India’s Looming Microcredit Crisis

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India’s Looming Microcredit Crisis

Microfinance schemes were meant to be the saviour of the world’s poor. But in parts of India, lenders are enticing borrowers into poverty traps.

A garlanded picture of a young woman stares out into the emptiness of an abandoned house. The small building in India’s south-eastern state of Andhra Pradesh was once home to a family of four. But everything changed the evening that Laxmi Narayan found his 20-year-old daughter, Monica, on fire. Unable to cope with the grief, and the constant reminders of what happened, the family decided to move in with relatives.

Monica’s family had borrowed about 50,000 rupees ($1,100) from a microfinance company. However, unable to make the repayments, the family say they were harassed and humiliated by recovery agents from the lender. One evening last October, agents told Monica’s parents that the young woman should be sold to pay off the loan. For Monica, it was the final insult. She poured kerosene over herself and set herself alight.Narayan says he tried desperately to save her. The scars on his face and hands are a permanent reminder of his failure to do so.

Microcredit, in which small loans are typically given to the very poor – mostly women – to help them generate their own incomes, was once hailed as the solution to global poverty. Yet for many of the rural poor, such schemes have become more like a death trap, including in Andhra Pradesh where micro financing was tied to at least 80 suicides in the state last year.

The problem for many in rural areas is that they are ill-serviced by mainstream banks, and even when big banks are present, many find the application process too challenging.But while microfinance schemes were meant to offer hope to the poor, they have frequently been the source of exploitation, with some institutions charging interest rates as high as 50 percent. It’s stories like that of Monica that have put microfinance under the spotlight in India – and created the worst ever crisis of confidence in the industry.

It wasn’t meant to be like this. The United Nations declared 2005 the international year of microcredit. In 2006, Bangladeshi economist Muhammad Yunus and the Grameen Bank he founded were awarded the Nobel Peace Prize. At the time, Yunus said boldly that microcredit had the potential to create a world in which poverty could only be seen in a museum. 
But less than half a decade later, microfinance is fighting for survival. In Andhra Pradesh, known as a hub of micro credit, debt repayments from the state’s about 8 million micro-borrowers have dropped to around 20 percent following a government crackdown in response to the large number of suicides. 
The microfinance crisis is reminiscent of the 2008 subprime mortgage meltdown in the United States, where companies handed out easy loans to higher risk homebuyers who suddenly found they couldn’t repay their debts when house prices crashed.

In India, though, the borrowers are even poorer. 
Take the case of Monica’s family. Her father runs a small street corner shop that sells betel nuts and tobacco, bringing in no more than 75 rupees a day. Her mother finds occasional work as a maid, while her younger sister is a student at a local government school.  
Unable to continue her studies after completing higher secondary education, Monica began tailoring clothes, which brought in 2,000 to 3,000 rupees a month. The family ended up borrowing 50,000 rupees from five separate microfinance companies. Initially, they borrowed only 10,000 rupees. But, struggling to meet their repayments, they started borrowing from other firms to pay for the first loan. Eventually, the lenders stopped extending loans, and the family was faced with two or three visits a day from recovery agents.
‘First, they took the sewing machines, the main source of her income. Then, they started telling us to bring my daughter to the market and pay back the money,’ Rama Devi, Monica’s mother, recalls. ‘It disturbed her a lot. When we went out to fetch something, Monica went inside, poured kerosene on herself, and set herself alight.’ Monica died three days later from her burns. 
Prakash, a farmer in a village about 50 kilometres away, faced similar problems with recovery agents. But while Prakash was able to cope with the taunts from the agents, he couldn’t handle the insults from his wife, who called him a burden to the family. Humiliated, he reportedly hung himself from a tree in the field where he used to work, leaving behind two young children and his elderly parents. His wife had borrowed 10,000 rupees from a micro finance company. 
Driving the microloan revolution in Andhra Pradesh have been so-called rural self-help groups, which have offered about 12 million women bank loans exceeding a total of about $2.5 billion. Members of such groups are offered loans, but the understanding is that if one member defaults, no further loans will be given to anyone in that group. The reasoning is that peer pressure will ensure that loans are paid back. But in Prakash’s case, the pressure on his wife took an ultimately fatal toll.

‘Multiple lending, over-indebtedness, coercive recovery practices, and unseemly enrichment by promoters and senior executives (of microcredit companies) have all led to this situation,’ says Vijay Mahajan, chairman of India's Microfinance Institutions Network. 

Although there are an estimated 1,000 microfinance institutions operating in India, a handful of companies dominate the market. In Andhra Pradesh, four companies control over 80 percent of the market, lending as much as $450 with no questions asked. In most cases they don’t even try to establish the capacity of the person to repay their loan, or even what the loan is for. 
Venkat Narayana, an economics professor at Kakatiya University, Warangal, suggests that making money, rather than helping those in need, is the driving force behind most lending now. ‘They are guided by greed, and the social purpose is completely ignored,’ Narayana says.
‘Microfinance institutions have failed to motivate people for development,’ he says. ‘There was no reorientation programme, and they failed to take care of the basic needs of the people – their financial literacy and human development. Unless you take care of all these, just offering credit can’t do anything.’ 
But the flood of unchecked lending has left many companies struggling now that the debts aren’t being repaid. The government in Andhra Pradesh, meanwhile, has tightened the noose by passing a tough new law that seeks to regulate the industry. And, although this correspondent made numerous attempts to speak with representatives of microfinance lenders, none were willing to go on record.

With several billion dollars stuck in the market with little or no hope of being recovered, Mahajan fears that should repayments dry up in Andhra Pradesh, the problems will quickly spread to other states, leaving the entire microloan industry on the verge of collapse.

‘The biggest tragedy will be that the 30 million poor households who got access to bank credit for the first time through micro-finance companies will have to go back to moneylenders,’ he says. 
In the meantime, the rural poor are left in no man’s land. Government banks won’t help them because they don’t have any guarantors, and microfinance is now too often looking like a poverty trap. Sadly, stories like that of Monica are likely to be repeated many more times.