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Commercialised microfinance: a Wall Street-style calamity for the poor?


Shares in India's largest microfinance institution, SKS, are now on sale and are expected to raise as much as $360 million. But is there a real link between the commercialisation of microfinance and actual results for the poor? Or is India in danger of repeating the mistakes of the US and UK in terms of allowing access to easy credit? When the World Bank and USAID began a determined push to commercialise microfinance in the 1990s and to inject Wall Street-style business savvy into this sector, expectations were high. The sector would be transformed, it was said, and poverty would be eradicated.

Reality, however, did not measure up, as debated at an ODI meeting in London on microfinance in the era of neoliberalism. Commercialised microfinance is increasingly associated not with sustainable poverty reduction, but with speculative excess and, in many cases, an increase in poverty and insecurity. Now there are concerns that commercialised microfinance has damaged local economies in the countries it should be helping, including India.

Commercialised microfinance in India: SKS

The non-profit Swayam Krishi Sangam (SKS) Society promised to be all about helping the poor. SKS used international donor grants and local charitable support to get started and grew fast, becoming the largest microfinance institution in India by 2006. CEO Vikram Akula was lauded by Time magazine as one of the world's most influential people. There was less interest, until recently (see The Economist and the New York Times) in exactly how this was achieved. Many now believe that the SKS business model represents all that is wrong with commercialised microfinance – a debate that dominates the microfinance blogosphere.

The initial funding for SKS was meant to benefit only the poor. That did not happen. Unlike most other Indian microfinance institutions, SKS paid its CEO and other key staff generous salaries and the CEO had share options that netted him $12.9 million just before the IPO, as reported in the New York Times. Many analysts, notably Professor M. S. Sriram, based at the Indian Institute of Management in Ahmedabad, have also questioned the role of the five Mutual Benefit Trusts (MBTs), set up with $500,000 of philanthropic donations to benefit SKS's borrowers. The MBTs were owned by around 500 village groups working with SKS, which held the assets of the non-profit SKS. However, the MBTs appear to have been under the control of the CEO himself. The paper seems to suggest that it was too easy for Mr Akula to arrange for the for-profit SKS Microfinance to purchase SKS Society's entire microloan portfolio. The money raised here was then used by SKS Society to buy shares in SKS Microfinance. Ordinary members of the MBTs – the SKS borrowers – had apparently no say in agreeing any of these arrangements.

There are concerns about the role of the SKS investor UNITUS, the US-based microfinance body. In common with many non-profits working in microfinance, UNITUS also opened a for-profit investment arm, the UNITUS Equity Fund, based in Mauritius. The Fund became a major investor in SKS and stands to earn around $70-$80 million on its shareholding. UNITUS Chairman, Joseph Grenny told the Economic Times of India this money would go to some new, but as yet unspecified, anti-poverty programmes. But the question remains – should a US-taxpayer-funded body be used to establish a for-profit body that then makes profitable investments in a for-profit body (SKS) that UNITUS is supporting with tax-payer funding? Also, is it right that the senior Executives of UNITUS should also be allowed to make lucrative private investments into SKS? In an interview with a US NGO, UNITUS Board Member, Geoff Wolley, reiterated that all those UNITUS Board members who privately invested in SKS through the UNITUS Equity Fund had agreed to donate all their profits to charity, but this does not alter the fact that they were initially allowed the freedom to leverage private gains thanks to public funding.

The overarching issue here, however, is whether or not commercialisation, and so an enhanced supply of microfinance, is always a good thing for the poor. Many microfinance advocates are willing to forgive SKS for its faults, and to accept the entire IPO process as well, because it is assumed that, in the end, the poor will reap the benefits said to inevitably arise because of more microfinance.

There are some problems here, however. First of all, little of the cash raised by offloading shares will go to SKS for additional lending: it goes instead to those who invested in SKS. But even if the IPO does generate a little more lending, there is strong evidence of a massive over-supply of microfinance in many parts of India, and that this has been bad for the poor. In Andhra Pradesh (the home state of SKS), this over-supply appears to have undermined the local economy, particularly in the rural areas where most of the poor live. For example, 82% of small farmers in Andhra Pradesh are now in serious microdebt compared to 49% in the rest of the country.

Studies show that the very poorest subsistence farmers have become trapped in 'microloan bicycling' – taking out new microloans to repay an old ones. There has been little impact on agricultural production and, with interest rates typically between 30% and 45%, the money earned on any extra produce was largely eaten up by high interest payments. The channelling of scarce financial resources into the least productive of small land plots in Andhra Pradesh, and away from more productive larger family farms, is seen as responsible for the 20% fall in rural incomes between 1993 and 2003. The high level of indebtedness of poor farmers in Andhra Pradesh has also been linked by, among others, the Times of India, to the high rate of suicides in the state. Despite all of this, many still believe that the solution for the country's impoverished farmers is yet more microcredit. More microfinance often means more problems, as discussed in Why Doesn't Microfinance Work?.

The mainstream development agencies are finally beginning to pick up on this dilemma. In its 2010 flagship report, the Inter-American Development Bank (IADB) portrayed the misallocation of capital in Latin America – way too much going to microenterprises and very little going into small and medium enterprises – as being responsible for that continent's high levels of poverty and under-development.

Time to rethink

A major rethink is urgently required, and I see three solutions:

•  A renewed emphasis on genuine Northern Italy-style financial cooperatives and saver-owned and controlled institutions along the lines of the old Building Societies in the UK, which worked well until they were demutualised and commercialised in the early 1990s.

•  Dedicated community development banks to ensure financial support for the best local business projects. The Caja Laboral Popular (CLP) in northern Spain is a prime example: owned by the community and supporting businesses that not only have growth potential, but that also provide decent employment for member-workers (such as cooperative enterprises).

•  A stronger focus on local credit unions to provide the very smallest of microloans used for consumption purposes

Above all, we need to take local financial systems out of the hands of would-be Wall Street-types and aggressive commercialised microfinance institutions and return them to their rightful owners: local communities and local people.