By Sam Mendelson,

Microfinance Focus, February 1, 2012: A little over a year ago, this industry of ours was shaken to its core. It wasn’t so much the events in Andhra Pradesh (AP) per se – distressing as some stories of client mistreatment were. It was the emergence of this negative narrative into the global mainstream press; the contagious perception that microfinance – far from being a panacea for poverty-alleviation – was not actually what it claimed on the tin.

This narrative, as we all know, is untrue – or at least true only in parts. The nadir was reached on 17th November 2010 – exactly one year ago from the final day of this Summit – when the NYT ran a cover story entitled “Indian Microcredit Faces Collapse from Defaults”, and the die was cast. Some of this opprobrium betrayed a misunderstanding of the sector as a whole. And to some criticisms – especially practices in AP, the only response could be “fair comment”. It was, and is, time for a re-think.

As co-author of the Microfinance Banana Skins survey from 2009 to 2011, I read hundreds of contributions from people in and around the industry. To describe many as “nervous” would be understatement. Recovering from the reputational damage is important, and so too must be putting the foundations in place – appropriate regulation, fair ratings, transparency – that prepare the sector for its next phase.

So, what will be the legacy of the 2010 “crisis”? What must and will be done to help our industry move forward? An article for conference delegates can assume a great deal of knowledge, and so a summary of the issues surrounding the AP crisis isn’t needed. Nor is an Op-Ed on the importance of social performance management (SPM) or the arguments for and against commercialism. Rather, I have buttressed the MBS by talking to some other experts, asking them for their own thoughts on what the legacy will be. It’s not scientific, but it is food for thought.

It’s worth beginning with the 2011 Banana Skins survey – conducted in late 2010. As expected, the crisis in India – along with problems in Morocco, Bosnia, and Pakistan – dominated responses. We reflected some of these fears in our introduction: “In the last two years, microfinance has found its enviable reputation under attack for a number of perceived reasons: its growing commercialism, as evidenced by an increasing focus on size and profitability, a decline in standards, particularly in the area of lending, and a sense that the industry may be drifting away from its original “double bottom line” purpose.

Of the 533 responses from 86 countries, many dozens cited AP specifically, and many more expressed concern at the issues being raised there: overconcentration; collection practices, mission drift, and pricing.

The rankings – which had “Reputation” rising 15 places to 2nd, “Political Interference” rising 5 to 5th, and “Mission Drift” climbing 10 to 9th, revealed an industry paying extremely close attention to India, and worrying what the future holds. Movement was not just relative, either, but absolute too. Respondents felt the risks were getting more and more severe, and betrayed a genuine concern for the future – or the value – of microfinance.

Many have espouses this latter concern. A stridently critical voice has been that of Dr. Milford Bateman, whose provocative book “Why Doesn’t Microfinance Work?” has been widely read (and disputed). It was Bateman whose comments attracted considerable attention of the UK Government’s All-Party Parliamentary Group (APPG) on Microfinance, who quoted him thus: “The MF movement…has failed to provide robust evidence that is it meaningfully associated with poverty reduction…many specialists [now believe] that microfinance actually undermines the process of sustainable poverty reduction and ‘bottom-up’ economic and social development”.

What was previously heresy (questioning microfinance’s positive impact on poverty) is now prevalent. Duvendack et al recently published a study (1) for the UK’s Department for International Development, which failed to find any evidence of positive impact. The perception that microfinance has failed to do what it should have these past decades – to prove its worth, instead of self-congratulating with heart-warming anecdotes – is now widespread. AP didn’t cause this perception. But it sure helped it along.

Much else has changed in the year since that NYT piece. The Malegam Committee returned its recommendations. The Reserve Bank of India implemented an interest rate cap and limits on margins. The subsequent proposed Microfinance Law brings microlenders under RBI control, and empowers it to set margin caps, repayment schedules and maximum interest rates. The world has been watching closely.

Rosalind Copisarow, Managing Director of Oikocredit International, has just returned from AP after talking with 13 MFIs. The outlook there, she says, is mixed. “Loan repayments have dried up over the past year. In particular MFIs which are not structured as cooperatives have seen repayments collapse from 98% to 3-5%. These MFIs are bound by the AP Ordinance which prohibits them from even visiting borrowers let alone collecting repayments from them. In contrast, MFIs structured as cooperatives (exempt from the Ordinance) are still seeing repayment rates of at least 75%, with over 95% in rural areas. ”

She notes too that the crisis has spread beyond AP. “In Mumbai, there are MFIs starving for cash as well. Commercial banks which were providing wholesale funding, got frightened by the events in AP and froze credit lines to MFIs across much of India”.

Is this crisis global, however, or India-centric? “Many factors have contributed to the crisis in India: enormous investor appetite fuelling an over supply of capital into the sector relative to 'natural' demand, high real interest rates, intense competition amongst MFIs combined with lax lending policies and no deposit taking ability amongst most of them, a vulnerable government administration combined with strong opposition party and a competing government run MF program. Some of these individual elements exist in other places too, but I don’t think we will see the same full confluence of events anywhere else”, Rosalind says.

Irrespective of whether AP is sui generis, there are undoubtedly changes taking place across the industry – including the widely-argued need for microfinance ‘beyond credit’. Anton Simanowitz of the Imp-Act Consortium describes in a plenary paper at this Summit what he sees as a client-focused microfinance: deepening financial inclusion and creating value for clients, as well as protecting them from harm (2).

Royston Braganza, CEO of Grameen Capital, also sees a renewed focus on the client. “We [must] turn back to basics, which is an overall focus on the original client. A focus on mission will come back – we’re seeing that already in SPM, transparency, pricing initiatives, responsible lending codes of conduct. The Indian sector will certainly recover – albeit without some of the valuations we saw before”.

Client ‘protection’ like that being promoted by the SMART Campaign and the Seal of Excellence misses half of the point though, according to Anton. “Yes you need to make sure MFIs don’t hurt their clients, but also you need to do things to strengthen their resilience, help them succeed. If those things are done well, issues of harsh collection practices are less of an issue. Organisations need to think about client vulnerability from shocks.”

The UK’s APPG, for its part, made nine key recommendations based on a multi-month consultation (3). Besides the need for more rigorous research and evidence of impact, the promotion of SPM, and more effective regulation, paramount was “to ensure that clients are able to access more than just a single one-size-fits-all credit product”. The importance of savings, remittances, insurance as well as client-appropriate credit is now virtually unanimously accepted.

Some of the current debate is wrongly framed in terms of “commercial v non-commercial”, according to Marcus Fedder, co-founder of Agora Microfinance Fund, a UK-based, socially-driven MIV, who believes the higher degree of transparency promoted by MFT and others, “has exposed the myth that only NGOs provide ‘good’ products and services. Interest rates charged by some NGO-MFIs are usurious”, he says. “The industry will only be able to show the world it has entered a new and better chapter if it can prove it is driven by client needs, that it takes social performance seriously, and that it operates sustainably without being drip-fed by donations. Whether this is happening will only become apparent in the coming years”.

Gil Lacson from Women’s World Banking framed such issues succinctly in the MBS survey. “Is microfinance primarily about financial inclusion or poverty alleviation? Is microfinance primarily a business opportunity or a development intervention? Does microfinance really meet both financial and social return expectations? Is it an ‘either or’? Or has microfinance many faces? Whatever the answers, the industry's reputation will never be the same”.

Whatever the answers are, we can all agree that these are exactly the right questions.

Hugh Sinclair of Micro Service Consult takes some negative answers from the crisis. “We have not improved, we have not taken the right steps, we continue to hide things, we continue to act inappropriately, and we will continue to jeopardise the few good players unless we take concerted action, rather than nonsense, self-regulatory and self-congratulatory actions with zero actual impact”.

It would be wrong to paint too dire a forecast. There are many positives to be drawn. There is a vigorous debate taking place in social performance management – as the SPTF, the Imp-Act Consortium, SMART Campaign and the Seal of Excellence demonstrate.

In the forward to the Banana Skins Survey, a bullish mood was struck: “In many markets, MFIs and investors have already taken notice of the changing risks. MFI growth has slowed, lending standards have been strengthened, and more attention is being given to social performance. In several countries…more sustainable growth models are emerging. Most regulators now acknowledge the valuable contribution that the microfinance sector is making to financial inclusion, and see it as part of their country’s financial infrastructure”.

It is an overused metaphor, but microfinance is at a crossroads. It is – rightly – no longer thought of as a panacea for poverty-alleviation. Those who believe in its continued ‘transformational’ potential know there is much to be done. Reputationally, the industry will have to do better to explain itself. Empirically, it must rigorously and candidly test its own assumptions. Existentially, it will need to continue to ask itself what microfinance is, and what it is for. And pragmatically, it must learn from its adolescent mistakes. The reckless arrogance of youth has passed. Adulthood now awaits.

References:

1.http://www.dfid.gov.uk/r4d/PDF/Outputs/SystematicReviews/Microfinance2011Duvendackreport.pdf

2.Challenges to the Field and Solutions: Over-Indebtedness, Client Drop-Outs, Unethical Collection Practices, Exorbitant Interest Rates, Mission Drift, Poor Governance Structures and More

3.http://www.appgmicrofinance.org/files/APPG%20on%20Microfinance%20inquiry%20report%202011%20-%20low%20res%281%29.pdf

About the Author: Sam Mendelson is co-founder and partner of SPA – a social performance consultancy – and co-author of the annual Microfinance Banana Skins survey of risk.

(This article was first published in the Microfinance Focus special print magazine which was distributed at the Global Microcredit Summit 2011 in Spain.)