The Financial Inclusion (Access) Paradigm: Client and Operational Level Lessons From The Andhra Pradesh Experience (PART I)

Ramesh S Arunachalam

Rural Finance Practitioner

The last few years have witnessed a repeatedly increasing emphasis on inclusive finance and this note attempts^[i] highlight various aspects with regard to this financial inclusion paradigm, based on the Indian and especially, Andhra Pradesh micro-finance experience

Let us first look at the scope of the financial inclusion paradigm, as it is currently practiced in India today and this takes us to the first lesson learnt from the present micro-finance crisis.

Lesson # 1: As evident from Box 1 below, the scope of current inclusive finance practice is rather narrow - while its intentions (like the report of the Financial Inclusion committee and other policy pronouncements) may have been to provide low income clients with access to a wide range of need based financial services, in reality, the inclusive finance (or financial inclusion) paradigm has mainly led to the proliferation of credit and primarily consumption loans, although there have been some small production/livelihood loans.

Given the huge focus on consumption loans and peripheral interest (on a relative basis) in small production and livelihood loans (as well as other products), it seems important to set the record straight with regard to access to this kind of credit. That is the main focus of this post…

In simple terms, access to credit seems to work well at certain levels and I would peg that in the range of Rs 10,000 – Rs 15,000^[ii] per client (and at most, < = Rs 25,000), where it is possible for families to use their total (household) sources of income and cash to service the formal/semi formal debt.

Undoubtedly, at this level, for several clients and their families, apart from serving consumption needs, this access to credit, has had some impact^[iii] including the following:

a)      It has enabled some households to take care of emergencies including medical related issues;

b)      It has facilitated several clients to swap high cost debt with relatively lower cost formal/semi-formal debt and thereby enabled the houses to have more discretionary cash/income (due to lesser interest paid), which many of them saved. In few cases, as I have seen, the availability of this small credit has also forced money lenders to reduce their lending rates;

c)      It sometimes has acted as crucial working capital for those people involved in micro-enterprises and also helped them make investments in productive assets;

d)      For still others, it has acted as an empowering tool and helped redefine the compensation structure in their (piece rate) work. For example, the poor, who were accessing raw materials from middle men (like raw materials for beedi rolling, lace making, agarbathi rolling, silk weaving, handicraft manufacture etc) on very exploitative terms, have, because of this access to small credit, been able to source their own raw material at lower rates and thereby get a higher profit. Sometimes, because of this the middlemen have come back to the micro-entrepreneurs and given them piece rate work on better terms. There are so many examples from all over India; and

e)      Where agriculture was involved, the small money sometimes enabled subsistence farmers to produce more grains and enhanced their food security (Much of IFAD’s work in Tamilnadu and Andhra Pradesh in late 1980s/1990s)

I could go on and describe many real life examples from all over India but the larger point of reasonable impact of micro-finance loans in the range of Rs 10,000 – Rs 15,000 per client should not and cannot be missed. This takes us to the next lesson learnt from the present AP crisis.

Lesson # 2: Standard (MFI) loans, which dominate micro-finance (or access to finance) today, tend to work well but for loan sizes in the range of Rs 10,000 – Rs 15,000 per client and at most <= Rs 25,000. Not to sound like a broken record, but would like to re-iterate that Rs 25,000 is the upper limit and certainly not the comfortable range, which would be more in the Rs 10,000 to Rs 15,000 bracket per client.

Three issues deserve mention at this juncture:

a)      When loans are in this range, the debt servicing capacity of many low income people and their households is adequate to meet the loan repayments plus provide for the family, save very serious emergencies, which can debilitate any (low income) household;

b)      The joint liability group works absolutely fine in this range of loans and there is significant camaraderie between members, even if they pay each other’s loans because they know for sure that their peer can eventually repay the loan and also return any peer (pressure) contribution to the loan rather easily; and

c)      The lending institution can generally believe in the “common notion” of the household cash flows from all working members  - including livelihood income, labor income, informal/other borrowings, household micro-savings in cash/small assets, and other inflows - being sufficient to service the debt comfortably. Here again, one must take into account all sources of income/cash before deciding on the exact quantum of the loan, especially, when it veers towards the upper limit of the above range (Rs 25,000) and that is absolutely critical.

This takes us to the 3^rd lesson learnt from the AP crisis.

Lesson # 3: Now, I see the Rs 25,000 loan amount as some sort of Lakshma Reka[iv], that the MFIs should not breach, unless they are absolutely SURE of the individual/household having the requisite debt servicing ability (could be a livelihood, production and/or labor etc) to repay the larger loan. This is the most important lesson from Andhra Pradesh for MFIs, banks, policy makers and other stakeholders. 

In Andhra Pradesh as well as other parts of India, MFIs, for a variety of reasons (given in Box 2 below), chased the same borrowers and literally loaded them with larger loans (often in parallel) and without due concern for their (clients) loan absorption capacity and debt servicing capacity. As one industry observer notes,

“This is the real genesis of the Andhra Pradesh crisis – and not the ordinance promulgated by the AP government as claimed by some stakeholders - as even before the promulgation of the said ordinance many poor clients were severely indebted (and had borrowed much) beyond their loan absorption capacity, often servicing their debt either through fresh borrowings, strong arm recovery and/or other means. There is however no denying the fact that the ordinance deepened and formalized the crisis – that point is well taken and agreed”

While MFIs grew for different reasons as noted in Box 2 above, it was during this period of burgeoning growth (April 2007 – March 2009 and thereafter) that the hitherto highly successful model of JLGs/Centres was severely diluted. And the changes did more harm than good to the original concept of concept of joint liability and peer pressure - where several JLGs operated in a mutually reinforcing manner within a center.

Four issues are relevant here:

·         First, the normal and established processes of client acquisition through green field methods - where MFIs laboriously promoted their very own groups and nurtured them and painstakingly created a culture of credit discipline and high repayment based on mutual trust and other aspects - was slowly abandoned by many MFIs because of their urgency to grow fast. Process mapping and efficiency considerations, which are by themselves good tools and/or laudable objectives respectively, were erroneously used to quicken client acquisition strategies and other processes. Thus, an undue emphasis was placed on quicker identification of clients, faster processing of loan applications and so on. And basic issues such as - understanding of client antecedents and situations, preparation of clients, analysis of client/household loan absorption and debt servicing capacity and the like - which were the hallmarks of the green field client acquisition strategy described earlier were slowly but surely ignored and bypassed.

·         Second, given that clients needed to be identified faster and quickly given a loan, the MFIs had just two options for client acquisition: a) Acquisition – where by MFIs started taking over the portfolio of smaller MFIs or specific JLGs. Sometimes, SHGs were also taken over (cannibalized) and split into several JLGs (depending on size of SHG); and b) Mutual Sharing – where by several MFIs decided to share and use their available JLGs/clients on successive days and through the basis of a simple reciprocal arrangement.

·         Third, both of the above led to the emergence of power brokers (also called as broker agents or ring leaders) – they were basically center leaders (or group leaders or even loan officers) who had access to a captive set of JLGs and clients. These new intermediaries started to match make with different MFIs on increasing attractive and exploitative terms. Thus, slowly these agents became the most powerful pivot in the local micro-finance system and various processes were outsourced to them, often without any quality checks. The outsourced processes ranged from client acquisition to KYC documentation, loan disbursement, repayment collection etc. Over time, this outsourcing through agents became an established strategy and the agents were omnipresent and omnipotent in the Indian micro-finance industry – and they often demanded their pound of flesh and got it too…it appears that the coercive practices and multiple lending, which were often cited in the present crisis, are perhaps due to the presence and use of such agents…

·         Fourth, and as the period (April 2007 – March 2009 and thereafter) progressed, growth came from not adding fresh clients. Rather, growth came through concurrent loans (from same MFI) to its clients and multiple lending to shared JLGs/clients, who were serviced by different MFIs on different days. The concurrent and parallel MFI loans, through shared JLGs and clients, appeared to be GOD sent and clients just grabbed them during the phase of burgeoning growth – as by then many of them realized that they could not service their increasing debt. The MFIs too were ecstatic about turbo charging financial inclusion and so were equity investors, banks, policy makers and other stakeholders including international bodies. This is a very critical point that needs to be noted and therefore the outreach of the Indian micro-finance industry needs significant correction and revision to reflect this reality.

With passage of time, the low-income clients again started to feel the pinch and could not service their (burgeoning) debt from their existing sources of income/cash (including livelihoods). Further, loans from informal and semi-formal sources also slowly started to dry up and hence, the existing debt could not be serviced from borrowing as well. And these households also had no serious assets as many of the loans were being used mainly for consumption expenses – and as a result, there were no investments in assets for livelihood and/or as general investment.

Hence, in the wake of increasing market imperfections (caused by several structural changes in India) for products/produce made by micro-entrepreneurs and also given the imperfect markets for labor of low income people, their sources of cash dried up even further and rendered them even more vulnerable and dependent on (MFI and other informal) loans for their survival, which they increasing found difficult to repay…The is a very critical aspect that needs to be noted because, it stresses how loan after loan was being disbursed to enable clients and households to subsist and survive…little did any one realize that this was a time bomb ticking away to explosion…and while the clients suffer on various counts now, the institutions that lent them money, their equity investors and other stakeholders reaped very significant rewards^[v] during a very short time.

Figure 1 below summarizes the above aspects diagrammatically…and the figure is self-explanatory…and situation I is symbolic of the erstwhile schemes in India like IRDP and situation II portrays what perhaps happened in the present Andhra Pradesh micro-finance crisis…

And that takes us to the next lesson from the present AP crisis…

Lesson # 4: Indiscriminate (and multiple) lending to low income people in pretext of furthering financial inclusion - without regard to their (and their families) loan absorption and debt servicing capacity and especially in the wake of vulnerable livelihoods - can only prove to be a recipe of disaster and will ultimately exclude them altogether from the financial system. As has been argued above, when people with weak and vulnerable livelihoods are lent large sums of money (> Rs 25,000), then repayment will either have to come from fresh loans (greening resulting in multiple lending) and/or restructuring of loans. At some point this cycle will (have to) stop and the bubble will then simply burst…and these clients will become financially excluded again…

Next Post: The Financial Inclusion (Access) Paradigm: Regulatory Level Lessons From The Indian and Andhra Pradesh Experience (PART II)

Happy New Year Once Again!

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[i] Please treat this as an attempt to connect the dots and I have tried to the best of my ability and knowledge…

[ii] 1 US $ = Indian Rupees 46.

[iii] Despite lack of rigorous studies

[iv] A popular metaphor for a line not to be crossed

[v] In fact, the above prompted a well known site www.indiamicrofinance.com to put up the following cartoon - on its website – highlighting the aspect of people using micro-finance to become rich (crore pathi)