Microfinance: Loan sharks driving village folks to suicide

The crisis has been building for weeks, but has now reached a critical stage. Indian banks, which put up about 80 per cent of the money that the companies lent to poor consumers, are increasingly worried that after surviving the global financial crisis mostly unscathed, they could now face serious losses. Indian banks have about $4 billion tied up in the industry, banking officials say.

“We are extremely worried about our exposure to the microfinance sector,” said Sunand K Mitra, a senior executive at Axis Bank.

The region’s crisis is likely to reverberate around the globe. Initially the work of nonprofit groups, the tiny loans to the poor known as microcredit once seemed a promising path out of poverty for millions. In recent years, foundations, venture capitalists and the World Bank have used India as a petri dish for similar for-profit ‘social enterprises’ that seek to make money while filling a social need. Like-minded industries have sprung up in Africa, Latin America and other parts of Asia.

But microfinance in pursuit of profits has led some microcredit companies around the world to extend loans to poor villagers at exorbitant interest rates and without enough regard for their ability to repay. Some companies have more than doubled their revenues annually.

Now some Indian officials fear that microfinance could become India’s version of the United States’ subprime mortgage debacle, in which the seemingly noble idea of extending home ownership to low-income households threatened to collapse the global banking system because of a reckless, grow-at-any-cost strategy.

Responding to public anger over abuses in the microcredit industry — and growing reports of suicides among people unable to pay mounting debts — legislators in Andhra Pradesh last month passed a stringent new law restricting how the companies can lend and collect money.

Even as the new legislation was being passed, local leaders urged people to renege on their loans, and repayments on nearly $2 billion in loans in the state have virtually ceased. Lenders say that less than 10 per cent of borrowers have made payments in the past couple of weeks.

If the trend continues, the industry faces collapse in a state where more than a third of its borrowers live. Lenders are also having trouble making new loans in other states, because banks have slowed lending to them as fears about defaults have grown.

Government officials say they had little choice but to act, and point to women like Durgamma Dappu, a widowed labourer from this impoverished village who took a loan from a private microfinance company because she wanted to build a house.

She had never had a bank account or earned a regular salary but was given a Rs 10,000 loan anyway, which she struggled to repay. So she took another from a different company, then another, until she was nearly Rs 1 lakh in debt. In September she fled her village, leaving her family little choice but to forfeit her tiny plot of land, and her dreams.

Use of coercive methods

“These institutions are using quite coercive methods to collect,” said Vasant Kumar, the state’s minister for rural development. “They aren’t looking at sustainability or ensuring the money is going to income-generating activities. They are just making money.”

Reddy Subrahmanyam, a senior official who helped write the Andhra Pradesh legislation, accuses microfinance companies of making ‘hyperprofits off the poor,’ and said the industry had become no better than the widely despised village loan sharks it was intended to replace.

“The money lender lives in the community,” he said. “At least you can burn down his house. With these companies, it is loot and scoot.”

Indeed, some of the anger appears to have been fuelled by the recent initial public offering of shares by SKS Microfinance, India’s largest for-profit microlender, which is backed by famous investors like George Soros and Vinod Khosla, a co-founder of Sun Microsystems.

SKS and its shareholders raised more than $350 million on the stock market in August. Its revenue and profits have grown around 100 per cent annually in recent years. This year, Vikram Akula, chairman of SKS Microfinance, privately sold shares worth about $13 million.

One of India’s leading social workers, Ela Bhatt, who heads the Self-Employed Women’s Association, or SEWA, said microfinance firms had lost sight of the fact that the poor needed more than loans to be successful entrepreneurs. They need business and financial advice as well, she said.

“They were more concerned about growth — not growth of the livelihoods and economic status of the clients, but only the institutions’ growth,” she said.

Mahajan, who is also the chairman of the Microfinance Institutions Network, said the industry was now planning to create a fund to help restructure the loans of the 20 per cent of borrowers in Andhra Pradesh who were struggling.

He also said the industry, which has been reluctant to accept outside help, would share its client databases with the government and was negotiating restrictions on retail lending that did not go through the nonprofit self-help lending groups.

The collapse of the industry could have severe consequences for borrowers, who may be forced to resort to money lenders once again.