Death by Finance: Why For-Profit MFIs are Giving Microfinance a Bad Name

Death by Finance: Why For-Profit MFIs are Giving Microfinance a Bad Name

A rise in borrower suicides in India has raised questions about the for-profit microfinance model. Photo: <a href="http://www.flickr.com/photos/agehelps/4843103209/#">Mayur Paul/HelpAge International (Flickr)</a>
A rise in borrower suicides in India has raised questions about the for-profit microfinance model. Photo: Mayur Paul/HelpAge International (Flickr)

"Work hard and make money. Do not take loans.”

That was the suicide note left by 18-year old Pelta Lalitha of Godhumaguda village in India.

Pelta was among more than 200 Indians who committed suicide in late 2010 because they were unable to repay their microloans. The deaths, reported last week by the Associated Press, have critics rushing to denounce microfinance. But a closer look suggests that profits, not microfinance, are the true culprit.

According to the AP, an internal probe commissioned by SKS Microfinance Ltd.—India’s largest microfinance institution (M.F.I.)—found that the company was directly linked to seven suicides in the Indian state of Andhra Pradesh. SKS loan officers allegedly harassed borrowers, forced them to sell their belongings and even instructed them to kill themselves if they couldn’t pay: In one case, a loan officer apparently told a woman to drown herself if she wanted her debt forgiven. The following day, the mother of four threw herself into a nearby pond and died.

SKS has denied involvement in any of the deaths. Still, it has become the focus of public scrutiny over the allegations, partly because of its status as a publicly traded, for-profit business.

In 2010, SKS became only the second M.F.I. in the world to go public, with an initial public offering (IPO) worth hundreds of millions of dollars. The offering attracted investors such as JP Morgan and Morgan Stanley, and raised eyebrows among leaders in the microfinance industry, including Dr. Muhammad Yunus of the Grameen Bank:

"The concern is that when you put an IPO, you are promising your investors that there is a lot of money to be made and this is a wrong message. Poor people should not be shown as an opportunity to make money out of."

So was the for-profit structure—which puts the interests of shareholders before those of poor borrowers—to blame for the meltdown? The answer lies in the SKS business model.

Between 2004 and 2010, the SKS loan portfolio grew by 165 percent. As the company sought to raise private capital for the 2010 IPO, SKS took inspiration from companies such as McDonalds and Starbucks to develop a program that trained over 500 new loan officers per month.

As the company grew, loan officers began ignoring protocols. Although loan officers were instructed not to form more than 36 groups per month, an SKS loan officer reportedly formed 273 groups. According to the AP, current and former SKS staffers also complained that they no longer had the time to review borrowers' assets and business plans. Still, they were pressured to give clients bigger and bigger loans, even when they could not repay: One woman was lent 150,000 rupees ($3,000) when she only earned 600 rupees ($12) per week.

"Professor Yunus was right," admitted SKS founder Vikram Akula at last week’s Harvard Social Enterprise Conference. "Bringing private capital into social enterprise was much harder than I anticipated." Akula had apparently tried to bring attention to the suicides at a board meeting last summer, but was ignored. He was pressured to resign from his position as CEO in late 2011.

No matter how you look at it, something went horribly wrong in Andhra Pradesh. But is the microfinance model itself to blame for the suicide deaths? Or did the hunt for profits overtake the social mission that companies like SKS were founded on?

Providing microcredit is expensive, and most M.F.I.s struggle just to break even. Because the loans are so small, and locating and servicing poor, rural borrowers costs so much, microfinance was never intended to be particularly profitable. That's also why traditional banks are unwilling to provide credit to the poor; it just isn't financially viable.

Therefore, in order for a publicly traded company to profit from a portfolio of microloans—while also satisfying shareholders and investors who expect big returns—something had to give. In the case of SKS, this meant rapid growth at the expense of the best practices developed over decades of lending to the poor. Rather than focusing on training the best employees, SKS opted for a system that churned out loan officers like Starbucks baristas. Instead of taking time to learn about their clients' finances, loan officers were pressured to lend as much money to as many people as possible, regardless of their ability to repay the resulting debt. And when borrowers ultimately could not pay, SKS opted for coercion over flexibility in order to protect its bottom line. The result was mass defaults and suicides.

It comes down to this: The world’s poor need financial services. Banks cannot provide small loans to poor people, and so they turn to microfinance institutions for access to credit. Without M.F.I.s, the poor would be forced to rely on local moneylenders, who, in some cases, charge interest rates as high as 200 percent per day.

While profits are important to the sustainability of M.F.I.s, the decision by SKS to go public blurred the line between self-sufficiency and pure profit motive. Therefore, given the damage done to the reputation of microfinance by irresponsible lenders like SKS, maybe it's time to go back to basics.

The father of microfinance, Muhammad Yunus, started Grameen Bank in 1976, with a simple model focused solely on lifting the poor out of poverty. In a January op-ed for the New York Times, Yunus lamented the rise of for-profit lenders such as SKS:

"I never imagined that one day microcredit would give rise to its own breed of loan sharks. But it has. And as a result, many borrowers in India have been defaulting on their microloans, which could then result in lenders being driven out of business. India’s crisis points to a clear need to get microcredit back on track."

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