Credit Bubbles in India’s Slums

Our readers will remember the near-reverence with which we read the dispatches from India some of whose credit companies, unsullied by too great a concern about profit, had brought credit to the Indian and other slums in minute quantities. Unfortunately the credit meltdown and the slackening concern about the other fellow and (and who after all asked him to raise a family?) has for a few years dimmed these inspiring reports. And, indeed, since then the big bank crisis pushed them off the screen entirely. What happened to them? That we learn from a recent reportage in The Wall Street Journal (13/08, “A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum” by Ketaki Gokhale): “Ramanagaram, India – A credit crisis is brewing in ‘microfinance,’ the business of making the tiniest loans in the world.
“Microlending fights poverty by helping poor people finance small businesses – snack stalls, fruit trees, milk-producing buffaloes – in slums and other places where it’s tough to get a normal loan. But what began as a social experiment to aid the world’s poorest has also shown it can turn a profit.

“That has attracted private-equity funds and other foreign investors, who’ve poured billions of dollars over the past few years into microfinance world-wide.
“The result: Today in India, some poor neighborhoods are being ‘carpet-bombed’ with loans, says Rajalaxmi Kamathm a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008 totalling $1,24 billion, according to S-Dhan, an industry association in New Delhi.

“‘We fear a bubble,’ says Jacques Grivel of the Luxembourg-based Finethis, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure in India. ‘Too much money is chasing too few good candidates.’

“Here in Ramanagaram, a silk-making city in southern India, Zahreen Tai noticed the change. Suddenly, in the shantytown where she lives, a lot of people wanted to loan her money. She borrowed $125 to invest in her husband’s vegetable cart. Then she borrowed more.

“‘I took from one bank to pay the previous one. And I did it again,’ says Ms. Taj, 46 years old. In four years she took a total of four loans from two microlenders in progressively larger amounts – two for $209, another for $293, and then $356.

“At the height of her borrowing binge, she says, she bought a television set. ‘The arrival of microfinance increased our desire for things we didn’t have,’ Ms. Ta says, ‘We all have dreams.’

“Today her house is bare except for a floor mat, and a pile of kitchen utensils. By selling her appliances and jewelry, she cut her debt by $94. That’s equal to roughly a quarter of her annual income.

“Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt load is stirring up social tension. Many borrowers complain that effective rates – which can vary from 24% annually to 39% annually – fuel a cycle of indebtedness.

“Alpana Killawals, a spokeswoman for the Reserve Bank of India, said in an email that the central bank doesn’t as a practice cap interest rates for microlenders, but does press them not to charge ‘excessive’ rates.

“Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.”

Muslim Leaders Advise Stopping Payments of Ransom Rates

“The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they’re not about to comply with that.

“The repayment revolt has spread to other communities, including the nearby city of Channapatna, and could reach further across India, observers say.

“‘We are very worried about this,’ says Vijayalakshmi Das of FWWBIndia, a company that connects microlenders with financing from mainstream banks. ‘Risk management is not a strong point for the majority of local microfinance providers. She adds, ‘Microfinance needs to learn a lesson.’

“Nationwise, average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009 to about $135 from $27 or so, according to a survey by Sa Dhan, the industry association. These sums are obviously tiny by global standards. But in rural India, the poorest often subsist on just a few dollars a week.

“Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger producing firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.

“This change opened the door to more private-equity money. Of the 54 private-equity deals (totalling $1,19 billion) in India’s banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chemmai-based private-equity research service.

“‘We’ve seen a major mission drift in microfinance, from being a social agency first,’ says Arnab Mukherji, a researcher at the Indian Institute of Management in Bangalore, to being “primarily a lending agency that wants to maximize its profit.’

“Making loans in poorest India sounds inherently risky. But investors argue that rural developing world has remained largely insulated from the global economic slump.
“International private equity funds started taking notice of Indian microfinance in March 2007. That’s when Sequoia Capital, a venture capital firm in Silicon Valley participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world’s largest micro-lenders.

“‘SKS showed the industry how to tap private equity to scale up,’ said Arun Natarajan of Venture Intelligence.

“Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, an affiliate of Silicon Valley Bank.”

– from Economic Reform, September 2009