Milking the cow for what it’s worth: Regulatory failure and perverse incentives in Andhra Pradesh

By Phil Mader , Governance Across Borders

Milking the cow for as much as it will give

At this week’s meeting of the microfinance sectoral organisation/lobby group Sa-Dhan, which represents 260 MFIs, the organisation’s executive director Mathew Titus admitted MFIs were not forthcoming in following voluntary codes of conduct. He also acknowled that the suicides and the resultant government ordinance had created a crisis of confidence in the microfinance sector. But the far greater, and unintended, admission of Sa-Dhan is that interest payments have been excessively high; the cow will simply not give milk forever at this rate. At its Thursday meeting, Sa-Dhan members agreed collectively to cut interest rates by 0.5 to 2 percent – the Indian broadsheet The Hindu smells an image makeover:

The step to snip rates is seen as part of the industry’s fresh initiatives to clear its image in the wake of the suicides in rural Andhra Pradesh allegedly due to coercive methods employed by some MFIs to collect dues and the subsequent ordinance clamped by the State Government.

The Hindu is probably right. SKS, which increasingly looks to be a central figure in this tragedy, has even offered to cut its lending rate by 2 percent. It looks like microfinanciers in India are worried they will lose public support, and are hurrying to cut back on their profitability until this storm blows over.

The incentive structure facing MFIs thus far has been to maximise profitability, attract investment capital, and then generate returns for shareholders. At least for the moment, that incentive structure has moved back while the cultural capital embodied in microfinance investments (in the Bourdieuan sense) must be restored/recapitalised through visible “socially responsible” behaviour

For years, the received wisdom among supporters of microfinance commercialisation has been that competition among privately-owned profit-maximising MFIs will lead to the lowest possible rates for borrowers (though some have begged to differ). If MFIs India now can suddenly cut back rates in order to attract or retain capital, they must be currently overcharging borrowers. Of course the Indian microfinance market is far from perfectly competitive, and the concerted action by MFIs in lowering interest rates and challenging the AP government’s ordinance shows that microfinanciers can even get together to co-ordinate and set prices.

Given that “a vast majority of MFIs in India are non-profit NGOs, which are legally not “owned” by anyone” (Vijay Mahajan and G. Nagashri’s words), therange of interest rates charged is surprisingly narrow. Sa-Dhan members (mostly NGOs) charge 19 to 27 percent, while MFIN MFIs – “31 non-banking finance companies (NBFC) MFIs including the top 10 MFIs” – “normally” charge24 percent. In this comparison, the non-profit microfinance sector appears to act as if it were a profit maximiser, guided by the ideal that microfinance companies must be “sustainable”, i.e. able to hold their own on the capital market against other investment opportunities. In the case of the for-profit sector, nomen est omen. Dropping interest rates in response to the AP tragedy constitutes an admission that both sectors’ ideal of profitability has been pursued on the backs of the poor.

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