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March 12, 2010

Microfinance Macro Mess

By Kartik Desai


Recently there has been a lot of debate on the Andhra Pradesh government's ordinance effectively preventing microfinance companies from operating in that state, as well as its alleged causes, including multiple lending and coercive collection practices by MFIs that have supposedly forgotten their social mission. However, the widespread criticism of microfinance and the Centre's and the RBI's unwillingness, so far, to step in decisively risks making an already bad situation even worse. Indeed, we risk throwing out the financial inclusion baby along with the supposedly muddy microfinance bathwater.

One should first recognise that over the last decade, MFIs have been able to provide credit to over 25 million poor households, eclipsing five decades of government efforts. And they were able to do this despite charging higher interest rates than banks or government programmes — so clearly there has to be something right about the customer-centricity of their model. Indeed, MFIs in India emerged largely out of social-driven enterprises, for most of whom profiteering was not the sole objective.

Even if one does not agree with that, the fact that MFIs have played a role in starting a real, more scalable financial inclusion movement in India, especially compared to the public sector, means it is important to step back and analyse the positives and negatives of the model rather than getting carried away by the venal campaign of a particular group of state politicians.

Let's start with scale as a non-negotiable objective. Clearly the microfinance sector has done well on this metric, for instance by successfully scaling up the human resources required for their high-touch, low-tech business model. And this scaling up was achieved in a high-growth scenario, as MFIs increased their clients by 60 per cent every year since 2007; and in a fairly competitive landscape, with hundreds of MFIs competing in India with several other informal (moneylenders) and formal (banks, large NBFCs) lending sources. So we cannot ignore the efforts behind this scale-up, and the business model that achieved it efficiently.

The delivery of most public goods in India still suffers from the "last mile" servicing problem. Government efforts have been based on mandates rather than an incentive-based approach. If cracking the last mile is a consistent and vital piece of the inclusion challenge, any potential solution, like the Indian microfinance model, deserves a good look. MFIs have demonstrated that a viable last mile solution exists in delivering basic services that the BOP (base or bottom of the pyramid) segment badly needs. A closer look at the business elements of the MFI model could help us learn how to develop better last mile channels elsewhere.

If these are their key positives, where have MFIs failed? They have successfully created a business model that serves the BOP, thereby creating value for themselves and their shareholders in a sustained manner. But they have not figured out how to share with customers the value that is being created. And we are back to the same old conventional business models where, most of the time, the value distribution is skewed towards the top and largely limited to shareholders and management.

And for the BOP segment this sharing is a "must-have" factor — even if from a pure business strategy approach — because this segment will always be close to the political class, for both the right and wrong reasons. Right, because they ought to be the focus given the lack of access to even the most basic services. Wrong, because any politician will get nervous when other channels are also able to provide critical services to a segment she thinks of as "my constituents".

So any private business model that wants to target this politically-active customer segment needs an adjustment to its business approach. And one clear way of doing so is to keep the customers at the very centre of the business.

This will make the politicians less anxious and keep most shareholders happy at the same time.

It will be a pity if we let the MFI model go to waste — and the AP government's ordinance is a surefire way to kill this sector. The Centre needs to curtail the Andhra crisis, and urgently, given the liquidity situation: banks have heavily reduced financing to MFIs. Any solution should discourage other state governments from Andhra-type knee-jerk reactions.

It is clear that MFI customers will be at the losing end if the microfinance model takes a hit. Customers are bound to lose out on availability of credit, as well as through increased credit costs — especially in unbanked geographies which are reached mainly by smaller, regional MFIs that are most at risk with liquidity in the sector running thin. If we agree that customers' interest should get prioritised over other stakeholders, the AP crisis begs immediate banking and political support to the microfinance sector. Otherwise, this could potentially undermine India's financial inclusion success story in the name of protecting the poor, which would be very unfortunate.

[Originally published in the Indian Express on December 3, 2010]


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