HYDERABAD, India--Microfinance has helped millions of poor people improve their lives by lending them small sums without having to put up collateral, such as Pramila, who lives in the Indian village of Nimragomla, where most of the residents work in farming.
Two years ago, the young housewife formed a group with four of her acquaintances, who applied for a loan from a microfinance institution (MFI) in Hyderabad, the capital of the southern state of Andhra Pradesh.
Pramila borrowed 12,000 rupees (around 17,000 yen, or $210) for herself with an annual percentage rate (APR) of 24.5 percent. Her plan was to repay the loan at 270 rupees a week over a 50-week period. She bought a 5,000-rupee sewing machine and fabrics to set up her own tailor shop.
Pramila charges 100 rupees for a woman's dress, and her monthly income is about 5,000 rupees. Pramila's husband makes 7,500 rupees a month driving trucks, so the additional income has made raising two sons, aged 8 and 6, easier to manage. The family also took out a mortgage from a state-run bank to move from a one-room brick hut to a new four-room home reinforced with concrete walls.
"I've nearly doubled my family's income because of microfinance," Pramila, 25, said with a smile.
In India, which with 31 million microfinance borrowers has the most in the world, microfinance has become a profitable business in a market that continues to grow quickly.
In microfinance lending, companies or NGOs provide business and school loans to help the borrowers lift themselves out of poverty. Generally, in place of collateral, joint liability falls on groups of acquaintances or family members, while loan officers make frequent visits to collect payments. Grameen Bank, based in Bangladesh, is known as the pioneer of microfinance. It was formed in 1976 by Muhammad Yunus, a university economics professor. Both Grameen Bank and Yunus were awarded the Nobel Peace Prize in 2006 for their efforts.
Today, however, excessive lending has become a problem for some microfinanciers, leading to stronger regulations that have thrown the industry into crisis.
That controversy has even affected Pramila. In mid-October, she stopped making payments.
"Suddenly, the person who had visited every single week to collect money stopped coming," she said. "Later I heard a rumor that 'there's a new law, so you don't have to return money borrowed from an MFI.' Nobody I knew was making payments anymore."
In October 2010, the Andhra Pradesh state government passed a law prohibiting home visits by MFI workers to collect loan payments, as well as attempts to lend more money to customers without permission from the state government. This effectively made it impossible for MFIs to operate. It was a major blow for them, as many major MFIs were formed in the state and 30 percent of the value of the industry's loans was concentrated there.
According to the Microfinance Institutions Network (MFIN), an industry group, the loan repayment rate in India averages in the upper 90s, but that plummeted to around 10 percent in Andhra Pradesh after its new law went into effect.
Financing for MFIs dried up as banks and other institutions feared losses. The value of 45 MFIN member companies' bad loans in fiscal 2011 nearly tripled over the previous year, while the value of their outstanding loans dropped by 15 percent. Twenty percent of their employees, or 17,000 people, left due to layoffs or other action.
The reason for the law, as explained by Principal Secretary Subrahmanyam of the state's Department of Rural Development, was that the MFIs coerced customers into borrowing more than they needed and used strong-arm tactics against those who fell behind on their payments. Subrahmanyam claims that for the four months starting in July 2010, 76 people committed suicide because they were struggling to pay back their loans.
"The problem is the MFIs' greed," he said. "In some cases, they took people's furniture without permission and forced women into prostitution."
The MFIN doubts the reliability of the suicide numbers and other aspects of the state government's study. Its president, Vijay Mahajan, argues that "while it is true that the competition heated up and there was too much lending, is it OK to impoverish the entire industry for a problem caused by only a part of it?"
He said there are some people relying on high-interest loans with 100 percent APR because they cannot borrow from MFIs.
Including nongovernment organizations (NGOs), there are roughly 500 MFIs in India, but no more than around 50 commercial enterprises account for 90 percent of all outstanding loans. Because MFIs are not allowed to handle savings accounts, they typically borrow money from banks at interest rates exceeding 10 percent, then lend it to their customers at APRs in the 20s to 30s.
Banks are obliged to direct a certain share of lending to the agricultural sector or MFIs. In many cases they lend to groups of rural citizens, but the process is time-consuming and costly. Lending to MFIs is a faster and simpler way to turn a profit, so banks ramped up financing for them.
Outstanding loans by MFIs totaled 34.5 billion rupees in fiscal 2006 and rose to 240 billion rupees in fiscal 2010. But that bubble burst.
India's central government has focused on MFIs as a means of reducing poverty, and last month it submitted a bill to the parliament that would make the central bank the lone supervisory authority over MFIs as well as impose restrictions such as interest rate caps, in a bid to restore people's trust in the industry.
If passed, the law would effectively negate the overly strict law in Andhra Pradesh. MFIs are very eagerly awaiting its passage, but there is no timeline for when that may happen.
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