In a three-part series, Roosevelt Institute Fellow Georgia Levenson Keohane explores India's microcredit crisis and what it teaches us about combating poverty. In Part I, Keohane explains how rapid expansion created a monster-sized bubble highly reminiscent of the U.S. subprime fiasco.
In recent weeks, those of us consumed with consumer finance have fixed our eyes on Elizabeth Warren and her embattled Consumer Financial Protection Bureau. Meanwhile, and seemingly worlds away, a credit crisis affecting millions of poor borrowers has been unfolding -- with more than a few features of our own subprime fiasco.
In India's Andhra Pradesh region, the center of that country's microfinance industry, default rates on microloans have skyrocketed and local and federal lawmakers have rushed to reign in lenders. Shares of SKS Microfinance -- the publicly traded microlender once heralded as the great success of social enterprise and proof it was possible to serve the poor and earn market rate returns in the process -- have plunged, down nearly 70% from their IPO price last summer.
The larger political backlash against microenterprise is not confined to India. On May 12th, Muhammad Yunus, winner of the Nobel Peace Prize in 2006 for his pioneering work in microcredit, was ousted by the Bangladeshi government from his post of Managing Director of Grameen Bank, rattling the field further. Like SKS stock, the euphoria once surrounding microcredit as panacea for global poverty has plummeted.
What does this crisis in South Asia tell us about the much hyped and hoped for microenterprise revolution? And more broadly, about our ability to harness market forces to solve complex social problems? Are there lessons here for American policy makers? The answer is 'yes', and the subject of the next two posts.
But first, some background.
What is microcredit? And why do we care?
The appeal of microcredit has always been its elegant simplicity. As a solution to market failure, the story goes like this: commercial banks do not readily lend to the poor because there is no profit in it. In the absence of collateral, lenders will only make small loans, and yet the cost of administering these loans -- due diligence, ongoing monitoring -- remains steep. In response, banks either charge punishingly high interest rates or opt not to lend in the first place. The poor are left with few informal borrowing options and are often at the mercy of loan sharks.
The architects of microcredit argued that by eliminating the profit motive -- or at least the steep profit requirements of commercial lenders -- small, affordable loans could be made and repaid. This would create self-sustaining credit markets for the poor, a virtuous cycle of investment in business and human capital, and a pathway out of entrenched poverty. In 1976, Yunus launched Grameen with a series of joint-liability loans to small cohorts of poor women. This model soon proved that the poor could be counted on for repayment and helped usher in extraordinary industry growth. Today, $65 billion in microcredit loans are made to 90 million borrowers worldwide.
A not-so-micro bubble
In recent years, much of this expansion has been fueled by an infusion of private capital. In one of the first high-profile examples of this trend, Compartamos, a Mexican microlender, morphed from a non-profit to a for-profit to a publicly traded company. In 2007, Compartamos' IPO raised $467 million in exchange for 30% of the company. Not surprisingly, other lenders followed suit.
Not everyone has cheered the source or pace of industry growth. In 2008, as subprime lending in the United States brought the American -- and global -- economy to its knees, many cautioned that the under-regulated microcredit markets might be next. Despite the warnings, private investment continued apace. Last July, SKS Microfinance in India issued 17 million shares to investors like George Soros' Quantum fund and the Silicon Valley VC firm Sequoia Capital. Yet just before the IPO, a number of unheeded Cassandras, like Sanjay Sinha of New Delhi's Micro-Credit ratings, had warned, "runaway growth at microfinance companies masks as erosion of lending standards and a lack of regulation that may help spark rising defaults."
Credit crisis redux
Unfortunately in India, much of this bubble has burst. The parallels between this south Asian microcredit crisis and our own subprime-induced calamity are striking: a rush of under-regulated private capital, high levels of financial illiteracy on the consumer side, inadequate sources of credit information on the lender side, and innovations in financial product design that also introduced greater risk into the system. The regulatory challenge in India, as in the U.S., is to protect consumers against hasty or predatory lending without choking off vital sources of capital.
Beyond the regulatory issues, however, the South Asian credit crisis raises a host of important questions for U.S. policy makers about social innovation: how do we improve the design, delivery and evaluation of programs and services to help poor and vulnerable people? Are there viable market solutions to complex social problems? Do they work? And how do we know? More on these tomorrow.
Georgia Levenson Keohane is a Fellow at the Roosevelt Institute.