Daniel Rozas warns that investors in Indian microfinance could lose a lot of money. Building on his earlier work on bankruptcies among microcreditors, he discusses how to prepare for failure:
The crisis in Andhra Pradesh has highlighted how exposed MFIs are to mass non-payments. Industry insiders have suggested that even some of the largest MFIs simply might not survive if the crisis is not resolved soon. And if that were to happen, is the industry prepared to deal with the process of unwinding one of these giants?
The top MFIs in India are large by any standard, with assets in the multiple $100s of millions, most of which are held in the form of outstanding microcredits. Once an MFI is hobbled to the point that it cannot survive as a going concern, what happens to these assets? Experience from other MFIs suggests that prospects for recouping them are not good.
Milford Bateman of the Overseas Development Institute goes much farther than warning of losses. Citing the work of William K. Black, author of The Best Way to Rob a Bank is to Own One, he contends that
Black's theory and analysis of control fraud provides the most appropriate explanatory framework for understanding the most important dynamics and trajectories that have undermined the microfinance industry in AP and more generally worldwide [emphasis added].
Black defines ‘control fraud’ as the legalised looting of an organisation by its senior managers. Importantly, ‘control fraud’ has two meanings: it is the descriptor for the situation where CEOs and a small number of senior colleagues have been able to loot the financial institution they are employed by and also own (fully or partly); it is also the descriptor for the individuals themselves that actually engage in this looting process.
I guess the primary beneficiaries of the alleged fraud in this case would be the poor people who got most of the investors' money and now may not pay it back.
Vineet Rai of Intellecap, based in Andhra Pradesh, compares the events to a traditional Indian story:
A king had a trusted monkey that was trained to wield a sword. As the king's bodyguard, the monkey would go to any length to protect him. One day, while the king was sleeping, a fly started pestering him. The monkey tried to shoo the fly away but it always came back. Frustrated, the monkey decided to kill the fly. He struck the sword right where it stood---on the king's face.
Last month, the state government put a halt to [the growth of microlending] with the AP Microfinance Ordinance, suspending operations of MFIs in the state and for all intents and purposes allowing borrowers to stop repaying their loans. The announcement of the Ordinance stressed the need to protect the poor—but the move might well, in the long term, leave them far worse off.
Now, with the AP Ordinance, the government seems determined to remove borrowers' access to MFIs. As a piece of legislation, the AP Ordinance has more to do with helping the state government program enjoy a monopoly over the poor than with preventing strong-armed debt collection.
Clearly it would be better for the government to understand that the poor have the right to make choices—and that there are better ways to serve the poor than crippling its competition.
At the same time, the MFIs need to understand that social businesses are complex and that, as they scale and become part of the mainstream financial system, they need to be more careful managers, of both their operational reality and their external image. When the most substantial plank in your reputation platform is poverty alleviation, perceptions are all-important.
Barbara Kiviat and Jonathan Morduch argue that the subprime metaphor is misleading in some important respects:
...we should recognize that Andhra Pradesh is in a much less precarious position than the U.S. was a few years ago, when an entire nation was caught up in the delusion that house prices would never stop their steep ascent. Most of the complaints about the microfinance sector in India come back to unscrupulous practices like loan officers talking borrowers into taking on too much debt and collection agents being coercive. These are serious allegations and the government of Andhra Pradesh has smartly moved to ban strong-arming, increase disclosure about loan costs, and control the number of loans one person can receive. But the core of the problem is at least not a profound misunderstanding and misuse of most families' largest asset.
Another important contrast follows from the fact that the U.S. subprime mortgage industry was built on a fundamentally different equation—and a fundamentally different pathology. At the heart of the subprime crisis was risk-based pricing. Thanks to credit scores, lenders had elaborate knowledge about any given individual's likely ability to repay a loan; the game was not to just lend to those who could repay, but to price loans sufficiently high to cover the costs of those who were expected to default. The premise of microfinance is at the other end of the spectrum: lenders intend to recapture every dollar they loan out and take great pride in the high percentage of loans repaid.