Microfinance in India

An Institution in Jeopardy?
Case study
Reference no 211-035-1

This case was written by Sushuma G, Amity Research Centers Headquarters,

Bangalore. It is intended to be used as the basis for class discussion rather than
to illustrate either effective or ineffective handling of a management situation.
The case was compiled from published sources.

© 2011, Amity Research Centers Headquarters, Bangalore.

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 211-035-1
Microfinance in India - An Institution in Jeopardy?

Microfinance in India - An Institution in Jeopardy?

Author: Ms. Sushuma G

Abstract: Financing the poor was crucial in India which had around 120 million homes with no access to
financial services. Microfinance with an aim to uplift the poor had provided small loans, mobilised small
savings and offered micro insurance services to the poor. Financial needs of the poor were met by a variety
of service providers such as Non government Organisations (NGOs), cooperatives, Self Help Groups
(SHGs), credit unions, commercial banks and microfinance institutions (MFIs). Microfinance had grown
rapidly worldwide and had proved to be successful in empowering the poor. Microfinance entered India
during the 90s and the sector grew rapidly since 2004. India was one of the largest microfinance markets in
the early 21st century accounting for 30% of the world’s microfinance borrowers. In India, majority of the
microfinance borrowers were women and the southern states became the major hub of the microfinance
industry. To accelerate microfinance expansion, commercial banks were encouraged to fund the SHGs and
MFIs. The benefits drawn by the microfinance industry lured the private equity investors to divert their funds
into this sector. Though increased finance would result in more financial services to the poor, the profit
motive of the investors had resulted in few erroneous lending and practices in the microfinance industry.
Microfinance industry was in crisis and criticised heavily as a result of the backlash in Andhra Pradesh due
to aggressive lending strategies and bad debt recovery practices. Though MFIs had served the unbanked
people efficiently, regulatory issues existed. The government had taken initiatives to protect the interest of
the investors, borrowers and aimed to regulate the microfinance industry. In such a scenario it needs to be
seen whether the microfinance industry would overcome the crisis and continue to serve the poor on social
grounds.

Pedagogical Objectives

The case study helps to understand and analyse:

 Evolution and Growth of Indian Microfinance Industry
 Crisis in Indian microfinance industry
 Future Plans.

Case Study

“The business model of microfinance institutions has to undergo a change”.1

– Rangarajan, Former Governor, Reserve Bank of India2

India with around 120 million homes with no financial access was the largest microfinance market in the
world in the early 21st century.3 Microfinance aimed to uplift the poor by providing access to basic financial
services. Worldwide, microfinance had reached the bottom of the pyramid through various financial services

1 Kazim Amy, “Microfinance companies seek crisis funding”,

http://www.ft.com/cms/s/0/7c32f508-ef9b-11df-8bbb-00144feab49a.html, November 15th 2010

2 Is the central banking institution of India. It formulates, implements and controls the monetary policy, manages foreign

exchange, issues currency and acts as a banker to the government and other banks.
3 “Some Facts About India's Microfinance Sector”,

http://www.vccircle.com/500/news/some-facts-about-indias-microfinance-sector, October 31st 2010

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such as loans, savings and microinsurance.4 Financial services offered by the microfinance industry had
helped the poor to augment their income, health and education. Financial service providers such as Non-
government organisations (NGOs), cooperatives, Self Help Groups (SHG) and microfinance institutions had
served the poor since 1990s. Microfinance had bridged the gap between the commercial banks and the
unorganised money lenders.5 In India microfinance assistance was offered through two models such as
SHG model and MFI model.6 India accounted for 30% of the world’s microfinance borrowers and 7% of the
world’s loan portfolio by the end of the first decade of the 21st century. Microfinance Institutions (MFI) were
more prominent in the southern part of the subcontinent serving around 70 million people as of 2010 and
majority of the microfinance borrowers were women.7

Microfinance started in India in the early 90s and in 1992 Reserve Bank of India (RBI) had allowed the
commercial banks to lend funds to the SHGs and MFIs to promote financial access to the poor and
accelerate the expansion of microfinance in India.8 Most MFIs charged high interest around 27% on an
average. However as the interest rate was less compared to the private money lenders microfinance
assistance was availed by the poor.9 Indian microfinance sector had grown at CAGR 105% during 2004–
09.10 Rapid growth, increasing client base and high returns had attracted many private equity investors to
infuse funds into the microfinance sector. Entry of Private Equity Funds (PEFs)11 into this sector had
increased since 2007.12 Commercialisation and the urge to be in par with their private investors had driven
the MFIs to disburse huge loans to the borrowers with no regard to the borrowers’ repayment abilities. This
led to multiple lending and majority of the funds were used for non income generating activities.
Indiscriminate lending and irresponsible borrowing had pushed the microfinance sector into crisis.
Continuous suicides in the southern state of Andhra Pradesh had resulted in backlash against the lenders
and politicians had revolted against the recovery of loans. Further several erroneous practices in the
microfinance sector had been brought to light during 2010. Improper regulation was another issue in this
sector.13 The government had appointed Malegam committee to recommend best practices and regulate
the microfinance industry and protect the interests of the poor. The committee had suggested measures like
interest cap on borrowings.14 The case study analyses the Indian microfinance industry scenario and
whether it would recover from the crisis and serve the poor successfully as intended.

Growth Saga of Microfinance in India

Financing the poor had gained momentum in India during the 1960s (Annexure I). Low income people,
mostly located in the rural areas during this period (1960s), had no or limited financial access. To augment
the financial access of the rural people, the government had taken initiatives such as nationalisation of
banks, opening up of rural branches and setting up of National Bank for Agriculture and Rural Development

4 “SKS Microfinance Ltd”, http://www.sebi.gov.in/dp/sksmicrofin.pdf, March 25th 2010

“© 2011, Amity Research Centers HQ, Bangalore. All rights reserved.”
5 Sona Varma, “Scaling Up Microfinance in India: The Role of the Private Sector”,

http://www.ifpri.org/sites/default/files/publications/oc63ch28.pdf
6 Sinha Frances, “State of Microfinance in India”, http://www.inm.org.bd/saarc/document/India.pdf, 2009
7 “Some Facts About India's Microfinance Sector”, op.cit.
8 “Scaling Up Microfinance in India: The Role of the Private Sector”, op.cit.
9 Kulkarni Vivek, “Microfinance, India's sub-prime crisis”,

http://www.thehindubusinessline.com/2011/01/15/stories/2011011550150800.htm,
January 15th 2011
10 Balakrishnan Reghu, “Soaring microfinance lures PE investors”,

http://www.financialexpress.com/news/soaring-microfiannce-lures-pe-investors/537843/, November 6th 2009

11 Is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities

according to one of the investment strategies associated with private equity.

12 George Manju Mary, et al., “Inverting the Pyramid: The Changing Face of Indian Microfinance”,

http://www.microfinancegateway.org/gm/document-1.9.26137/24.pdf, October 2007

13 “Q&A: The Future of Microfinance”,

http://www.microfinancehorizon.org/featured-articles/qa-the-future-of-microfinance/, November 23rd 2010

14 “Malegam panel proposes 24 pc cap on interest rate on MFI loans”, http://articles.economictimes.indiatimes.com/2011-

01-19/news/28431245_1_malegam-panel-mfis-microfinance-institutions, January 19th 2011

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(NABARD)15 during the period 1960 – 80s (also referred as social banking phase). Though the credit
volumes in the rural areas increased, institutional structure was neither profitable nor suitable to meet the
needs of the rural poor. In the next phase during the 90s civil society initiatives started through which rural
women workers were offered credit facilities. During the 90s, NABARD promoted programs such as SHG –
Bank linkage and linked informal women groups to formal banking. Credit were extended to the poor on the
basis of reliance of peer pressure, self help and self sustainability and not based on collaterals. Credit was
offered at market rates in the second phase and not at subsidies as in the case of social banking phase.16
Based on the proposal of NABARD, RBI had allowed commercial banks to fund the informal groups (SHG)
without any collateral to meet the huge credit demands of the rural populace. Subsequently SHG movement
expanded rapidly offering small loans to the rural poor. These initiatives led to the development of the
concept of microfinance in India during the 90s.17

Microfinance was referred to the delivery of small loans to the unbanked poor which enhanced their income
generating opportunities and alleviated them from poverty. Similar to the other income groups, poor people
were also in need of various financial services which were mainly met by various financial intermediaries
mostly informal. Majority of the microfinance borrowers in India were women as microfinance was
considered as means for women empowerment and gender equality.18 In India microfinance was delivered
through two models – SHG Model and MFI model. These was similar to the SHG Bank Linkage program
wherein people with common interests join together and contribute regular savings to a common fund which
was later used as collateral for future loans. Under this model government agency or an NGO provided
developmental help to the SHG to manage their funds and records. According to report titled “Inverting the
Pyramid” from Intellecap19, SHG model was dominant during the 90s and the early 2000s in terms of loans
disbursed and number of borrowers. However, MFI model had been gaining ground and SHG showed a
declining trend since 2004 (Exhibit I). Under the MFI model, MFI, a separate entity, provided loans directly
to the borrowers and managed them with their employees. MFI issued loans with no collateral or prior
savings. Loan disbursement and collection of repayments were taken care by the MFI staff. Various forms
of MFIs were functioning in India which could be categorised into for profit and non profit organisations. –
Not for profit organisations such as trusts, cooperatives and non profit Non Banking Financial Companies
(NBFCs)20 were registered as Section 25 Companies.21 The profit MFIs were registered as NBFCs and
were regulated by the RBI.22 MFIs were allowed to provide credit but were restricted to mobilise savings.23
In 2000, RBI included microfinance as one of the high priority sectors to which commercial banks could lend
their money. Subsequently, banks in India had provided huge funds to the microfinance sector to meet their
priority sector lending targets. This facilitated the rapid growth of the microfinance industry in India.24 Further
banks like ICICI25 had devised innovative ways to partner with NGO-MFIs to reach the rural masses.26

15 Is set up as an apex Development Bank with a mandate for facilitating credit flow for promotion and development of
agriculture, small-scale industries, cottage and village industries, handicrafts and other rural crafts.
16 “Inverting the Pyramid: The Changing Face of Indian Microfinance”, op.cit.
17 “Scaling Up Microfinance in India: The Role of the Private Sector”, op.cit.
18 Ghosh Rajarshi, “Microfinance in India – A critique”,

http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN024232.pdf
19 Since 2002, Intellecap has been committed to economic and social development through market-based solutions that

help build and scale innovative businesses for social change.

20 Are financial institutions that provide banking services without meeting the legal definition of a bank.
21 Section 25 companies was one legal form of Non profit organisation regulated under the Companies Act of 1956. They

have the most reliable strongest organizational structure and are formed for the sole purpose of promoting commerce art,
science, religion, charity or any other useful object and have been granted a licence by the central government
recognizing them as such.
22 “SKS Microfinance Ltd”, op.cit.
23 “State of Microfinance in India”, op.cit.
24 “Scaling Up Microfinance in India: The Role of the Private Sector”, op.cit.
25 Is a major banking and financial services company based in Mumbai. It is the second largest bank in India and the

largest private sector bank in India by market capitalization.

26 “Inverting the Pyramid: The Changing Face of Indian Microfinance”, op.cit.

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Exhibit I
Microfinance Loan Disbursements

Source: “SKS Microfinance Ltd”, http://www.sebi.gov.in/dp/sksmicrofin.pdf, March 25th 2010

In 2009, the number of microfinance clients was estimated to be around 73.6 million and outstanding credit
stood at INR 344.13 billion.27 The average outstanding loan per client had also increased from INR 4200 in
2008 to INR 5200 in 2009 mainly due to the increase in number of borrowers with loan in excess of INR
10000. MFI channel gained momentum in India and had surpassed the SHG model in terms of loans
disbursed and the number of clients served. MFI channel had a CAGR of 50.3% growth during 2007–09 in
terms of clients and CAGR of 84.3% in outstanding loan portfolio.28 While the average loan offered under
the SHG model was INR 3789, the average loan offered by MFIs was INR 6519 in 2009.29 Bharat
Microfinance report30 had revealed that for profit MFIs’ growth was higher compared to non profit MFIs both
in terms of clients and loans outstanding during 2009.31 Of the 331 poorest districts in India, MFIs had
extended their reach in 234 districts as of 2009.32 (Exhibit II). In this period MFIs had offered their services
in 60 new districts (total 465 districts) of which more than half were the poorest districts in India. The
repayment rate in the MFI model was higher. Though SHG had also increased their client base and loan
portfolio, non performing asset ratio and SHG management issues were of concern. Based on the past
growth rates of both delivery channels (2009), the Bharat Microfinance report estimated that microfinance
industry portfolio would reach to INR 2000 billion by 2015.33

27 “Overview of Indian Microfinance: Key takeaways from the Bharat MF Report [part-1]”,
http://www.microfinancefocus.com/news/2010/04/20/overview-of-indian-microfinance-key-takeaways-from-the-bharat-mf-
report-part-1/, April 20th 2010
28 “SKS Microfinance Ltd”, op.cit.
29 “Overview of Indian Microfinance: Key takeaways from the Bharat MF Report [part-1]”, op.cit.
30 Published by Sa-Dhan, the association of community development finance institution, gives an analysis of the

microfinance industry in India.

31 “SKS Microfinance Ltd”, op.cit.
32 “The Bharat Microfinance Report – Quick Data 2009”, http://indiamicrofinance.com/the-bharat-microfinance-report-

quick-data-2009.html, July 15th 2009

33 “Overview of Indian Microfinance: Key takeaways from the Bharat MF Report [part-1]”, op.cit.

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Exhibit II
MFIs Reach in Poorest Districts

Source: “The Bharat Microfinance Report – Quick Data 2009”,

http://indiamicrofinance.com/the-bharat-microfinance-report-quick-data-2009.html, July 15th 2009

Many NGO-MFIs, started during the 90s, became regulated entities in the early 21st century and increased
their loan size and expanded their client base. On the other hand many NBFC had downscale their
operations to venture into low income markets offering small loans. MFIs during the 90s aimed to provide
financial services to the unbanked poor. Second generation MFIs started during the 2000s considered
microfinance as a business and aimed to create value for the share holders. Microfinance as a social
business had brought in changes in legal structures, capital structures and sources of funds (Exhibit III).
Further many non profit MFIs had transformed into for profit MFIs to provide varied services to the clients,
increase their balance sheet and attract funds. Many large corporate firms like Reliance34, Muthoot
Finance35 had showed interest to enter into microfinance industry. MFIs which were confined to credit
services had extended to provide savings, pensions and insurance services to the poor. MFIs outreach had
also increased during the early 21st century. MFIs and SHGs which had earlier focused upon the southern
states of the country had extended to few northern states with high incidence of poverty. Urban
microfinance had also gained ground since 2000s.36

34 Is India's largest private sector enterprise, with businesses in the energy and materials value chain.
35 The largest gold financing company in India in terms of loan portfolio. They provide personal and business loans
secured by gold jewellery, or Gold Loans, primarily to individuals who possess gold jewellery but could not access formal
credit within a reasonable time.
36 “Inverting the Pyramid: The Changing Face of Indian Microfinance”, op.cit.

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Exhibit III
Changing Traits of MFIs
Character Traits First Generation MFIs (90s) Second Generation MFIs (2000s)
Promoter Profiles Development Workers Entrepreneurs, professionals with mainstream
banking, consulting or corporate experience
Motivations Client outreach, Poverty Alleviation Shareholder value creation (social and
financial), institutional sustainability
Legal Forms Not for profit forms: Society / Trust For-profit forms: Non Banking Finance
Company (NBFC)
Capital Structures Mostly grant and debt funded Equity, debt, portfolio sale, exploring capital
markets, future plans for IPOs
Geographic Ambitions Regional National and in some cases, global
Growth Strategies Organic Slow, branch by branch Inorganic Fast, exploring mergers, acquisitions
expansion and franchising
Product Focus Single Product: General purpose Multi –product: Diversification into individual
loan loans, asset financing, housing loans,
insurance, remittances
Strategic Alliances Donors, Technical assistance Equity investors, Lenders, Mainstream financial
partners, NGOs businesses, retail players
Time Taken for Break- Five to six years One to one and a half years at the branch level,
even Two to three years at the head office level
Human Resources Development/ Social welfare Management graduates, expertise in business
professionals with expertise in disciplines such as finance, technology,
community mobilization, project marketing
management
Governance Largely patrons of the NGO Relevant expertise for institution
Perception of Beneficiaries unable to access An untapped customer segment
Microfinance Users formal markets
Source: George Manju Mary, et al., “Inverting the Pyramid: The Changing Face of Indian Microfinance”,
http://www.microfinancegateway.org/gm/document-1.9.26137/24.pdf, October 2007

Success of MFIs had attracted commercial capital from varied sources. Large MFIs had accessed funds
from capital markets through debentures, bonds and other instruments. Further MFIs had issued equity to
investors such as venture capitalist, private equity and financial institutions. Venture Intelligence37 had
estimated that around 40% of the total Indian private equity deals were in the microfinance sector during
2008-09. Indian microfinance industry accounted for 7% of the global microfinance loan portfolio size as of
2010. Microfinance industry had grown at 80% since 2007 and around 3000 MFIs and NGO-MFIs were
present in the country as of 2010.38 Microfinance had brought in social and economic benefits to the poor.
As intended micro credit had generated additional income to the poor and had facilitated in asset building
and enhanced their social status. Majority of the microfinance borrowers were women and it had paved way
to women empowerment. Women had a better exposure by running their own business and improved
financial status had enhanced their status in the family and the society. Microfinance had also resulted in
poverty reduction.39

MFIs aimed to control their operating costs by implementing new technologies and increasing customer
base. MFIs member base increased to 22.6 million by the end of 2000s. Computerised management
information system and online data transfers had been implemented in large MFIs. Use of local languages

37 Is the leading source of information and analysis on private equity, venture capital and M&A in India.
38 “Some Facts About India's Microfinance Sector”, op.cit.
39 “SKS Microfinance Ltd”, op.cit.

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for data entry had reduced training needs and costs. Further MFIs had been exploring means to enhance
their services through use of mobile phones and offering new financial products and services to the poor.40

Indian Microfinance Blues

Microfinance had a dominant role in providing financial services to the poor in India. It had grown rapidly in
terms of branches, members and loan outstanding since 200741 (Exhibit IV). As of 2010 the industry had
$4.6 billion outstanding loan to 70 million borrowers. Microfinance industry offered loans with interest
charged at 24% - 30%. Though the interest rate was higher than the formal banking system it was less than
the money lenders. At the same time, MFIs procured loans from banks at 9% -14%. The rapid growth of the
microfinance industry in the early 21st century had attracted private equity funds and other commercial
players to enter this sector. With the entry of commercial players into the microfinance industry, the social
mission was sidelined and many microfinance lenders (non profit) had started to transform into for profit
organisations. SKS Microfinance42, one of the MFIs in India, made an Initial Public Offering (IPO) in 2010
and attracted huge funds. Subsequently incorrect practices, governance and transparency issues in the
microfinance industry came to light.43

Exhibit IV
Indian Microfinance Industry Growth

Source: Kulkarni Vivek, “Microfinance, India's sub-prime crisis”,

http://www.thehindubusinessline.com/2011/01/15/stories/2011011550150800.htm, January 15th 2011

Earning profits and creating value for the shareholders gained prominence. To boost their revenue MFIs
had implemented aggressive lending strategies with no regard to the repayment capacity of the borrowers.44
Reddy Subrahmanyam (Subrahmanyam), Senior Rural Development Official had expressed that, "Loans
have been given to rural people without checking whether they had the capacity to repay".45 To grow rapidly
MFIs had adopted Joint Liability Group (JLG) method where agents persuaded 5-6 women who need a loan
to join a group and guarantee each one’s loans. This method lacked the bonding between the members and
peer pressure to repay the loans.46 Lending process were not as per the RBI guidelines. Group formation
was not given due consideration and loans were offered without any check on credit history, purpose of loan
and repayment ability. Individual promissory notes were obtained against the guidelines of RBI. Such
aggressive lending policies had also resulted in multiple lending.47

In addition, many borrowers had used the microfinance loans for consumption purposes instead of investing
them for income generation purposes which worsened their financial status further.48 Dr Rangarajan,

40 ibid.
41 “Microfinance, India's sub-prime crisis”, op.cit.
42 Is a non-banking finance company (NBFC), regulated by the Reserve Bank of India. SKS claims its mission is to

eradicate poverty by providing financial services to the poor.

43 “Crisis in the Indian Microfinance Industry”,

http://www.articlesbase.com/banking-articles/crisis-in-the-indian-microfinance-industry-3575556.html, October 30th 2010

44 ibid.
45 Biswas Soutik, “India's micro-finance suicide epidemic”,

http://www.bbc.co.uk/news/world-south-asia-11997571, December 16th 2010

46 “Microfinance, India's sub-prime crisis”, op.cit.
47 Chintala Prashanth, “Macros that felled microfinance”,

http://www.business-standard.com/india/news/macros-that-felled-microfinance/429578/, March 24th 2011

48 “Crisis in the Indian Microfinance Industry”, op.cit.

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Chairman of the Prime Minister's Economic Advisory Council had said that, “This is self-defeating and
inconsistent with the repayment capacity of the borrowers. The provision of credit for consumption purposes
has to be a small part of the total MFI credit”.49 As recovery of loans was tough, MFIs had followed unfair
recovery methods which became a huge burden for the poor populace.50 In cases where the borrowers
were not able to repay their loans, the recovery agents of MFIs convinced the borrowers to take fresh loans
to repay the old ones. Malegam committee report had pointed out that, “The organisation supposed to bring
them (the poor) out of poverty not only takes away the surplus, but also their honour... even their life”.51
Further, MFIs had portrayed 100% loan recovery to the banks that lent them in order to mobilise additional
funds.52

Andhra Pradesh had in excess of 10 million households which had availed microcredit facilities.53 Over a
period micro loans became a death trap for many people. According to the government sources, “More than
80 people have taken their own lives in the last few months (2010) after defaulting on micro-loans”.54 Vijay
Mahajan (Mahajan), Chairman, India's Microfinance Institutions Network (MFIN)55 had opined that "Multiple
lending, over-indebtedness, coercive recovery practices and unseemly enrichment by promoters and senior
executives [of micro-credit companies] has led to this situation".56 Subsequent to the suicide epidemic in
Andhra Pradesh the government had passed state legislation in October 2010 restricting microfinance
lending and collection practices. In spite of the stringent law, many politicians encouraged the stoppage of
repayment and around 10% of the borrowers had remitted their payments during November 2010.
Stoppage of repayments worsened the microfinance crisis. It had not only impacted the MFIs and the
borrowers but also the banking industry. Banks in India had funded 80% of the microfinance loans offered to
the borrowers and were concerned about the future losses. Few bank officials had revealed that Indian
banks had around $4 billion exposure in the microfinance industry. Sunand K. Mitra, a Senior Executive at
Axis Bank57 expressed that, “We are extremely worried about our exposure to the microfinance sector”.58
Fear of huge losses as a result of deferred loan repayments had made the banks to stop their lending to the
microfinance industry.59

In the initial years of microfinance movement (1990s) small loans offered to the poor was a powerful means
to eradicate poverty. Over the years, for profit organisations had increased with an aim to make money by
serving the poor. The profit motive of the venture capitalist and private equity investors led the microfinance
providers to lend loans at high interest rates. Such scenario existed in Africa, Latin America and other parts
of Asia. Microfinance business was very successful and few institutions had doubled their revenues
annually. V. Vasant Kumar, Minister for Rural Development, Andhra Pradesh blamed the industry that,
“These institutions are using quite coercive methods to collect. They aren’t looking at sustainability or
ensuring the money is going to income-generating activities. They are just making money”.60 The IPO of
SKS in August 2010 was another reason for the anger against the microfinance industry. SKS and its
shareholders had raised in excess of $350 million from the stock market. Subrahmanyam had accused that
microfinance companies were making hyper profits. Many officials had referred the Indian microfinance
crisis as similar to the US subprime crisis (2008) that impacted the global banking industry because of their

49 “Microfinance business model ‘is faulty'”,

http://www.thehindubusinessline.in/bline/2011/01/06/stories/2011010653180400.htm, January 6th 2011
50 “Crisis in the Indian Microfinance Industry”, op.cit.
51 “Macros that felled microfinance”, op.cit.
52 ibid.
53 “India's micro-finance suicide epidemic”, op.cit.
54 ibid.
55 Is the national organisation of Microfinance NBFC’s in India and consists of those microfinance companies which are

regulated by the Reserve Bank of India. It is a self-regulatory organisation of NBFC MFIs that aims to work with regulators
to promote microfinance to achieve larger financial inclusion goals.
56 “India's micro-finance suicide epidemic”, op.cit.
57 Is a financial services firm that had begun operations in 1994, after the Government of India allowed new private banks

to be established.
58 Polgreen Lydia, et al., “India Microcredit Faces Collapse From Defaults”,

http://www.relooney.info/0_NS4053_1159.pdf, November 17th 2010

59 “India's micro-finance suicide epidemic”, op.cit.
60 “India Microcredit Faces Collapse From Defaults”, op.cit.

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‘growth–at-any-cost’ strategy. Ela Bhatt, Head of Self-Employed Women’s Association61 b(SEWA), had said
that poor needed business and financial advice along with funds. She further opined that, “They were more
concerned about growth – not growth of the livelihoods and economic status of the clients, but only the
institutions’ growth”.62

Post crisis, MFIs had not offered fresh loans in Andhra Pradesh. Further they had also restricted their
lending to 30-40% of the collection received in other parts of the country. Balance money was retained to
repay the banks. Udaia Kumar (Udaia), MD of Share Microfin63 said that, “Low institutional-level funding and
inappropriate bureaucratic and political interventions in Andhra have brought the sector to the end of the
road”.64 In the end of 2010, MFIN represented 44 for-profit micro credit companies and had requested main
lenders of the industry for business continuity loan for its members. While the MFIN had feared that small
MFIs without adequate reserves might default on the loans received from banks, banks had warned the
industry that few defaults would downgrade the industry as such and would hike the funding cost in the
future. Mahajan had expressed that, “The banks are basically converting a problem into a crisis by not
dispersing additional loans. They are causing a liquidity crisis which will kill us before the Andhra Pradesh
borrowers”.65

Road Ahead

Microfinance had proved to be a powerful tool in financing the unbanked poor where the banks had failed.
The number of loan accounts had increased from 10 million in 2007 to 27 million in 2010 and the
outstanding loan increased from $840 million to $4 billion during the same period. However post crisis in
2010, microfinance industry had been highly criticised for charging high interest rates and made huge
revenues at the cost of the poor. Microfinance crisis revolved around the hyper profits earned by the MFIs,
huge cost incurred to reach the poor in the remote areas and sustainability of the business.66 While the
microfinance industry had said that they charged high interest rates to cover the cost incurred to serve
people in the remote areas, microfinance founder and Nobel Prize winner Muhammad Yunus warned that
high growth and profit had corrupted the microfinance industry.67 Vikram Akula, Chairman of SKS
Microfinance had said that his company had, “Reduced its interest rate by six percentage points, to 24
percent, in the past several years as volume had brought down expenses”.68 On the contrary, Rangarajan
had indicated that institutions had to lend at rates which would facilitate the borrower to repay the principal
amount. He commented that, “MFIs must introspect and decide on the level of margin they want to keep
given their cost of borrowing from banks and ensure that greater effectiveness is involved in the process of
lending”.69 He further added that the business model of Indian microfinance was at fault and had to be
revised.70

Experts had opined that non-adherence of the RBI guidelines by the microfinance service providers was the
main cause of the crisis in the industry. To expand their operations and earn profits, NGOs which served a
limited geographical area had transformed into Section 25 companies. Further microfinance became a good
business venture for the private equity funds.71 In the microfinance industry commission to agent were given

61 Is a trade union for poor, self-employed women workers in India. It is an organisation of poor, self-employed women
workers. These are women who earn a living through their own labour or small businesses. SEWA was founded in 1972 by
the noted Gandhian and civil rights leader Dr Ela Bhatt.
62 “India Microcredit Faces Collapse From Defaults”, op.cit.
63 Is a regulated Non-Banking Financial Company (NBFC) providing financial and support services to the marginalised

sections in society, particularly to poor rural and urban women across India.
64 “Macros that felled microfinance”, op.cit.
65 “Microfinance companies seek crisis funding”, op.cit.
66 Throat Usha, “Financial inclusion beyond microfinance”,

http://www.thehindubusinessline.com/opinion/article1609037.ece?homepage=true, April 8th 2011

67 Alini Erica, “Microfinance meltdown”, http://www2.macleans.ca/2010/11/25/microfinance-meltdown/, November 25th 2010
68 “India Microcredit Faces Collapse From Defaults”, op.cit.
69 “Microfinance business model ‘is faulty'”, op.cit.
70 “Microfinance companies seek crisis funding”, op.cit.
71 “Macros that felled microfinance”, op.cit.

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based on the number of clients and loans and executive remuneration was on the basis of profits which led
to excessive lending. Spate of suicides made the state to restrict the collection of loans and fresh loans
were allowed only when few conditions were satisfied.72 Further legislation allowed monthly repayments
rather than weekly payments. But the industry felt that this would result in decline in repayment rate as the
poor people cannot store money for long and their pressing financial needs would drive them to spend it
rather than repaying the loan.73 Udaia had agreed that microfinance sector needed few specific
regulations.74 However, Kaushik Basu, the Chief Economic Adviser to the Finance Ministry opined that
extensive regulation of the microfinance industry would impact its existence altogether.75

Microfinance had improved the financials of the rural entrepreneurs and experts and industry officials felt
that restoring this sector from crisis was crucial. Usha Thorat, Former Deputy Governor of RBI had pointed
out that, “The challenge ultimately lies in reducing costs through the use of technology, taking advantage of
economies of scale and passing on the benefits to the customer while providing a reasonable return on
capital to the investor”.76 MFIN had planned to create a fund and restructure the loans of 20% of the
borrowers in Andhra Pradesh. It had also planned to share their client databases with the government and
had been trying to negotiate restrictions on loans that were not disbursed through non profit SHGs.77 MFIs
intended to join the credit bureaus such as Credit Information Bureau (India) Ltd. (CIBIL)78 and share the
information of the borrowers to ensure that excessive borrowing or lending do not occur. Mahajan had
revealed that one of the industry guideline would be that no borrower would avail loan from more than three
lenders and their total outstanding loan would not exceed INR 50000. He added that, “Our intention is to
become the Nasscom of the micro-finance sector. We don’t want to just take care of current issues but also
take a long-term view on how to nurture the micro-lending industry”.79
In the late 2010, RBI had set up a committee under the chairmanship of Y. H. Malegam, one of the Board
Directors of RBI, to review the industry. Malegam committee had made few recommendations such as
margin cap of 10% on large MFIs, cap of 24% on interest on individual loans and maximum loan size of INR
25000. The committee had said that lending to microfinance could be categorised as priority sector lending
only if those MFIs follow certain conditions. It had stressed that 75% of the microfinance loans should be
used for income generation purposes and the loans should be offered to JLG/ SHG members. Further it
indicated the need for transparency, client protection code, redressal procedure and code of conduct.80
While RBI officials and the government stressed upon strict regulation on the microfinance sector, few
industry experts had opined that too many regulations would hinder the growth of this sector.81

The current crisis in the microfinance industry had shaken the investor confidence. Regulations were
needed to restore confidence. N. Srinivasan, author of the annual State of the Sector, Microfinance India
report was pessimistic about the future of most of the MFIs.82 MS Sriram, a researcher and consultant, had
said that, “In the current circumstances, the finance minister has made a bold and affirmative statement in
the recent Budget (2011). He has also thrown in some money for an India Microfinance Equity Fund. This
augurs well for the MFI sector – showing policy continuity rather than policy turnaround based on
Malegam’s recommendations. Otherwise we would only be able to say microcredit had a bright future

72 “Financial inclusion beyond microfinance”, op.cit.

73 “Microfinance companies seek crisis funding”, op.cit.
74 “Macros that felled microfinance”, op.cit.
75 “Microfinance business model ‘is faulty'”, op.cit.
76 “Financial inclusion beyond microfinance”, op.cit.
77 “India Microcredit Faces Collapse From Defaults”, op.cit.
78 India's first Credit Information Bureau, is an effort made by the Government of India and the Reserve Bank of India to

improve the functionality and stability of the Indian financial system by containing NPAs while improving credit grantors'
portfolio quality.
79 “India’s Micro Industry to Share Data”, http://www.cmlnortheast.org/microfinance-institution/indias-micro-industry-to-

share-data.html, March 1st 2011

80 “Financial inclusion beyond microfinance”, op.cit.
81 Nayak Gayatri, “Microfinance in India is like subprime lending: Y V Reddy”,

http://articles.economictimes.indiatimes.com/2010-11-23/news/27602978_1_priority-sector-lending-sks-microfinance-
microfinance-industry, November 23rd 2010
82 “How the Andhra Crisis is Going to Affect Investment in Indian Microfinance?”,

http://indiamicrofinance.com/andhra-crisis-investment-indian-microfinance.html, November 30th 2010

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behind it, not ahead of it”.83 Thomas Davenport, Director, International Finance Corporation (IFC)84, South
Asia had commented on the investment in microfinance industry that, “It is a good investment with good
sponsors, although some things have to change. We cannot expect the growth multiples seen until now.
MFIs will also have to self-regulate, improve risk management and develop standards and code of conduct.
Also it is important that they diversify product range. Till now, they have only focused on loans. There has to
be complementary products such as health insurance as well”.85 In such a scenario it remained to be seen
whether the self regulation by the industry and the initiatives by the government and the policy makers to
regulate the microfinance industry would restore investors’ and borrowers’ confidence and continue to serve
the poor efficiently.

83 MS Sriram, “M S Sriram: Microfinance policy - Rewind or Turnaround?”,

http://www.business-standard.com/india/news/m-s-sriram-microfinance-policy-rewind-or-turnaround/426937/, March 2nd
2011
84 Fosters sustainable economic growth in developing countries by financing private sector investment, mobilizing capital

in the international financial markets, and providing advisory services to businesses and governments.
85 “MFIs Are Still An Investible Opportunity”,

http://lite.epaper.timesofindia.com/getpage.aspx?articles=yes&pageid=6&max=true&articleid=Ar00600&sectid=4edid=&edl
abel=ETBG&mydateHid=28-03-2011&pubname=Economic+Times+-+Bangalore+-
+Corporate&title=%E2%80%98MFIs+Are+Still+An+Investible+Opportunity%E2%80%99&edname=&publabel=ET, March 28th
2011

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Annexure I
Microfinance Evolution in India

Source: George Manju Mary, et al., “Inverting the Pyramid: The Changing Face of Indian Microfinance”,
http://www.microfinancegateway.org/gm/document-1.9.26137/24.pdf, October 2007

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