Andhra Pradesh: from microfinance Mecca to credit crunch

Andhra Pradesh, India’s fifth-largest State, has always been considered as one of the most insightful examples of “good” microfinance.  It is in fact the site of about a third of the country’s $5.3 billion in microfinance loans, and before October 2010 Andhra Pradesh microloans were seen as a clear example of how micro-lending could provide the poor a first foothold in the bottom rung, from which they could climb the ladder of development.

However, this apparently rosy scenario changed dramatically after the credit crunch of 2010, when the basic microfinance principle of helping the poor has been reversed, by turning micro-lending into a profit maximizing industry so familiar in many other contexts.

The microfinance crisis which erupted in October 2010 is in fact the deepest crisis event in microfinance so far, and unveiled the shaking foundations on which this sector was flowering.

After the suicide boom happened in October 2010, when Andhra Pradesh suffered a total of 14,364 suicide cases in the first nine months of the year, people started questioning the role of microfinance institutions, and wondering to what extent mismanagement of lending could have contributed to that disaster. People went out on streets demonstrating against the microfinance lenders, and their hero had turned into a villain in just a matter of a month.

Looking at these tragic and unexpected facts, questions naturally arise and urge to be answered. Did microfinance really play a role in the 2010 Andhra Pradesh crisis? Why did men turn microfinance into a mess? What was wrong with their way of doing microfinance? How can we avoid making the same errors in the future?

I will try to give some clues to answer these complex questions, hoping that this article will raise in the reader a desire and a need for further investigation on this issue.

Putting the rise of Indian microfinance into perspective reveals longer-term causal processes driving the creation of the massive debt bubble in Andhra Pradesh which generated the crisis of Indian microfinance.

First, we have to briefly sketch a picture of the microfinance world in Andhra Pradesh, before 2010.  The traditional microfinance structure that emerged from the 1980s was based on women self-help groups. Through the help of Indian government, NGOs and communities grants began funding self-help groups usually made by 15 to 20 women, using social standing and peer pressure to ensure repayment, with threat to lose access to future loans as an incentive. Women were considered to have higher repayment rates, and suffered the most from the lack of family resources or loans to promote their initiatives and business ideas. This innovative lending mechanism was therefore a powerful way to empower women, and thereby to let many families lift themselves up the poverty line.

Soon, the National Bank for Agriculture and Rural Development funded cooperative lending, and the sector progressively expanded.  Non-profit organizations subsequently got involved as middlemen between banks and borrowers.  The success of microfinance organizations in the 1990s induced many entrepreneurs to think of microfinance industry as a new profitable market. Subsequently, some NGOs and microfinance institutions were made private in an attempt to harness these profits, and other economic agents such as banks and investors began paying serious attention to microfinance.

In this new expanding framework, by 2005 non-profits such as SKS and Share Microfin turned themselves into profit-making enterprises. Capital flowed into the new industry from commercial banks, venture firms and private equity. In August 2010, SKS became the second MFI to go public, by listing its shares on a public stock market.

Unfortunately, the situation was about to deteriorate soon. Due to extremely loose credit conditions and absence of adequate regulation of the sector, in 2010 the overall rate of indebtedness was extremely high, anything but sustainable. In fact, according to a survey carried out in 2 Andhra Pradesh districts by the “Center of Microfinance and Microsave” in 2012, 84% of households had two or more loans, while 58% even had four or more loans. Regardless of who originated the majority of these loans (MFIs, SHGs, or moneylenders) it was clear that the majority of borrowers would have not repaid their loans, and eventually the bubble exploded.

Andhra Pradesh microfinance collapse has been compared in its dynamics to the US subprime crisis, since they both were connected with a good social policy, and they both have slipped out the hands of policy makers and regulators, driven by market forces.

In conclusion, to partially answer the questions mentioned in the beginning of the article, we always have to consider that complex problems rarely have simple solutions and as that in multifaceted contexts it is necessary to balance all different aspects of a possible solution, to make this solution real and effective. In our case, there does not exist a simple solution to help the poor earning their way out of poverty. Therefore, we should not oversimplify reality considering all types of microfinance to be the answer. The focus should be instead on how to do microfinance in a responsible and sustainable way. In fact, only when accompanied by an adequate regulation specifying borrowing conditions, an interest threshold preventing institutions from charging excessive interest rates, and limitations tailored on a specific country context, microfinance can be an answer and contribute to poverty alleviation.

As Duflo and Banarjee thoroughly analyse, “When it works well, microfinance can be a win-win situation, as the poor can borrow money at rates that may look high, but are much lower than those offered by moneylenders; and banks can make a sustainable business in lending to the poor. All this rests as much on a social contract as on a legal contract. MFIs need to be more diligent in their lending and screen borrowers better — if too many borrowers can’t repay their loans, the social obligation will start to fall apart.”


Francesca Miserocchi

This article is taken from Bocconi Students for Microfincance website because we really liked it:

BSM is committed to the development of an academic platform providing guidance to those interested in Impact Finance and Microfinance in particular


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