Dissecting the mechanics of growth in Indian microfinance

Let us stop crying over spilt milk but let us not forget what has happened in the past in the desire to achieve scale speedily. Going forward, it would be prudent for the Department of Non-Banking Supervision, RBI as well as proactive MFI boards (like Sahayata and SKS) and other stakeholders to look at growth trends closely

An earlier article in Moneylife (Lessons from the commercial microfinance model in India,) showed how the burgeoning growth of the commercial non-banking finance company (NBFC) model in Indian microfinance—during the period April 2008 to March 2010—perhaps led to the 2010 Andhra Pradesh microfinance crisis, which was the third in a series of crisis situations (the first being Krishna and second being Kolar) in the last six years.

Okay, you may ask why growth and desire to build scale rapidly suddenly became important—that is a very relevant question but let us hold off on it as it is dealt with in detail in a future forthcoming article in this series. Coming back to the aspect of growth, as David Roodman has consistently argued in his blog, the desire to grow at a burgeoning pace was perhaps one of the major causes of the 2010 micro-finance crisis.  Let us look at some data and understand how this growth actually happened from the Krishna through Kolar to the 2010 Andhra Pradesh (AP) micro-finance crisis. They hold very important lessons for boards of NBFC microfinance institutions (MFIs), regulators, investors and others in terms of how MFIs grew and what the resultant implications were.

Let us first look at the years 2003-04, 2004-05 and 2005-06—i.e., years before and during the Krishna microfinance crisis

As the data in Table 1 suggests, growth was extremely significant in terms of clients and gross loan portfolio (GLP) added in the years prior to the Krishna crisis:
1.    Specifically, in the year preceding the Krishna crisis (2004-05), the top five AP headquartered MFIs added 6.21 times more clients and 4.53 times more GLP, respectively, than in the base year (end March 2004 figures).
2.    Further, during the year of the Krishna crisis (2005-06), the top five AP headquartered MFIs added 10.44 times more clients and 5.08 times more GLP than in the base year (end March 2004 figures).
3.    These were huge numbers by standards that existed then. This rapid growth was perhaps one of the major reasons for the overheating in the Krishna district microfinance market then and without question, it played a significant part in the resulting crisis at the local level.

Let us now look at the data in Table 2 which contains data for years (2006-07, 2007-08, 2008-09 and 2009-10) after the Krishna crisis. Several trends are discernible from the data
As expected due to the crisis, the base year (year after Krishna crisis, April 2006-March 2007) saw a slowdown and the top five AP MFIs (all NBFCs) added just 0.52 times clients and 0.94 times GLP as compared to the previous year (2005-6, the year of the Krishna crisis).

However, thereafter, data suggests that growth was extremely significant in terms of clients and GLP added:
  •  For example, in the year preceding the Kolar crisis (2007-08 two years after Krishna), the top five AP headquartered MFIs added 2.89 times more clients and 4.35 times more GLP, respectively, than in the base year (end March 2007 figures), which had experienced a slowdown as noted above.
  •   Further, in the year of the Kolar crisis (2008-09), the top five AP headquartered MFIs added 6.66 times more clients and 6.32 times more GLP than in the base year (end March 2007 figures)
  •   Last but not the least, in the year after the Kolar crisis (2009-10)—i.e., just before 2010 AP crisis—the top five AP headquartered MFIs added 8.68 times more clients and 15.60 times more gross loan portfolio than in the base year (end March 2007 figures). These are huge numbers by any standards and without doubt, they are among the major factors that led to the sub-prime like situation in Andhra Pradesh that caused the 2010 microfinance crisis eventually.

So, what are the key learning points that deserve emphasis?

First, clearly, while there was a slowdown after the Krishna crisis, this slowdown is at best, called as temporary. Readers would recall that in 2005-06 in Andhra Pradesh, when the first major microfinance crisis was experienced in the Krishna district, it was a localised affair and rather limited to Krishna and perhaps Guntur districts where two of the largest AP headquartered MFIs were competing fiercely. While there was a lot of rhetoric after the Krishna crisis, in reality, very few lessons were learnt. That is why you see a rather phenomenal growth in terms of clients and GLP added, just two years after the Krishna crisis.

Second, when a similar crisis occurred in Kolar (Karnataka) in 2009, as before, the symptoms of the crisis were perhaps tackled but the inherent causes (the flawed operating model of the NBFC MFIs as Dr C Rangarajan has pointed out) were ignored. In fact fewer lessons (than after the Krishna crisis) were learnt and soon, the MFIs were back to their old ways of multiple and over lending to shared clients in shared JLGs. With senior management and boards of many MFIs looking primarily at building a mass of clients (the classic quantity rather than quality aspect), achieving scale rapidly became the most important factor. Client level controls were forgotten and with the mushrooming of centre leaders as agents, soon, many MFIs started using the decentralised (agency) model to build rapid scale. With their systems and capacities unable to manage this growth, frauds and the like started burgeoning too (Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor,). The numbers clearly tell the story as the year 2009-10 (year after Kolar) saw as unprecedented growth among the five AP headquartered MFIs (many of whom were in Karnataka as well) and the `rest is history…

A third additional point needs to be made with regard to 2010 AP micro-finance crisis. In the year preceding the 2010 crisis, the growth of MFIs was not only burgeoning in terms of clients added (as compared to the base year) but more importantly, it was humungous in terms of the GLP added (in reference to the base year). This represents a significant difference between 2005-06 Krishna crisis and the 2010 AP microfinance crisis because with regard to the latter, the year preceding the crisis saw MFIs deepen their engagements with clients in terms of larger and perhaps multiple loans. This is evident from the fact that while clients added by top five AP MFIs (in 2009-10) was 8.68 times that in the base year (2006-07), the GLP added was nearly double this at 15.60 times the base year. The corresponding figures during Krishna were—10.44 for clients added and 5.68 for GLP added. Therefore, one could argue that while growth that focused on adding more clients (cannibalization of SHGs) with (perhaps) lower loan sizes was the undoing of the MFIs in Krishna (2005/06), growth focused on larger and multiple loans led to the 2010 AP micro-finance crisis. 

Fourth, the data from Table 3 below provides some very interesting trends with regard to why this growth occurred in Indian microfinance across the three years leading up to the 2010 AP microfinance crisis:


Thus, as seen from the above, one must note, that it was during the period of this burgeoning growth (especially, April 2009-March 2010) that many of the NBFC MFIs received significant equity investments and priority sector lending (PSL)/other funds from investors and banks/DFIs, post Kolar. The Kolar crisis happened somewhere in January 2009 and if you look at the equity investments and funds from banks/DFIs in the subsequent year, you will clearly understand what I am saying. Without doubt, as evident from the above, it is clear that despite Kolar, the five AP headquartered MFIs grew at a fast pace and thereby attracted greater equity investment and also larger amount of DFI/bank funds and used these to grow further. An interesting point to be noted here is that while the five AP NBFC MFIs increased their clients by 3 times across the 24 months, they increased their gross loan portfolio by nearly 3.59 times. This indicates, ceterus paribus, these five AP NBFC MFIs deepened their portfolio in 2009 -2010. This also perhaps provides some surrogate evidence with regard to increasing loan sizes and multiple lending in 2009-10. The following graphs clearly highlight this phenomenon. 

From the above graph, it is clear that despite the two earlier crisis situations in Indian microfinance (Krishna/Kolar), clients added by top five AP MFIs significantly increased across the years.
From the above graph, it is clear that despite the two earlier crisis situations in Indian microfinance (Krishna/Kolar), the GLP added by top five AP MFIs steeply increased across the years.

Now, the microfinance industry and other stakeholders (including regulators) were gung-ho about this growth—in the name of financial inclusion—without asking serious questions on how such rapidly burgeoning growth (emphasis added) was possible in the first place? Had such questions been asked—especially by the regulators and other stakeholders—at relevant crisis points, then, issues such as multiple, over and ghost lending would (perhaps) have got the attention they deserved and maybe we would not have come to have the 2010 AP microfinance crisis.

Never mind. Let us stop crying over spilt milk but let us not forget what has happened in the past in the desire to achieve scale speedily. Going forward, it would be prudent for the Department of Non-Banking Supervision, RBI as well as proactive MFI boards (like Sahayata and SKS) and other stakeholders to look at growth trends closely (quarter-on-quarter) and constantly keep asking questions such as the following:
  •  How are MFIs growing quarter-on-quarter? Is the growth unusually large? Is it supply led? Are the growth rates commensurate with their capacity to manage that growth? Are client level and other internal controls being broken? Is there cause to believe that growth and scale are being rapidly built through multiple, ghost and over lending? What are the motivations for the concerned institutions (MFIs) to grow this rapidly? To show better operating results? Have greater returns? Pay higher salaries and commissions to staff/management? Get better valuations? Tap capital markets at a premium etc? Enhance financial inclusion?
  •   Are clients having multiple loans and do they appear to be (over) indebted? Are they in a position to repay loans from their known (legitimate) sources of income/cash? Have institutions (for whatever be the reason) provided successive loans (one after another), despite knowing that the concerned clients cannot repay existing (multiple) loans from the known (legitimate) sources of income/cash? Have clients used one loan to repay another a loan? Is periodic refinancing required to provide sufficient liquidity to enable the client to service another/existing loans? Has an additional loan been provided mid-way through an on-going loan and especially, on easier terms? In other words, are clients over leveraged? Have there been a series of delinquent payments and one equalising payment (often from another loan) and has this pattern been repeated? Have coercive repayment practices been used to ensure better repayment? Has there been a lack of transparency with the product terms and the like, especially, in terms of the effective interest rates as well as other issues?

  And if such analysis happens on a regular (quarterly) basis, then, I am sure that the policy as well as regulatory/supervisory failure, so evident from the past crisis situations, will not occur in the future and that alone will serve the cause of financial inclusion and inclusive growth better. And before I sign off I would like us to remember the quote of late Shashi Rajagopalan (independent consultant and former RBI director)—one of the most client sensitive practitioners that microfinance has ever seen—who, commenting on CGAP’s paper on SKS microfinance (http://www.cgap.org/gm/document-1.9.47613/FN65_Rev.pdf), noted that,

“Notwithstanding the sleight of hand by which large numbers of women are shown to be shareholders through MBTs, many NBFC MFIs are closely held companies, and, in my view, statistics quoted by such closely held companies are hard to ascertain. It appears to be in everyone's interest to pretend that these companies are indeed growing at the rates claimed and that their default rates are indeed the rates claimed. Anyone buying into these figures, has either never given and collected credit, or, is either incredibly naive, or has a stake in pretending that this is indeed a wonderful gift to the low income group. CGAP is gung-ho about things that it ought to be much more discerning on, if indeed it wants people with low income to truly benefit from regular access to genuine and usable credit.”

(The writer has over two decades of grassroots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural/urban development and urban poverty alleviation/governance. He has worked extensively in Asia, Africa, North America and Europe with a wide range of stakeholders, from the private sector and academia to governments)

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