The darling of world development for more than 30 years, microfinance has thrived on the promise of empowering poor entrepreneurs in regions like east Africa and India to lift themselves out of poverty. Banks such as Grameen or Compartamos might lend a sum as small as $25 to women in Bangladesh to set up a food stall or start planting vegetables. In return, she will repay the debt at a reasonable rate well below the interest level charged by local loan sharks.
The concept is simple. But since the godfather of microfinance, Muhammad Yunus, first entrusted a group of impoverished villagers with $27 in 1974, lending to the world’s neediest has become big business. In India alone, more than 15 million borrowers owe $2.3 billion to microfinance banks, while the average household’s microfinance debt has increased fivefold in the last five years. Lured by remarkable repayment rates – some institutions claim to get back up to 98 per cent from their customers – private equity funds have piled in, pumping cash into the banks that service small townships.
‘Even during the very, very lean period of October 2008 to March 2009, microfinance stood out as one of the sectors that continued to attract investment,’ says Arun Natarajan, founder of research firm Venture Intelligence in Chennai. ‘When a sector becomes attractive, a whole bunch of companies come in. The first five, ten companies that come in are quite disciplined and they have a process. But when money comes in droves to the second and third tier of companies, there could be issues.’
By mid-2009 it seemed storm clouds were gathering. Respected lenders started talking about seeing clients overwhelmed with offers and juggling loans from five or six different institutions. Rajalaxmi Kamath and Arnab Mukherji, analysts at the Indian Institute of Management in Bangalore, produced a study of 20 families which showed that half were indebted to four or more lenders. ‘This is like a game of musical chairs, and with multiple sources of financing the music stops rarely,’ they wrote. ‘When (we are not using the more optimistic “if”) the music does stop, the accumulated delinquency will suddenly show up.’
Is a sub-prime crisis brewing? One US newspaper stoked controversy by accusing lenders of ‘carpet bombing’ poor Indian traders with loans in the hilly silk town of Ramanagaram. Locals, it was reported, had gone on a borrowing binge, using loans intended for business purposes to buy televisions and fridges. It was a charge angrily rejected by well-known financial service companies like Ujjivan and SKS, who accused journalists of reckless inaccuracy.
‘Most of our customers are responsible borrowers, and they understand their debt capacity,’ says Ujjivan boss Samit Ghosh. Ghosh’s firm insists on giving customers a three-day financial training course before lending to them, teaching them about repayment rates and the dangers of overstretching themselves.
It is still uncertain whether the bubble described in August will burst. In a move that will turn out to be either supreme confidence or hubris, SKS recently began trialling ‘microfinance mortgages’: home loans in cash to borrowers with no income papers or bank accounts. Sceptics shake their heads in disbelief, pointing out that this comes little more than a year after the collapse of Fannie Mae and Freddie Mac in the US, but enthusiasts are unshaken.
‘In the history of microfinance across the world there are a lot of such examples [of temporary excess],’ says Ghosh. ‘But the overriding benefits to society of providing financial services to those who have been deprived overcome such obstacles. Microfinance will continue to flourish.’