Crisis at the Bottom of the Pyramid: A Case Study of Micro-Finance in India

Abstract

The micro-finance industry in India is in the midst of the most severe crisis in its 25 years history. The genesis of the problem was the clash between the original micro-finance goals of poverty alleviation with the profit maximization goals of the micro-finance institutions. In the state of Andhra Pradesh, micro-finance institutions have been accused of lending practices that adversely affected the lives of the poor borrower, to the extent that they were driven to commit suicide. This led to government intervention with an ordinance that effectively stopped collection of micro-debt and prohibited new micro-loans in the state. The Andhra Pradesh government action led to a 600 fold decrease in financing to the very poorest of India’s citizens. The more systemic outcome from this was the lending freeze by the banks to the micro-finance sector, not just in the state but all across India. The crisis that erupted initially in the state of Andhra Pradesh in the early October 2010 had its contagion spread across the whole country and globally. This current stalemate brings to fore the importance and urgency of getting the right policy for the micro-finance sector. This paper provides background and insight to the crisis which raises important questions about the evolution of micro-finance market. This paper also delineates the three distinct aspects where the government needs to play a pivotal role for sustainable development of micro-finance in India. The first role is to protect the rights of the micro-borrower, the consumer of the micro-financial services. The second role is that of prudential oversight of risk taking by firms operating in micro-finance. The third role is a developmental role where the key issues are diversification of access to funds, innovations in distribution and product structure and the use of new technologies. Each of these roles needs to be placed in an existing or a new regulatory agency.