India’s Microfinance Industry Fuels Suicides

Most of us remember Muhammad Yunus’s 2006 Nobel peace prize for microfinance, small loans to start businesses, with extremely low default rates. Now it looks like this industry has done what many American financiers have done, lent more than people can ever pay back, in order to make greater profits. In India and other parts of Asia, however, cultural factors mean that over indebtedness causes more than just sadness and bankruptcy. This lending without regard to ability to repay has causes suicide on the part of borrowers. This is particularly insidious, given that- unlike home loans or payday loans in the U.S. -  the whole point of microfinance is to help the poor start businesses.

Moreover, the industry itself faces imminent collapse as almost all borrowers in one of India’s largest states have stopped repaying their loans, egged on by politicians who accuse the industry of earning outsize profits on the backs of the poor. Indian banks, which put up about 80 percent of the money that the companies lent to poor consumers, are increasingly worried that they could now face serious losses. Indian banks have about $4 billion tied up in the industry. Initially the work of nonprofit groups, the tiny loans to the poor known as microcredit once seemed a promising path out of poverty for millions. In recent years, foundations, venture capitalists and the World Bank have used India as a petri dish for similar for-profit “social enterprises” that seek to make money while filling a social need. Like-minded industries have sprung up in Africa, Latin America and other parts of Asia. Some companies have more than doubled their revenues annually. Recently, one of India’s largest for-profit micro lenders, SKS Microfinance, went through an initial public offering, fueling anger. The company is backed by famous investors like George Soros and Vinod Khosla, a co-founder of Sun Microsystems.SKS and its shareholders raised more than $350 million on the stock market in August.

And it’s not just money at stake of course.  People are committing suicide over the shame of not being able to pay the debts back. A 30-year-old mother of two boys poured 2 liters of kerosene on herself and lit a match, after she and her husband argued bitterly the day before over how they would repay multiple loans. Shobha Srivinas, was being pressured to pay interest on her 12,000 rupee ($265) loan. Lenders also were demanding that she cover for the other women who had borrowed, since borrowers essentially guarantee each other’s loans in order to use social pressures to ensure repayment. She had her husband are both dead after he was unable to put out the flames and got caught in them himself. More than 70 people committed suicide in this particular Indian state from March 1 to Nov. 19 to escape payments or end the agonies their debt had triggered. According to Malcom Harper, Microcredit has become “Walmartized” by unrestrained selling of cheap products to the poor. “Selling debt is like selling drugs,” says Harper, 75, the author of more than 20 books on microfinance and other topics.“Selling debt to illiterate women in Andhra Pradesh, you’ve got to be a lot more responsible.”

This is obviously not the way Yunus designed the loans. Yunus, 70, had his own ideas about which profits were proper when setting up microloans, which he set at the cost of funds plus 10 percent, he says. Indian micro lenders themselves borrow from banks at 13 percent or more on average and extend credit to the poor. They charge interest rates that can rise to 36 percent. “Microfinance has been abused and distorted,” Yunus said. “I feel so sad because that’s not the microcredit I have created.” He also reports being embarrassed, and is now less happy to be a founder of microfinance. 

Comments

[jpe]

My recollection of the rebuttal posts from other blogs is that the suicide rate among borrowers is consistent w/ the rate in the broader population, which suggests that the claim that microfinance is the proximate cause of a suicide outbreak is false.

(Felix Salmon had a post on this a few weeks ago linking to various blog posts)

[Thomas Wicklund]

I haven't seen the specific case reported above, but another side of this has been reported in The Economist lately (Nov 18, 2010 and Dec 9, 2010 issues). According to The Economist, one of the suicides the Indian state of Andra Pradesh blames on Microfinance had borrowed 15,000 rupees at 36% interest. But he also owed over 34,000 rupees to a local, informal moneylender at over 50% interest.

Note that microfinance gets the blame here (it's a visible target), not the local, informal moneylender.

From what I understand, there are far more loans, for more money, at higher interest, to local moneylenders than to microfinance.

If microfinance companies are pushing people into loans they can't afford, there is a problem. If they are providing loans which would otherwise go to local moneylenders (if they were in the U.S. we'd probably call them loan sharks), then it's not clear how real the problem is.

I'd like to see some accurate statistics comparing the size of microfinance to other credit in India, microfinance profits, suicide rates, etc. before blaming the microfinance industry. So far, the media seems to be reporting anecdotes and quotes from various officials, always a good way to slant the story in a desired direction.

[zoe]

Interesting paper regarding this topic and an explanation for why there has been such an influx of investments into the industry. Quite simply loans were distributed without clear oversight or control, and this is partly the result of the money flowing via NGOs or MIV (investment vehicles) as investors were long told that microfinance investments considerably reduce portfolio volatility. The paper questions whether microfinance Investments Resilient to Systematic Shocks? Literature Review is high recommended, critical but accurate.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1734042

[mt]

1) I think this is a good example of a point I made in a comment to another recent post cautioning about dangerous levels of overconfidence when trying to alter people's behavior. An idea that seems to work on a small scale does not necessarily work on a larger one.

2) I followed the link to the Bloomberg article. It seems that the basic lending of SKS Microfinance is not that far off from Mr Yunus' cost + 10 formula. They supposedly lend at cost of debt plus 12. The problems are that (a) cost of debt at 12% is high to begin with - it is hard to find uses of money that generate 24% plus returns (although India probably generates more than most countries) which means a lot of loans are bad ideas (parenthetically, this is the main reason I like usury laws). (b) Cost of debt is not cost of capital, you have to account for equity, and that is where this breaks down. To quote the Bloomberg article:
“They have to decide between the interests of their customers and interests of their investors,” he says. Gibbons, 70, says he learned that lesson when he tried to raise 4 million pounds from two wealthy nonresident Indian investors in November 2006. Talks failed because of differences over expectations for returns on equity and other contract terms, he says. “That’s what made me think this just can’t be done,” he says.

This model only works where funds are donated or cost of funds is otherwise minimal. The borrower has to have a loan cost that is less than the highly probable return on its use of the money and that is very hard if the loan cost has a return on equity in it.

3) I don't think "massive suicide" is accurate. The article's figures indicate that microcredit related suicides were .005 of total suicides in the state. They represent about .00000007 of India's population; if there are a million customers, it's .00007 of them. Yes, every life is important. But we have much higher death totals from alcohol and automobile activity so loss of life is something that societies allow to occur as a tradeoff for certain activities. To ban microcredit because of that is a Prohibition-like overreaction.

[Nathalie Martin]

Thanks everyone for those interesting comments. I have made a few changes to reflect them.

[Leigh Kimmel]

This is yet another example of what happens when credit is extended to people who simply aren't good credit risks, whether in order to expand one's profits or because there's pressure not to "unfairly" deny them credit just because they're poor.

Also, as a program is expanded, the pressure to get more people into it often results in the systems to check eligibility start breaking down. The microfinance programs that work best spend the necessary time to carefully examine potential recipients' financial situations, marketable skills, business plans, etc to make sure that what they're borrowing to do is actually viable. Frex, helping a seamstress buy a sewing machine so that she can expand her sewing business, making sure that she has the necessary skills and resources to actually use the sewing machine, that the market really exists for enough more clothing to cover the payments on the loan, etc. But as the program expands, the process of checking these things gets elided over, so that instead of actually checking the situation, the lenders simply take people's word for it (and this doesn't necessarily mean lying and fraud -- often we're talking about people who don't know how to accurately judge their situation, and who thus mistake wishful thinking for actualities) and people get lent money for grand projects that are doomed to fail from the beginning.