high loan disbursement targets putting pressure on credit standards, and growth outstripping infrastructure.


What bubble?

Despite such incidents, many industry leaders and observers reject fears of a bubble.

“There's certainly a risk in pockets of high density,” says Venky Natarajan, managing director of Lok Capital, a venture capital fund focused on the microfinance sector. But overall there is no bubble, he says, since India remains a vastly underserved market.

“The volume of the poor is so huge, it is impossible to compare with smaller markets” like Morocco, says Mr. Natarajan, noting that when the repayment crisis hit that country last year, “almost every poor person there had an MFI loan.”

And while Indian MFI annual interest rates of 25 percent to 35 percent are higher than those charged by government-supported self-help groups, they are still far lower than in countries such as Mexico, where MFIs have been known to charge over 60 percent interest, he says. Mexican MFI Compartamos has come under fire for charging annual interest rates in excess of 100 percent.

World Bank and Indian government reports have shown that rural households in India have the capacity to service debts of up to $1,000, says Y.V. Shivnarain, vice president of Spandana Spoorthy Financial Limited, one of the largest MFIs in the country. The average microloan size in India is $109, compared with $295 in Mexico, according to the Microfinance Information Exchange (MIX).

“As long as the client has the capacity, there is no problem with multiple loans,” Mr. Shivnarain says, adding that Spandana agents repeatedly warn their clients about overborrowing.

In Yadamari, for instance, Gajendra and his wife have the income to make the weekly repayments on the 50,000 rupees they owe in multiple loans (which they used to pay for a cow, an autorickshaw, and their son’s job application).

But others are overextended. In the nearby village of Perumallapalli, Pushpalatha, whose husband works at a nearby dairy, has three loans – 10,000 rupees ($200) from a local self-help group and another 10,000 rupees from the local moneylender, both to pay for a wedding, and a third from a microfinance institution to repay the moneylender.

"Over a period, [people] may be pushed into a debt trap," says K. Raja Reddy of the Andhra Pradesh Mahila Abhivruddi Society, which supports self-help groups in India. "Then one fine morning they have to sell off their household assets or default."

High-risk investors

Even some in the industry acknowledge the problems brought by growth as well as the impact of venture capital in a sector intended to serve the poor.

“Initial funders came from a development and poverty angle, so they were patient,” says Achla Sabyasachi, vice president of Sa-Dhan, a 234-member association including self-help groups and microfinance institutions. “But VCs [venture capitalists] look for high risk and high returns.”

In February, India's central bank warned microfinance institutions that unless they improved their governance, they could lose their “priority lending” status that gives them a vital credit line.

Concerns within the industry, too, have prompted efforts to improve transparency and minimize risk. Industry associations have committed to setting up a credit bureau to share information on clients and have established a code of conduct on recovery practices and lending limits. Some companies have begun to focus on underserved states.

“What’s true for any business is truer for microfinance, which directly affects the lives of the poor,” says Lok Capital's Natarajan. “As long as whoever enters the market puts the customer first, there won't be a problem.”


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