In the last two days, I've read separate pieces on bad stuff happening to fast-growing microcreditors in Pakistan and India. The tone in both is brutally honest. The problems they describe may merely be growing pains. Microcredit has experienced crises, or at least widespread repayment difficulties before, in Bolivia and Bangladesh in the late 1990s and in Andhra Pradesh in 2006, yet gone on to thrive. Or the threats might be existential: I don't know. The similarities to the sub-prime crisis are inescapable. Both make a point I pondered last summer, that by design group lenders are to an extent flying blind about the state of their borrowers' finances.
The first piece is Unraveling the Delinquency Problem (2008/2009) in Punjab-Pakistan written by Hussan-Bano Burki and published by the Pakistan Microfinance Network (hat tip to Uzma Qureshi). It is intense, compelling, quotable. You wouldn't know it from the new World Bank report but Kashf, one of the largest microfinance institutions in Pakistan, experienced a borrower revolt about a year ago. It was centered around the city of Muridke, near Lahore, in Punjab, and apparently did not go national. It appears akin to the one in AP in 2006, with a murky mix of aggressive lending and opportunistic politicians, and finger-pointing all around. Unlike in AP, though, an analyst seems to have penetrated deeply into what happened. Perhaps this is what cracked the nut:
...the potential for response error on structured interviews with individual borrowers was huge. The research team found that a borrower...was not willing to commit herself individually to even acknowledging the delinquency problem that was spreading quickly from group to group, and across cities.
In a group, however, the borrowers revealed much more as the borrowers in each focus group built upon each other's discussion points.
Here's a sampling of the analysis:
- Because of pressure on staff for quick outreach, coupled with multiple responsibilities of loan officers, inadequate staff incentive systems, and weak internal monitoring and control systems: some microfinance loan officers across various key MFPs, appeared to be short-circuiting operational procedures and risk control systems. The study observed that the following practices were becoming common amongst MFPs' staff:
- Delegating their responsibilities of client selection and application verification to leaders of borrower-groups or other non-staff members such as local activists.
- “Hijacking” groups of borrowers of competing MFPs through tactics including offering incentives to borrower-groups' leaders to shift patronage and hiring competitor MFPs loan officers for accessing the staff's portfolio during the employment with competing MFP.
- MFPs' marketing and new client mobilization strategy relied heavily on use of local activists/group leaders. Consequently, the information on MFPs' terms and conditions was being spread unevenly, based upon the local activists' preferences and social outreach, within a target community. But more significantly, this heavy reliance by MFPs on local activists and group leaders was creating a situation whereby most of the potential clients tended to see the local activist / group leader rather than the specific MFP as the source of credit. This was creating an extraordinary leverage for the local activists on MFPs and clients, and was creating venues for commission agents / group leaders / activists to seek commissions from borrowers for providing access to microfinance loans. Group-leaders / commission agents were also providing borrowers access to multiple loans from different MFPs.
- MFPs were adjusting terms and conditions to make larger loans accessible on easier terms. To compete with growing competition in ventured market segments, MFPs were trying to lure or retain borrowers by increasing loan size, reducing application processing time and simplifying documentation requirements. In the absence of compensating risk control measures, the research warned that such adjustments could increase credit risk for MFPs.
- Many borrowers were expanding their credit exposure by taking parallel loans from multiple MFPs. The research estimated that 40% to 70% borrowers in mature, saturated markets had taken parallel loans.
The group pressure, thought to provide social collateral and ensure repayments of loans in group-lending model, could be seen working in the opposite direction during this delinquency crisis: During this delinquency revolt, group pressure forced group consensus for withholding repayment of loan installments.
Kashf's January--March 2009 quarterly report makes curt mention of the revolt:
An internal causation research was carried out by the Research Department to examine the recent delinquency crisis in Punjab. This research was carried out in the areas of Jallo and Muridke, and revealed that the delinquency was a result of involvement of activists and politicians.
Burki says it was more complicated than that:
Field feedback...suggests that it was always the case that borrowers first decided to revolt, and then tried to receive the support of politicians. In many of the communities of the borrowers sampled, there was no role of politicians in the revolt, but only the borrower's determination not to repay.
Yet when local politicians did extend their explicit or tacit sanction to the borrowers to withhold repayments, their support became potent cement to the borrowers' resolve.
Still, I found hope that the borrower revolt did not reveal a fatal flaw in microcredit, but reparable laxity in management:
It needs to be noted here that the delinquency crisis did not hit the affected MFP because the clients were disgruntled by MFP-X. In fact both delinquent and repaying borrowers were unanimous in their view that MFP-X offered them the easiest service in terms of quickest disbursement of loan, larger loan size, and multiple loan products. Furthermore, nowhere did any borrower mention high interest rates as a justification for inability to repay: instead even the delinquent borrowers admitted that microfinance provided them an option other than money lenders for accessing loans that their family and friends cannot provide. The key reason given by most delinquent borrowers for not repaying was that “no one else was repaying”.
To my knowledge, the borrower revolt not only stayed confined to one region; it has also remained confined to Kashf.
The other piece is an article by N. Srinivasan, author of Microfinance India: State of the Sector Report 2009, in the current issue of Microfinance Insights. The article is gated and is not even in the online table of contents at this writing. He asks, "Is the 99% Repayment Rate an Illusion?" and goes on to enumerate why pursuit of perfect repayment is at once implausible and dangerous. (The 2008 average in India was 99%.)
It’s possible through coercive action to get the borrowers (or their group guarantors) to repay the instalments, regardless of their income flows. But this causes acute stress on the poor households, especially when the weekly payments have to be continued at a time when personal misfortunes befall the poor families. Under such conditions, one wonders whether microfinance has a soul and whether such credit mechanisms really serve the vulnerable.
Excessive attention to produce 100% repayment creates hostility on the part of borrowers. It even alienates borrowers with a good repayment record when they learn of the extreme distress caused to their neighbours because of such forcible methods. When the borrowers get access to alternate avenues, they would not only leave the MFI, but also could actively refuse to pay up dues. Some of the problems in Kolar, Karnataka, in southern India, were attributed to strong-arm tactics that led to the alienation of customers; the customers willingly went along with the fatwa [issued by a local religious leader]- not to repay.
Some of the undesirable practices that have been reportedly used at a few MFIs include employees being given a loan to adjust against amounts in default; granting of fresh loans in the names of non-defaulting or new clients to repay another borrower’s old loan; and, adjusting loan prepayments against defaulted loan dues. Such practices destroy the corporate ethic and introduce operational risks that are difficult to mitigate. Such practices make customers an unwitting party to shady behaviour and introduce indiscipline.
Even the much maligned moneylenders have a more pragmatic approach to dealing with defaults that are beyond the control of the borrower. They do not hesitate to offer a borrower more time to repay a loan, under certain circumstances. We in the microfinance sector have a lot to learn. MFIs have to learn to design their business model in tune with customers’ economic condition and livelihoods. Lenders should peg their expectations of credit performance at realistic levels. Investors must learn to live with higher loan-loss risks than are currently being accepted. The sector must come out of the denial mode of not recognizing defaults and seriously examine the chasm between knowledge and expectation relating to repayments. The sooner this is done, the better it is for the MFIs’ health and customers’ well being.