Microfinance Focus, October 7, 2011: “It is irrational exuberance in microfinance that led to the Indian microfinance crisis and it exists in many other regions as well. It needs to be addressed and it needs to be addressed now”, said Sanjay Sinha, Managing Director of Micro-credit Ratings international (M-CRIL) and a member of the UN Advisor’s Group on Financial Inclusion Sectors.

Speaking on the webinar ‘Microfinance: Is there a crisis’ organized by Local Voice 4 Development, Mr. Sinha said that there is certainly a crisis which needs to be addressed. However, he believes that the international organizations responsible for microfinance are not sufficiently engaged in it.

Mr. Sinha stressed that the crisis needs to be recognized. “There is not yet a strong international environment in which MFIs focus on the financial needs of their clients and not just on their own achievement of client numbers and portfolio size”, he said.

Last year M-CRIL estimated that the number of microfinance loans exceeded the number of clients by 40% before the crisis started in 2010. In the poorer northern states, parts of central India and some pockets of the southern states (AP, Tamil Nadu), MFIs have not extended their services much. While in many places in South India and in the Eastern state of West Bengal, the overlap is 100 percent. Many clients had 3-5 loans when the crisis occurred.

“The immediate cause of the crisis was that multiple lending had led to a situation of over indebtedness of the clients. There was a presumption amongst the media and the local government that this has led to suicides”. Mr. Sinha said. He further remarked, “Unfortunately a lot of suicides happen in Andhra Pradesh every year and every year, they are blamed on something different”.

According to Mr. Sinha, MFIs in India grew 80-100 percent a year during 2007-1010 until the AP ordinance brought about the crisis. Growth was financed by loan funds from commercial banks. But Central Bank requirements on good financial management meant that they needed equity as well as loan funds to grow. For this MFIs sought commercial equity investments which were obtained at high valuations by promising continued high growth rates and related high returns to the investors.

“MFIs naturally had to deliver on their promises and in order to keep the number ticking along it was quicker and less costly to deliver high growth in the better connected, better governed, easy to reach areas. The clients in these regions became the low hanging fruit of MFIs. It was this that led to geographical concentration and multiple lending”, he said.

But whether that over lending resulted in significant degree of coercion which is sufficient to cause suicide is in some doubt. M-CRIL teams that visit the fields have never reported something so bad, Mr. Sinha assured.

Mr. Sanjay however said that in early 2010 microfinance clients in South India reported running from one two hour meeting to another, 3-5 times a week and having to juggle finances to repay loans. “So, undoubtedly there was some degree of distress from multiple lending”, he said.

It was at this time that linking of suicides with microfinance became common in Andhra Pradesh. The State Government then decided to step in, apparently to protect the consumers with stringent rules for microfinance practices. The rules were so stringent that it effectively brought the activity to a halt.

“Since the borrowers did not exactly rise in revolt against the government action, there was clearly some relief at being freed from the hot-house kind of the environment that had developed from too much money chasing too little client”

Mr. Sinha argued that the Indian situation is not unique. “There are similar ‘hot-house’ conditions in significant pockets of a number of Asian countries including Bangladesh, Cambodia, Pakistan, Philippines and Nepal. In parts of Morocco, Bosnia, Georgia and other Central Asian Republics, there is similar situation”.

However, it is not being sufficiently realized and in many countries MFIs are in denial of the crisis the same way the Indian MFIs were till October 2010 when the crisis happened, he says. “Countries which are in denial of a microfinance crisis are Bangladesh, Nepal and Cambodia”, he added.

Replying to an audience question about the failure of rating agencies in predicting political risks, Mr. Sinha said that some of the largest microfinance institutions deliberately went to rating agencies which were not dedicated exclusively to the microfinance sector. “As a result they were rated on the basis of normal rating agency’s parameters. They forgot that there is a political economy out there. M-CRIL, however had been issuing warnings at least one year before the crisis but nobody was listening”, he said.