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The crisis that erupted in the early October 2016 at the epicentre of microfinance in the Indian State of Andhra Pradesh has badly hit the sector of microfinance in India and it has implications not only in the state of Andhra Pradesh but has repercussions across the country and globally also. As events continue to unfold in Andhra Pradesh, this research article provides background and the repercussions of the situation, which broadly raises important questions related with the evolution of microfinance markets.

A decade ago, the central preoccupation of the microfinance industry was the search for scalable and financially sustainable models for delivering financial services to low-income people. Today, we see huge progress on that front. Across the globe, including in India, the microcredit movement has proved that it is possible to deliver financial services to poor people living in rural areas at a large scale, free from any reliance on subsidies. As a result, millions of poor households today have access to credit, and also increasingly to savings, insurance, and money transfer services that they use to manage household finances more effectively. And yet there are still 2.7 billion people in the world without access to formal financial services that are less expensive and safer than informal alternatives. It remains a priority to ensure that previously unreached low-income population segments gain access to these services, including in large swathes of India.

Even within this wider context, though, we see important limitations of the microcredit-only delivery model and the ramifications of the strains caused by very rapid growth. Developments in Andhra Pradesh shine the spotlight on some of the same issues that have emerged in other high-growth microfinance markets in recent years.

In India, investors’ emphasis on growth and the higher valuations generated from high growth rates have created strong incentives for fast expansion. These incentives are transmitted from the top managers of MFIs down through middle management to the frontline loan officers. These cascading incentives can drive behaviour that distorts basic good banking principles and can lead to vulnerabilities that need to be addressed: Rapid expansion of credit in highly concentrated markets and loss of credit discipline can lead to much greater risk of stress from higher levels of indebtedness. Growth can undermine credit discipline, driving unhealthy rises in loan amounts, cutting corners in the underwriting process, and resulting in an excessive supply of credit. Incentives at the field level are often based solely on disbursements and collection volumes, with insufficient incentives for sound underwriting or customer care.

Growth that outpaces the internal controls of financial service providers makes them more vulnerable to inadequate technology and systems and unhealthy rates of staff attrition and turnover.

Relying on credit-only services makes Indian MFIs particularly vulnerable on asset quality since borrowers have no deposit relationship to the MFI. And the MFIs’ heavy reliance on basic bank debt (plus a mix of capital markets instruments) leaves Indian MFIs vulnerable to refinance risks in times of market stress.

All of this raises key issues for the microfinance community to address. First, at the institutional level:

How do we assess financial service providers’ shareholders, management, and staff incentives to ensure long-term viability, understanding that viability comes not just from shareholder value, but from a strong value proposition to clients?

How sustainable is the specialized microcredit institution model?

What can investors and institutions do to ensure sustainable growth and avoid market saturation or clients’ over-indebtedness? How can socially motivated investors be encouraged to redirect investments from the few, but high-profile saturated markets, to the many financial services “deserts” worldwide?

Then at the market level:

1. Can self-regulation work when it comes to sharing credit information and establishing codes of conduct on issues around culturally acceptable collection systems, dispute settlement systems, etc.?
2. What kind of formal market infrastructure is needed to support growing providers and protect clients? What are reasonable levels of productive debt for poor people to carry?

How can the focus be shifted to credit crisis prevention? What will it take to increase focus on understanding clients’ financial service needs? What is the role of regulators and policy makers to ensure client protection and consumer financial capability that leads to better household decision making? How should policy makers balance ensuring broad-based access to finance and safeguarding client interests?

These questions speak to the bigger issue of how to deliver high-quality services to more people while ensuring appropriate safeguards for clients. A vision of financial inclusion that truly addresses the needs of poor clients dictates that responsibility lies not just with the providers, but also with policy makers, donors and investors, and the global microfinance community to ensure appropriate governance, operational policies, and incentive structures at all levels, with appropriate client safeguards, to offer high-quality services. As local markets mature, the delivery model for financial services for the poor must evolve to support healthy outreach and the growth of a broad range of products that poor people need.

MicroFinance; Financial Inclusions; mobilized savings