Gary Goldman

For Arunachalam, MFI Industry Still Has Lessons to Learn

Ramesh Arunachalam is a development practitioner whose expertise includes urban poverty alleviation as well as microfinance, a field he unabashedly supports while remaining a staunch critic. After decades of close work with Microfinance Institutions (MFIs) and various stakeholders including governments and regulators, he recently published “The Journey of Indian Microfinance: Lessons for the Future.” This reflective book follows the startling evolution of an industry first perceived in the country as a revolutionary game-changer and now viewed by the mainstream as a vilified model controlled by money-hungry lenders. Arunachalam suggests a practical framework that policy-makers and other stakeholders will need to follow in order for Microfinance to thrive once more. Months after the dramatic rash of suicides by microcredit clients in Andhra Pradesh, what exactly did MFIs get it wrong?

Arunachalam: MFIs engaged in multiple lending for consumption purposes and often granted loans without assessing the loan absorption capacity of the clients. Implied in this statement is the fact that MFIs have pushed loans indiscriminately to low-income clients for consumption purposes without any sensitivity to their debt servicing ability, tried to grow very fast in this manner, and therefore to make unnatural profits. It seems more and more clear that MFIs grew to attract capital at high valuations and, thereafter, had to justify these high valuations by providing better returns to investors. Investors likewise, as they had paid huge premiums, wanted to recover their investment fast and hence, were perhaps pushing the MFIs to grow faster. Banks and policy-makers also joined the bandwagon, causing much euphoria about financial inclusion that also resulted in unsound burgeoning growth. State governments, on their part, took some very rigid stands as well, including delivery of hugely subsidized credit. All of the above created the 2010 Indian Microfinance crisis in my opinion. Have lessons been learned, at least domestically?

Arunachalam: While the industry must recover, I however believe that lessons have not yet been learned fully by all stakeholders. I hope that the days and months to follow will see “introspection” with integrity by all stakeholders concerned – MFIs, lenders, equity investors, clients, financial regulators and state governments – and this must result in clients being placed first. You are a firm believer in the limitless possibilities of providing financial services to the poor, but it’s also clear that you became completely disillusioned with some of the actors of microfinance over the past years. Was your book born out of frustration?

Arunachalam: The popular perception of microfinance has hit a real low and much of the good work by many stakeholders, including some MFIs, is also being viewed suspiciously. This is indeed a very sorry state of affairs. How did this happen? How did microfinance, which was regarded as a noble profession, come to be viewed this way? To what extent did change in the microfinance paradigm to hardcore commercialization cause this negative perception about microfinance? These and other questions started to flit across my mind and I decided to pen my thoughts. My simple book is an outcome of that. Do you believe that the plummeting of the industry in India could be replicated elsewhere in the world?

Arunachalam: I believe that a crisis should never be wasted and I have tried to convert it into a learning opportunity. Commercialization, without checks and balances, can cause similar crises elsewhere. Financially including low-income people without simultaneously addressing structural issues related to poverty and exclusion will simply not help, and financial inclusion will ultimately result in greater exclusion among other things – especially in agriculture/allied sectors. When people with weak and vulnerable livelihoods are lent large sums of money, then repayment will either have to come from fresh loans or a restructuring of loans. At some point, this cycle will stop and the bubble will simply burst. These clients will then become financially excluded all over again What can be done to avoid this situation, then?

Arunachalam: Re-engineering the financial inclusion paradigm to ensure the delivery of a wide-range of vulnerability reducing financial services – quality credit, savings, insurance, risk management services – is critical. Furthermore, the focus of financial inclusion must also be re-engineered such that the delivery of financial services is used strategically to drive higher rewards, better remuneration, and greater power down the value chain. Enhancing the staying power of small producers will result in their having better bargaining capacity, which in turn will mean that they can negotiate better with market elements and get a return or price that is due to them and commensurate with the value that they create in the first place. Finally, there has been a lot of speculation regarding setting up a “credit bureau” in India, referred to as a way to solve some of microfinance’s most daunting challenges (aggregation of data, quality reports, regulation…). In your opinion, is this a positive first step?

While a credit bureau is certainly a positive step, it should not be made into a magic wand that can solve the present crisis. Despite the most sophisticated credit bureaus, the sub-prime crisis in the US could not be avoided and therefore, no credit bureau-irrespective of the manner is likely to be a foolproof strategy. When we talk about Microfinance clients, there is so much information asymmetry in regards to their loans and lives that I am not sure that the proposed credit bureau would be able to acquire such information. We do not have access to any reliable and valid data on informal sources of finance – or the SHG bank linkage program -, and getting them at the scale required for the proposed credit bureau would be next to impossible in the Indian context. Finally, a credit bureau will perhaps depersonalize the client-loan officer relationship even more. What is needed at this time is deeper involvement and knowledge of the client’s life and business and stronger relationship building with clients.

Find out more about Arunachalam’s efforts and thoughts by reading his blog, Candid Unheard Voice of Indian Microfinance.

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financial inclusion, microfinance, poverty alleviation