Crisis in Indian microfinance and a way forward: Governance reforms and the Tamil Nadu model

Abstract

In recent months, microfinance practitioners worldwide have been holding their breath over events unfolding in India. Beginning in summer 2010 with controversies surrounding the IPO of SKS, a large microfinance institution (MFI) and a major player in the market, the crisis subsequently deepened in the state of Andhra Pradesh, with borrowers defaulting on payments and even taking their own lives. Echoed by the media, hostility to microfinance rose to unprecedented levels, and some politicians even encouraged borrowers not to pay back their microloans. Fearing deterioration in MFIs’ financial solidity, numerous banks suspended flows of funds to them, leaving them severely cash strapped. Nevertheless, until recently, Indian MFIs were widely praised for their contribution to the fight against poverty. By providing financial services to low-income clients, particularly women who would otherwise have limited or no access to them, microfinance has enabled them to develop small businesses and to reduce the volatility of their incomes. Even tiny loans have often been sufficient to empower the Indian poor. How, then, can the current turbulence be explained? Our field study of microfinance in India during January 2011, at the end of the second year of a three-year Leverhulme-funded research project, addresses these concerns in a two-fold way. First, the study looks at the global picture of the whole set of interorganisational partnerships that relate MFIs to relevant stakeholders and regulators; as such, it is best positioned to bring to light systemic issues of the microfinance market and to identify suitable policy responses. Second, our analysis focuses on the state of Tamil Nadu, which is geographically close to Andhra Pradesh and similar to it in terms of size and maturity of the microfinance market but to which the crisis has not spread. It thus enables us to identify differences in the operations of MFIs in the two states that, despite a common landscape, may explain their differential capacity to achieve financial and social performance. On this basis, our analysis aims to contribute to the definition of a more sustainable model of microfinance, possibly to be extended to other parts of India.