Andhra Pradesh Microfinance Crisis could become a National Crisis

Andhra Pradesh Financial Crisis Threatens to Snowball into a National Crisis

By Nachiket Mor and Bindu Ananth

The financial sector crisis in Andhra Pradesh seems to be playing out like a very bad dream that doesn’t end. It has been 33 days since the State Government of Andhra Pradesh passed a sweeping Ordinance governing all lending activities in the state by banks as well as non-bank finance companies (with only perhaps State Bank of India excluded from its ambit since it is not constituted as a company under the Companies Act but through its own Act) with stipulations that no collateral may be taken, repayments must be monthly, nobody must have more than one loan outstanding, all financial services business must be carried out in government offices and the permission of government agencies must be taken before any loans can be taken.

Quite aside from the number of fundamental rights of its own citizens that the Ordinance infringes upon, it directly challenges the competence and the capacity of the Reserve Bank of India (RBI) to govern the financial system in the state since both sets of entities are directly regulated by it and given their systemic importance have been subjected to several rounds of supervisory audits over a number of years.

ifmr nachiket andhra microfinance

Nachiket Mor and Bindu Ananth of IFMR Trust

Not surprisingly, this political event has led to large scale defaults taking place inside the State and as on date, most banks and non-banks are in violation of the provisions of the Ordinance in one way or another, making their directors (including independent directors) liable for imprisonment.  What is very surprising though is the complete absence of any public statement either from the Central Government or from the Reserve Bank of India.

The last time something similar happened in Andhra Pradesh was in 2006 in Krishna district and both the RBI and the Central Government acted swiftly and brought an end to the crisis and did not allow it to spread beyond one district.  This time around over a month has passed without any word from both these entities and there is a fear that, emboldened by this tacit encouragement, other State Governments will follow suit.  Since this is a very real possibility, all banks and capital market participants have immediately stopped extending any funding to non-bank finance companies on a nationwide basis. In particular, focus has been on those RBI regulated non-bank finance companies whose businesses have enjoyed a priority sector tag on account of the criticality of their operations for the wellbeing of weaker sections of society.

This complete withdrawal of liquidity combined with the loss of capital that is sure to follow from all these defaults points to a likely collapse, on a nationwide basis, of financial services infrastructure that serves 2 crore low-income households with significant NPA implications for the banking system.  Ironically, we may be one of the few countries in the world to have escaped the contagion effects of the 2008 global financial crisis on account of a robust economy but we will very likely be the first country in world where a crisis was created directly by the actions of a state government that ought to have acted in the role of a protector.

While there are many aspects of the situation that need to be addressed, we would like to comment on three key aspects that seem particularly salient to us:

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