Microfinance in India is undergoing a crisis caused by a toxic mix of mushrooming growth and political volatility. As they ponder their next steps, participants in the Indian microfinance sector would do well to examine another crisis that touched microfinance, in Bolivia in the years 1999 and 2000. Hyderabad, meet La Paz.
Arid, high-altitude La Paz may not share much physical resemblance with steamy Hyderabad, but like Hyderabad, it had a population in need and social entrepreneurs who created a successful microfinance sector. In the late 1990s, Bolivia had the most developed microfinance market in Latin America, with several mature lenders serving Bolivia's many informal microenterprises.
A Bubble in Bolivia
The sector began to tilt into crisis with the entry of consumer lenders from Chile and other countries in the late 1990s. The consumer lenders brought techniques from developed economies aimed at the middle class. They pushed out loans very fast. But Bolivia's middle class was tiny, and so the consumer lenders found a new customer base among the microenterprise owners who were already clients of microfinance institutions. Their pitch said, "If you're a good microfinance client, come to us. We'll give you a bigger loan and you'll get it faster." This appeal allowed them to double the total number of small loans outstanding in the market within a year. Debt stress rose among inexperienced clients.
Just as in India, some over-indebted clients became openly desperate, and their plight caught the attention of politically motivated actors. A debt protest movement began, starting with street marches and hunger strikes and eventually escalating to the takeover of the banking superintendency by dynamite-wearing protestors. They held the banking supervisors hostage in their offices while demanding debt forgiveness. At another stage, linked to the wave of political violence that finally overthrew the Bolivian government, protestors hauled the furniture and computers from lenders' office out into the thin La Paz air and set them on fire.
Everyone involved with microfinance in Bolivia, including many over-indebted customers, suffered deep pain during that crisis, but ten years later, the institutions have recovered and the microfinance sector has been healthy for several years running, notwithstanding the global economic crisis. The way out of the crises required a number of adjustments to set the sector on a stronger, more consumer-friendly footing. If similar adjustments were instituted by the policy makers and financial institutions in India, the outcome of today's crisis might (after the current pain), be a more robust microfinance sector that serves its clients better.
Recipe for Reform
First of all, the bad players were weeded out. The consumer lenders whose methods were irresponsible lost the money they had brought to Bolivia. They fled in disgrace. Consumer lending disappeared from the country for most of the next decade.
This left the Bolivian microfinance institutions. Their methods were basically sound, but they needed to make some crucial adjustments. They revised their loan approval methods to focus more on the borrower's ability to repay, so as not to lend too much. Importantly, they realized that the country's credit bureau needed an overhaul. It would have to include the clients from every kind of lender, and it would have to make its data more complete and timely. Today, the credit bureau informs microfinance institutions like BancoSol as soon as a client seeks a loan at another institution.
The microlenders also realized that they needed to give their clients a better mix of services, and over the next few years they added savings, money transfers, and more experimental programs like health insurance. They also realized that in a highly charged political environment, interest rates would always provoke public challenges, so they worked hard to bring down rates by cutting costs. Interest rates fell from an average of over 35 percent to just under 20 percent.
And they learned the value of having a strong capital base and capable governance to weather the inevitable storms.
The banking authorities, for their part, also learned from the crisis. They found out that they needed to understand the business models of microenterprise lending and consumer lending better so that they could spot weaknesses. This meant developing a cadre of supervisors dedicated to microfinance and commitment to frequent dialogue with industry associations.
Clients, too, may have learned to be more careful. The leaders of some of the debt protests turned out to be charlatans for whom the protests were a moneymaking operation ("Pay your dues to join the movement and we'll get your debts forgiven."). They were ultimately brought to justice by the very people who joined the movement. Clients may now be more aware of the difference between a legitimate credit provider and a schemer. And clients who once flaunted their multiple loans as status symbols may now recognize that bicycling credits ultimately results in an unmanageable debt load.
There is one enormous difference that makes a positive outcome in Hyderabad much less likely than it was in La Paz. In the Bolivian crisis, the protesters came from outside the government, and the government worked closely with the industry to reach a resolution. In Hyderabad, the opposition to microfinance comes from inside the government, specifically, the government of the state of Andhra Pradesh, making it much harder for the regulatory authorities (the Reserve Bank of India) to negotiate a relatively apolitical solution. In the past, the Reserve Bank of India has, like the banking authorities in Bolivia, recognized the importance of microfinance institutions in bringing financial services to low income people. But its voice is not the only powerful determinant of the way forward.
(For more on the microfinance crisis in Bolivia, see Mainstreaming Microfinance: How Lending to the Poor, Began, Grew and Came of Age in Bolivia, by Elisabeth Rhyne, Kumarian Press: 2001.)