Should MFIs be allowed to fail?
Cataclysmic events are no strange beast to the banking business. As for microfinance, the sector will survive even as some players drop out.
Sure, I say. I’m taking a contrarian position in the industry and here’s why. Let’s look at why people have loved the microfinance industry, at least in the past.
First, there was enough propaganda that it was alleviating poverty to make you feel good about association. And proponents will still argue that if some of the struggling MFIs are allowed to fail, it will crush the dreams of financial inclusion and, thereby, a chance to ‘better the lot of the poorer sections of society’.
This simply does not hold. Six years into this, it is starkly apparent to me that financial inclusion in the form of high interest loans does not better the lot of anyone very much. There is very little productive use of the money and very little of sustainable value has been created with microfinance funds — the value creation per rupee is lower than if the funds were deployed elsewhere.
To create sustainable changes we need something more fundamental than financial inclusion. We need ways to enhance human capability and the creation of value and then let the funds follow, not lead.
Second, there’s been the tenet that the industry stakeholders have stuck by — that the need and demand is huge and therefore that supply should not be choked in the short term. This is tricky. Of course, there is enormous demand among the poor for money. There’s demand everywhere for money. But the kicker is that the demand is for cash in hand and not for debt.
People want money to manage their cash flow but are not really thrilled at the prospect of paying it back.
Typically they are not ecstatic, loyal customers but rather opportunistic borrowers, and managing repayments is the single biggest task of lenders. The microfinance industry has shown that under ideal circumstances of few lenders and no political intervention, its repayment mechanisms can work very well.
However, as the Andhra Pradesh crisis has clearly demonstrated, customers see little value in sustaining debt, little loyalty to the lender and can be easily convinced to default. If indeed the value creation and livelihood development facilitated by microfinance was so profound, then the customers would be rising up against the AP government to protect the value that they saw in their debt relationships.
So if we are to protect the industry or individual players within the industry, what is it we are really trying to protect and why? If we take the view of the ultimate outcome of value creation on a longer time scale, it is major upheavals that pave the way for completely new thinking and fundamentally new and better models.
In nature it has been the cataclysmic instances that have paved the way for the most significant evolutionary advances. It has been the famines and floods that have tested the limits of the robustness of the organism’s constitution, and with thinking organisms, their foresight and ability adapt to these new circumstances.
It is when only the most robust remain to breed with completely new behavioural paradigms constructed from lessons of the past that real advance is made. And as it is for organisms, so also it is for organisations.
In the microfinance industry, the opportunistic, highly leveraged approach of rapid growth without genuine customer engagement and value creation was evident among a number of players long before the Andhra political intervention. Customers jumped easily among lenders and borrowed from one to pay another and the premise that microfinance largely funded micro-enterprise was challenged with direct evidence to the contrary.
And cataclysmic defaults are no strange beast when it comes to this segment — the banking sector has experienced it before and individual players in the industry have battled it even when the going was good for others in the industry.
The good news is that there are companies within the industry that have vigilantly protected themselves against these risks, building value steadily and deliberately. It is these that will emerge stronger from with even better mechanisms to build real value for customers and consequently, loyalty.
So in the long run, I believe, the industry will survive even as some of the players drop out, and the crisis will actually speed up the path to a genuine solution to the country’s larger problems.
Originally published in The Hindu Business Line