Regulators Crack Down on Microfinance Industry in India

BY Fred de Sam Lazaro  March 30, 2011 at 3:43 PM EST

New rules aimed at regulating India’s microfinance industry, whose spectacular growth and near collapse strongly echo the U.S. subprime mortgage crisis, are set to take effect April 1.

Neighboring Bangladesh’s supreme court will also resume hearing an appeal from Muhammad Yunus on April 4. Yunus was removed last month as head of the Grameen Bank, which he founded and grew into a billion-dollar cooperative, winning him and the bank the Nobel Peace Prize.

The future of what many experts agree is an effective tool to fight poverty in two critical markets could be at stake. In India and Bangladesh, roughly three-quarters of a billion people live on less than two U.S. dollars a day. We may also find answers to whether there’s room for profit-making in a business historically the realm of non-profits or cooperatives.

Yunus did not invent the concept of microlending. However, with media-savvy honed as a student in Colorado and Tennessee, he won international acclaim for his efforts based on a simple idea: that poor people are credit-worthy and if the terms are not usurious they can use credit to work their way out of poverty. The Grameen Bank’s 8.3 million borrowers would seem to bear that out. All of them also have savings accounts with the bank, totaling more than $1.4 billion.

Grameen’s success played no small part in spawning a commercial microlending industry in India. In less than a decade, there were $7 billion dollars in loans handed out. One company, SKS Micro Finance, raised $350 million in an initial public stock offering. However, the goal of many of the new commercial lenders seemed to shift away from helping the poor start new enterprises. They pushed loans with no questions asked; not about the purpose, not even whether borrowers had loans outstanding from other companies. The goal, it seemed, was to increase the number of borrowers and thereby attract the big investors.

In no time, people began taking out new loans simply to stay current on old ones, with predictable consequences. A spate of suicides in the southern state of Andhra Pradesh drew in political leaders, some exhorting borrowers to stop making payments. Banks stopped lending to microfinance companies, drying up their source of capital (unlike Grameen, which finances its loans through borrowers’ deposits, India’s commercial lenders rely primarily on private banks). The industry verged on collapse.

India’s government has agreed to infuse $22 million to make capital available to smaller microlenders, along with the new central bank rules. The move adds national regulations to local ones enacted earlier in Andhra Pradesh, including interest rate caps and closer scrutiny of credit limits and borrowers’ incomes.

A key question among development experts is how to scale up ideas such as microfinance. India’s experience suggests that a “mission-driven” and social business approach such as Grameen’s is the way to go. Other analysts say Grameen’s success itself has inevitably drawn it into parochial Bangladeshi politics, and many of the country’s prominent thinkers have resented the international spotlight and perceived interference that Yunus has brought to what they consider a national issue.

Riding on the court’s decision — or perhaps a settlement with government officials — is the continued control of Grameen by its borrowers, one of the world’s most spectacular examples of what Yunus calls a social business.

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