Indian microfinance crisis: What can international agencies like CGAP learn from it?

The Consultative Group to Assist the Poor could not spot the inherent weaknesses in the commercial microfinance model that it was unabashedly promoting. This is a reason for self-introspection by its board, senior management and other stakeholders involved in its governance. CGAP, as an institution, should become more accountable to low-income people, whom it exists to serve in the first place

In India, financial inclusion has translated merely to the delivery of consumption credit (and some small production loans). That consumption credit alone is insufficient to reduce or alleviate poverty is perhaps a no-brainer, for all honest development practitioners. Despite the lack of serious impact studies, for those who have worked at the grass-roots and continue to so, it is rather evident that mere access to finance cannot and will not help people out of poverty. Access to finance, is therefore best viewed as a necessary, but not sufficient condition for poverty alleviation.

While microfinanciers and access to finance advocates can perhaps take comfort in the fact that consumption loans alone cannot make a dent on poverty, there is a caveat in order. They cannot escape the fact that the drive and desire to include low-income people with regard to financial services has resulted in the proliferation of financial services focused on loans and even within loans, primarily consumption lending. The enthusiasm to include low-income people has also led to not-so-good practices including multiple lending, over-lending, top-up loans, ghost/benami loans and the like driven by the motivation of some MFIs (microfinance institutions) to generate huge wealth for themselves and their promoters. In fact, one of the major reasons for the ongoing Indian microfinance crisis is the present mindless drive to include people financially, without asking the question (s) on whether the current bouquet of financial services being offered are appropriate, whether the practices being followed are fair, transparent and ethically sound and whether the other conditions so much necessary for effective use of the financial services exist at the grass-roots.

Without question, the onusi  for this (at least in some small part) lies on institutions like the CGAPii —which is said to be the foremost agency for promoting financial access to low-income people globally. Without question, CGAP has played a very important in the Indian microfinance sector through various efforts over the last decade -ranging from capacity building to credit rating, researchiii  on equity, technology, innovation and the like and dissemination of global best practices to microfinance stakeholders and the like. CGAP has also been at the forefront providing transparency and other awardsiv  as well as grants-in-aid (to the tune of several crores of rupees) to some of the Grameen replicator MFIsv  that mainly provide consumption loans using a high commercial for-profit strategy. Last but not the least, CGAP has also (indirectly) facilitated various institutions to invest in many Indian MFIs.

That is not all. At many conferences in India, it is common to see a couple of CGAP staff and their presence at discussions (on various occasions) with important microfinance stakeholders in India including DFIs, commercial banks, large MFIs and even regulators. Further, institutions like CGAP also intervene through projects such as the responsible microfinance project, promoted under the aegis of the World Bank and implemented in India by SIDBI (Small Industry Development Bank of India). Thus, in India, CGAP has become synonymous with Grameen MFIs and whenever an MFI gets into some sort of trouble with a state government in India, the first thing that the MFI does is to argue that it reports to and is recognised by CGAPvi . Please see quote below, which is provided as an example:

"MFI 'Z' has always been transparent and continues to be so. We have shown our original audited financial statements and rating reports of the last 3 years for verification and authenticity. We have our website which contains all the updates. We report regularly to all national and international microfinance agencies including CGAP of World Bank. Sir, we have also received the highest five-star rating for transparency from the Mix Market of CGAP-World Bank."vii

Now, given so much of active interaction with various stakeholders in India and given this leverage, it is indeed an obvious disappointment that CGAP could not spot the inherent weaknesses in the commercial microfinance model that it was unabashedly promoting. Without question, this is surely a reason for self-introspection by its board, senior management and other stakeholders involved in its governance. And going forward, they would also need to discuss ways in which CGAP, as an institution, becomes more accountable to the low-income people (whom it exists to serve in the first place) and ensures that promoting access to financial services does not in any way infringe on the rights to life, liberty and pursuit of happiness of such low-income people. Going to scale is critical but scale and growth cannot come at the expense of delivering appropriate financial services through fair and transparent mechanisms. There can be no compromise whatsoever on that and CGAP must ensure that this basic tenet is internalised in other countries where the microfinance sector is on such a rapid growth path.

Take the case of India—while MFIs grew for different reasons, it was during this period of burgeoning growth (April 2008-March 2010 and thereafter until September 2010) that the hitherto highly-successful model of JLGs/Centres was severely diluted. And the changes did more harm than good to the original concept of joint liability and peer pressure—where several JLGs operated in a mutually-reinforcing manner within a centre.

Four issues are relevant here:

  • One, the normal and established processes of client acquisition through green-field methods—where MFIs laboriously promoted their very own groups and nurtured them and painstakingly created a culture of credit discipline and high repayment based on mutual trust and other aspects—were slowly abandoned by many MFIs because of their urgency to grow fast. Process mapping and efficiency considerations, which are by themselves good tools and/or laudable objectives respectively, were erroneously used to quicken client-acquisition strategies and other processes. Thus, an undue emphasis was placed on quicker identification of clients, faster processing of loan applications and so on. And basic issues such as understanding of client antecedents and situations, preparation of clients, analysis of client/household loan absorption and debt-servicing capacity and the like—which were the hallmarks of the green-field client-acquisition strategy in the traditional Grameen model—were slowly but surely ignored and bypassed
  •  Two, given that clients needed to be identified faster and loans disbursed to them quickly, the MFIs concerned had just two options for client acquisition: (a) Acquisition—whereby MFIs started taking over the portfolio of smaller MFIs or specific JLGs. Sometimes, SHGs were also taken over (cannibalised) and split into several JLGs (depending on size of SHG); and (b) Mutual Sharing—whereby several MFIs decided to share and use their available JLGs/clients on successive days and on the basis of a simple reciprocal arrangement. While both strategies were used, over time, cartels of MFIs started to follow the latter as it was a win-win situation for all of them
  •   Three, both of the above led to the emergence of power brokers (also called as broker agentsviii  or ring leaders)-they were basically centre-leaders (or group leaders or even loan officers) who had access to a captive set of JLGs and clients. These new intermediaries started to match-make with different MFIs on increasingly attractive and exploitative terms. Thus, slowly, these agents became the most powerful pivot in the local microfinance system and various processes were outsourced to them, often without any quality checks. The outsourced processes ranged from client acquisition to KYC (Know Your Customer) documentation, loan disbursement, repayment collection etc. Over time, this outsourcing through agents became an established strategy and the agents were omnipresent and omnipotent in the Indian microfinance industry-and they often demanded their pound of flesh and got it too. It appears that the coercive practices and multiple lending, which have often been cited in the present crisis, are perhaps due to the presence and use of such agents. It also appears that it would be difficult to enforce concepts like social performanceix  on the ground, given the burgeoning growth and prevalence of such agent-led decentralised microfinance models, and
  •   Four, and as the period (April 2008-March 2010 and thereafter) progressed, growth came not from adding fresh clients. Rather, growth came through concurrent loans (from the same MFI) to its clients and multiple lending to shared JLGs/clients, who were serviced by different MFIs on different days. In fact, data (Table 1) reveal that for a set of 6 large AP-headquartered NBFC MFIs, while their clients grew by about 1.30 times across 2 reference periods (April 2008-March 2009 and April 2009-March 2010), the growth in gross loan portfolio was about 2.47 times, indicating that portfolio deepening had occurred perhaps through larger or successive or multiple loans to the clients.  

These concurrent and parallel MFI loans, through shared JLGs and clients, appeared to be God-sent and clients just grabbed them during the phase of burgeoning growth-as by then many of them realised that they could not service their increasing debt. The cases of Zaheera Bhee and others clearly illustrate this. The MFIs too were ecstatic about turbo-charging financial inclusion and so were equity investors, banks, policymakers and other stakeholders including international bodies like CGAP. This is a very critical point that needs to be noted. The outreach of the Indian microfinance industry needs significant correction and revision to reflect this reality of multiple loans to shared JLGs/clients.

Therefore, it is high time that institutions like CGAP recognise and use the following lessons (from the Indian microfinance crisis) with regard to promoting financial access for low-income people in its day-to-day work:

Lesson # 1. 
   The scope of current inclusive finance practice in India is rather narrow. While the intentions (like the report of the Financial Inclusion Committee and other policy pronouncements) may have been to provide low-income clients with access to a wide range of need-based financial services, in reality, the inclusive finance (or financial inclusion) paradigmxi  has mainly led to the proliferation of credit and primarily consumption loans, although there have been some small production/livelihood loans.
Lesson # 2.    Standard (MFI) loans for consumption and/or small production needs, which dominate microfinance (or access to finance) in India today, tend to work well but for loan sizes in the range of Rs10,000-Rs15,000 per client and at most <= Rs 25,000.
Lesson # 3.    Rs 25,000 as the loan amount is some sort of Lakshman Rekhaxii , that the MFIs should not breach, unless they are absolutely sure of the individual/household having the requisite debt servicing ability (could be a livelihood, production and/or labour, etc) to repay the larger loan. This is the most important lesson from Andhra Pradesh for MFIs, banks, policymakers and other stakeholders.
Lesson # 4.    Indiscriminate (and multiple) lending to low-income people under the pretext of furthering financial inclusion-without regard to their (and their families) loan absorption and debt servicing capacity, and especially in the wake of vulnerable livelihoods, can only prove to be a recipe for  disaster, and will ultimately exclude them altogether from the financial system. As has been argued above, when people with weak and vulnerable livelihoods are lent large sums of money (> Rs25,000), then repayment will either have to come from fresh loans (greening resulting in multiple lending) and/or restructuring of loans. At some point, this cycle will (have to) stop and the bubble will simply burst. These clients will then become financially excluded all over again.

Okay, if that is the scenario, then what can institutions like CGAP do to help the microfinance industry overcome the present situation? First, CGAP can help re-engineer the financial inclusion paradigm, to address some of the issues mentioned above. In my opinion, this re-engineering should ensure the delivery of quality credit that will reduce risk and vulnerability of low-income clients and give them more choices.xiii  By quality credit, I am arguing for a greater focus on post-harvest and/or post-production financing for agriculture and other sectors that provide (or can provide) significant livelihoods opportunities for low-income people. In other words, among other things, this would call for financing of agriculture produce/other productsxiv  marketing—a very critical aspect for small/marginal producers as it has the potential to enhance choices for them in terms of buyers etc. Of course, here, the existing relationships would need to be better understood if financial products are to be developed and delivered through appropriate channelsxv . Second, CGAP must ensure that the focus of financial inclusion is so re-engineered such that the delivery of a wide range of financial services (loans, savings, insurance, pensions etc) are used strategically to drive higher rewards, better remuneration and greater power down the value chain as shown in Figure 1—otherwise, it will be of limited use.

Hence, CGAP needs to help initiate a new microfinance paradigmxvi  where financial products, mechanisms and instruments can be used to:

  • Reduce risk/vulnerabilityxvii  in the existing livelihoods of low-income people, arising from various market imperfections—examples include warehouse receipt financing, pro-poor value-chain financing, etc
  •   Help create strong safety and security netsxviii  for these low-income clients for a range of aspects as shown in Figure 2
  • Enable these low-income clients to pursue diversified/migratory livelihoods where required
  •   Facilitate re-inclusion of these low-income people (who were once included but subsequently excluded because of fragile livelihoods), and
  •   Create risk management mechanismsxix  to ensure that they continue to stay financially included, in the context of their fragile livelihoods.

Thus, I would very much like CGAP to champion the larger cause of re-engineering the financial inclusion paradigm to facilitate poverty alleviation on the ground. They have it in their DNA and, in line with their acronym, CGAP must now become the "Consultative Group to Alleviate Poverty" and assume the lead role in fighting and trying to eradicate poverty globally. I am sure they have the wherewithal and resources to do this and let us hope their governing council, senior management and other governance structures take this appeal seriously.

  iMy intention is not to blame anyone. I am merely highlighting what has happened and would like to see course corrections
  iiThe Consultative Group to Assist the Poor, is a specialized multi-donor body that is housed at the World Bank.
  iiiCGAP's paper after the 1st Indian IPO did not seriously discuss the Governance problems in the MFI concerned despite many of these issues being found in the public domain (read paper, "Commercialization of Microfinance in India: A Discussion of the Emperor's Apparel", by Professor Sriram in EPW, June 12th 2010, Vol: XLV No: 24)
 iv Some of the institutions that received the CGAP transparency award appear to have had serious governance problems.
  vThe CEO of one of the Grameen replicator MFIs that CGAP gave a huge grant-in-aid to some years ago was cited by The Economic Times in Jan/Feb 2011 as having annual compensation much higher than the highest paid CEO of one of India's large private sector banks.
  viIf CGAP is interested, I can share letters that are in circulation.
  viiLetter dated, September 6th 2006 from MFI Y to District Collector.
  viii(a); (b); (c)
  xiIn India, typically, financial inclusion (FI) is presently characterized by: (1) Preoccupation with opening of savings accounts; (2) Large focus on consumption credit and small production loans; (3) Low outreach with regard to vulnerable groups in agriculture; (4) Lack of suitable and affordable risk management services; and (5) Lack of appropriate livelihood financing. The above two aspects of lack of suitable and affordable risk management services and lack of appropriate and affordable livelihood financing are note worthy aspects because they again show the huge gaps between a great vision and intended strategy (the recommendation of the well intentioned financial inclusion committee) and actual implementation on the ground, which is narrowly focused on consumption and small production credit
  xiiA popular metaphor for a line not to be crossed
  xiiiThis can happen through alternative channels that afford lower costs, have greater trust, and high levels of mutual acceptance
  xivLike handicrafts etc
  xvOf course, this would need to be validated specifically for a context, a product and a partner but these are general suggested arrangements.
  xviSourced with adaptation from Arunachalam "UNDP Financial Inclusion Strategy in 7 Focus States: Strategic Consideration and Suggestions, UNDP" (2007)
  xviiWeather and crop insurance are gaining ground. Contract farming schemes exist but are not producer oriented
  xviiiSome innovations exist here for health as well as life coverage but much work is necessary in the nature of product design and also distribution. Micro-pension schemes are also available.
  xixPost harvest loans in fisheries/agriculture and warehouse receipts are examples of such products.
  xxThe figure draws on ideas from reports published by the NCEUS

(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).

Ramesh S Arunachalam
1 decade ago
Sorry beth, one small correction

I also said that I was disappointed because they could NOT spot the frauds and multiple lending happening through an out and out commercial model.
Ramesh S Arunachalam
1 decade ago
Dear Beth

Thanks for your comments and I would be grateful if you can re-read my article carefully again. I have not blamed just CGAP but clearly stated that since they shaped a lot of the commercial model and because they could not help build sufficient safeguards, they are to take at least a small portion of the blame. I also said that I was disappointed because they could spot the frauds and multiple lending happening through an out and out commercial model.

That said, I fully agree with you that many stakeholders (and not just CGAP) are indeed responsible for unabashedly pushing the commercial model – without safeguards. Not all commercial models are bad but there need to be checks and balances always to prevent frauds and I am sure you would agree with that. I hope I have made myself clear on that and your point on this is a fair one. Thanks and much appreciated!

That said, I would also like to tell you where my disappointment comes from. On numerous occasions, I have warned CGAP between April 2005 - October 2010 on what was happening in Indian micro-finance. In may 2005, the CGAP representative saw Dr Thorat and I present our paper on institutional and market failures (in front of no less than a joint secretary, MoF) and the next day, I spent one hour with the CGAP representative explaining the frauds in Indian micro-finance. In 2005, I again told 1 CGAP officer about all that is going wrong at an informal meeting and discussion in the car while driving him to the airport at Hyderabad and also told two of them when we met on a flight from Mumbai on 28th June 2005 and we travelled to Chennai and had the opportunity to discuss for almost an hour. On April 5th 2006, I also told two officials affiliated with CGAP initiatives on data and research on what was going on. I presented credible evidence in all cases. I feel that CGAP, with all its leverage could have done something to stem the rot then. That is why I say I am disappointed. I can provide names, dates and places but my objective is not to blame anyone. I simply felt that CGAP could have done more and thereby helped to prevent a larger crisis.

Let me tell you a recent instance…that happened before the 2010 crisis of October…

On 17th August 2010, my paper on Corporate Governance related to MFIs in the context of the SKS IPO - which provided hardcore and concrete evidence with regard to Governance and other issues raised in Prof Sriram’s paper - was forwarded to CGAP (3 people) by a world bank staff from India. I did not try to send the paper. On the contrary, a World Bank staff in India contacted me and asked if the paper could be forwarded. I agreed and I was copied. I later wrote to the three people (on September 22nd 2010) and asked them for feedback on the paper and also told them that I would send them a revised and updated paper. Pat came the reply from one of them (on 23rd September 2010) and I have reproduced the same as Technical Appendix 29 A in my book and quoted portions below:

“Many thanks for sharing the document with us. It was good to have another perspective and you added some levels of analysis we had not seen anywhere else. We were not able to spend too much time on your piece since it was not for wider citation, and we had a paper to produce ourselves which relied on sources we could cite. A CGAP note on SKS should come out in the next couple of days. There has been so much written and discussed about SKS it is hard to guage what more would be helpful at this stage. I think your piece does bring out new facts which included a level of detail we had not seen elsewhere. But what would be productive at this stage? It certainly would be healthy to be sure all the facts are known. Its important that we draw lessons, but we also need to move on.”

After some mail exchanges, the CGAP SKS paper came out and I wrote back to CGAP on 30th September 2010 and I reproduce the same here from technical appendix 29 A in my book:

Hello and I have seen the CGAP note on SKS that you referred to in your mail below. While I appreciate the hard work, I must say that the paper falls short in using objective information available in the public domain and it also also ignores important published material including annual reports and DRHP. The matters of conflict of interest, which are of paramount importance in Corporate Governance and related issues have been not addressed adequately. What amazes me is the fact that it is a complete one sided approach that the article has taken. All arguments put forth in Prof Sriram's paper have been ignored and his paper published in EPW was not even cited. Please take this as my first comments and I will come back to you with detailed comments officially - I am sure you apprerciate the fact that some one is writing back to you on this. CGAP's crediability will be seriously undermined by such one sided articles...the true facts are quite different...

This again is one instance where CGAP could have done more to highlight serious governance issues and as the events of October 2010 showed, there were many governance issues (sudden sacking of CEO, governance aspect of MBTs, loan to promoter to buy shares in same company at par value etc) that came to be raised by several stakeholders and the rest is now history…

Beth, again, your point on blame to be shared is a very fair one but l am also raising a larger issue – how and where are client interests being protected at CGAP and its governance structures? How is CGAP accountable to the low income people for whom it was set up – initially to alleviate poverty and later to promote access to finance? Last but not the least, what about representation on CGAP board for recipient (non-donor) countries? I believe, given CGAP’s strategic position, these are all very crucial questions and it is my humble submission that CGAP must start its process of introspection across its various Governance structures.

I am glad that CGAP is now advocating a commercial approach with safeguards but they must ensure that this gets implemented on the ground (they may have advocated such an approach before but sadly, that was not translated to action in India and many other places and that is precisely why they should introspect). And that is why it is crucial that the CGAP board also has adequate representation for governments or central banks (and not just MFIs) from recipient countries.

Very few people will come out and say what I have been saying. My intentions are clear and I have no vested interest what-so-ever – all I want is a healthy micro-finance industry to develop globally so that low income clients get access to fair, transparent and need based financial services delivered in an ethically sound manner. And I still believe that CGAP can help facilitate this, provided they introspect and make the necessary course corrections. Whether they do so or not is entirely up to them and only time will provide us the answers.

Thanks again for taking the time to comment. Much appreciated and as always, it is indeed a pleasure to hear from you Beth and I have always admired your honesty and plain speaking…Thanks and have a good day at work!


With warmest regards

Beth Rhyne
1 decade ago
Dear Ramesh, I think that if you look at what CGAP has been advocating for the past several years, you will find that what it stands for now (and this is not new) is very much the approach you are advocating. Moreover, it is not entirely fair to single out CGAP as if it is responsible for the path microfinance has taken in India. Many other factors are at work, and many other players, (myself and the organizations I have worked with included), were part of shaping the drive for scale and sustainability that ultimately became too narrowly focused on credit growth.
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