Microfinance Focus, Oct 26, 2010 (By Dr. Oliver Schmidt) : The essence of capitalism is wealth creation from assets. Microfinance offers low income households to capitalize on their assets. Government, however, is mostly not concerned about wealth creation from assets. It is concerned about bureaucratic power. Such power as an end itself, or as an alternative means to create wealth for those who wield it, thrives on low-income-households. But what if those households become empowered to question bureaucracy, to reject its ways, to shrug it off? For those wielding bureaucratic power, that is a serious threat. That is why government bureaucracies have hindered, haggled and constraint microfinance every now and then.
 
India is known to entertain a monstrous government bureaucracy. It has provided more opportunity for wielding bureaucratic power than most other democracies. This power has thrived on suppressing capitalism for most of its 52 years of charge. In particular, it has controlled the supply of financial services. In response, India’s leading private sector players have built organizations that resemble bureaucracies in many ways; also its non-governmental organization (NGO) sector, which brought about some of the most reputed NGOs of the world, is largely organized along bureaucratic customs and procedures. The result of this bureaucracy story is the largest poor population in the world; shouting poverty and backwardness that no other G20 country has allowed to cling to its people.
 
Microfinance Institutions (MFIs) like SKS defy the realm of bureaucracy. They are essentially capitalistic. They create wealth from assets: the portfolios they lend out, the technology they apply – the Grameen lending approach, the use of branding techniques, the use of computerization and mobile phone –, the human resource they build. SKS has in many ways been stronger and faster and more focused in this than others. That is why it has attracted more and earlier investors – people who want to create wealth from assets – than other MFIs. SKS offers microfinance to more low-income-households than any other MFI in the world. According to a random-trial study[1] done in Hyderabad with customers of Spandana Spoorthy, a competitor of SKS which applies largely the same business model, microfinance of the type that SKS offers has a robust short-term effect on entrepreneurial performance and micro-enterprise growth. In the long term, it is supposed to contribute to better schooling and healthcare of the household’s children and to strengthen female involvement in household decision making; the evidence for these effects is rather anecdotal, though.
 
No powers that be will ever wither away silently. The bureaucratic powers of India have long been waiting for their chance to slash back. That chance has come in a situation which was created somewhat imprudently through the parallel occurrence of three factors:
 
-          One, SKS has successfully gone public, i. e. taken its shares to be traded at the stock market. But its leadership has not well digested the consequences of that change. Going public means also being accountable to the public in what used to be internal affairs before. That publicity is partly stipulated by the rules of the stock market, and partly by media scrutiny.
 
-          Two, MFIs have found it difficult to balance the dynamics of extensive growth with the risks of information asymmetries in lending markets. India’s leading MFIs have initiated the world’s first credit information bureau for microfinance. However, as most microfinance customers also borrow from informal sources – these regularly account for the major portion of their debts – and as several of them – estimates say about 20% – are also members of self-help-groups[2](self-help groups are community based groups of 10 to 20 members. In India, they are nurtured by a large government-backed bank-linkage program as well as by a large NGO-sector), it is difficult to establish a true (relevant) picture of customers’ indebtedness. Meanwhile, MFIs continue to ‘chase’ the same customers as they expand into new areas of operation. The speed of that expansion has seriously curtailed the quality of human resource deployed which in turn added negative repercussions on tracking customers’ indebtedness status. Some of the results have been reported – multiple affiliation of groups to different MFIs; multiple loans from several MFIs to the same individual; use of large portions of those multiple loans unproductively (e. g. purchase of household devices) .
 
-          Three, in cyclical turns the number of suicides among poor Indians surges and/or receives extra attention by the media. There is no evidence whatsoever that these suicides have been caused by MFIs. Still, that story is regularly made up, usually by politicians[3] who want to be seen doing something about things they have no influence over, or things they have themselves messed up. The root cause of the suicides is regularly a deep economic devastation of the source of livelihood – e. g. weavers in Andrah Pradesh. Contracting income leads to over-indebtedness which is worsened where lenders lack the capacity – and occasionally prudence – to assess it properly in the first place.
 
The bureaucratic powers have successfully blended these three factors into a story of shattered integrity of the capitalist MFIs; where MFIs are accused to exploit the poor to fill the pockets of their greedy owners. It is a sad irony that they are using the same story that microfinance used as its founding myth. According to this myth microfinance lending is ‘good’ because it is fair and empowering as opposed to the ‘bad’ moneylender who exploits the poor for his own greed. The irony is no coincidence. A good part of the ‘microfinance community’ is as weary and anxious about SKS as are the bureaucratic powers. That is because they themselves have failed to make a difference at large. NGOs have, by and large, remained niche players, who offer financial services in an unsustainable and sometimes unreliable manner. Instead, they have entertained customs and procedures of bureaucratic nature; their way of seeking and accounting for funding particularly springs to mind.
 
In summary, the so called Indian crisis is about the clash of agents of change, like SKS, and agents of the status quo, like the Andrah Pradesh government. Business-shaped, for-profit financial services are the vehicle of change. A plethora of bureaucracy – registration based on monthly reports on an array of fuzzy factors, authority to ultimately approve (second) loans – are the vehicles of the status quo. In the status quo, bureaucratic sleaze and sycophancy and corruption will continue to reign over a constituency of impoverished and disempowered households. In the scenario of change, these households will be formal customers of formal organizations and their relation will be governed by transparent formal rules. This change will squeeze its own agents, as SKS is just now experiencing. The stock market, after all, is one of the most formalized platforms of the world; and it is absolutely impartial and non-bribable.
 
The bureaucracy has understood the rules of the media and uses them for their cause – as MFIs of all strands always did themselves. Hence, it has spun an intuitive story of ‘bad’ for-profit MFIs; the aim of the story is to ultimately destroy first their integrity and then their space of business. This is mostly totally exaggerated out of proportion or deeply hypocritical or both. There are undeniable problems though.
 
Some of the problems are the pains of transformation. After all, the for-profit MFIs are coming from an NGO-background, i. e. from the realm of bureaucracy. As they transform into the realm of private asset holders, there are issues of control and legitimacy of assets which before did not formally exist or were formally not any-one’s property. So, there is a legal-formal issue, and there is a behavioral-communicative issue – one may find it difficult to restrain the founder-syndrome, but will still have to bend it to formal rules of which NGOs are free. These issues are sometimes subsumed under the theme of governance. Some of the pains are caused by over-speeded extensive growth. Some commentators have taken these to indicate a ‘bubble’; alarmist commentators have compared them to the US housing market bubble that led to the global financial crisis. That notion is technically questionable. There is little indication that the core of the microfinance asset – i. e. the MFIs’ loan portfolio – is valued unduly. Moreover, there is little reason to believe that it would vanish in a domino effect as befell the US housing market. There are warning signs and dangers at the fringes, no doubt about that –as mentioned above, there is a serious issue of managerial control of operational conduct at the field level (it may be argued that people like Dr. Akula should be more occupied with those, rather than with board and senior management positions). It may turn out that the whole microfinance portfolio is considerably smaller in terms of customers reached than thought today, once some proper counting (and accounting) would take place. However, e. g. in the realm of India’s SHGs, improved counting has actually corrected the numbers upwards. In any case, a down-adjustment of customer outreach does not imply that the asset is structurally bad. Given the element of market psychology – in this context, the psychology of the relatively small group of microfinance investors – it seems therefore irresponsible to talk of a bubble.
 
For all those who supported use of public money – taxpayers or benevolent donors – for creating the foundation on which MFIs like SKS now stand, the most pressing question is: Do they really make a difference? Or will their customers continue to live lives shaped by poverty? As the evidence stands, and thin enough it is, they do make a modest difference, and that difference contributes to some of these customers creating robust livelihoods for themselves and their families. Compared to the results of bureaucracy, SKS is clearly doing better; moreover, it continues to evolve, e. g. introduce new products such as insurance. However, it is true that compared to the claims made earlier by MFIs, they have delivered little. The ultimate success or failure of microfinance capitalism will be decided by MFIs staying on the course of transformation, concentrating on the most important issue. For example SKS has kept the customers’ part of its shares within the realm of bureaucracy[4]. The choice true to its philosophy of creating wealth from assets would be for SKS to give direct control of this part to individual customers (‘micro-shareholdership’). Moreover, these MFIs must shape their management and operational systems towards the standards of the formal market. That should increasingly entail shifting focus from extensive to intensive growth, i. e. more products, more business per customer rather than the same singular product to ever new customers.  Bureaucratic measures like those proposed by the Andhra Pradesh government will not help; but that does not mean that the government could not play a constructive role. Obviously, the stock market is the first example of a highly regulated business space – but it is one where the interests of bureaucratic power and wealth-from-asset creation are balanced out. In the same sense, government rules e. g. for transparency would strengthen the right incentives in the private realm, rather than suppressing it.
 
 
[1] This is according to a random-trial study done in Hyderabad with customers of Spandana Spoorthy, a competitor of SKS which applies largely the same business model (and standard group loan product).
[2] The self-help groups are community based groups of 10 to 20 members. In India, they are nurtured by a large government-backed bank-linkage program as well as by a large NGO-sector.
[3] In India, ‘bureaucrat’ refers to an employed public servant, as opposed to a politician who holds an election-based public office. Here, ‘bureaucracy’, as far as it refers to public realm, encompasses both of them.
[4] See the issue of ‘MBTs’ – Microfinance Focus