Millions of defaults threaten future of microfinance in India

In February 2020, unaware the coronavirus pandemic was about to wipe out her livelihood, Arpita Das borrowed $2,300 to buy materials and equipment for her family fishing business in West Bengal, India. A few weeks later, demand for her prawns collapsed, leaving her unable to make the $180 monthly repayments to two microlenders.

The 33-year-old mother of two, who had never missed a payment since she started borrowing three years earlier, is now living off the vegetables and grains she grows on a plot of land outside the home she shares with her husband and his parents. With the whole family out of work, they are unlikely to have any income unless she can borrow $1,400 for this year’s prawn harvest.

During India’s initial three-month lockdown, one of Das’ lenders would call her regularly to see how she was doing. Now reps visit her in person at home every few weeks to see if she can pay. “I tell them that I don’t have the money,” she says from a remote town on the banks of the Kangsabati River. “They say I won’t be eligible to borrow more unless I repay my current loan. How can I restart my business if I can’t get a loan?” Das says she fears she may be forced to turn to moneylenders, who charge rates as high as 100%.

Borrowers around the world have been hit hard by COVID-19, but perhaps nowhere more so than in India. It’s the global leader in microfinance, the financial service that offers loans to entrepreneurs too poor to qualify for conventional bank loans.

Individually, these loans aren’t big — only $487 on average — but the number of people taking them out is huge, even by the standards of the world’s second-most-populous country. In the past five years, the pool of small borrowers has almost doubled, to 58 million, according to Microfinance Institutions Network, or MFIN. Roughly 1 in every 20 Indians is in debt to a microlender. In total, they owe about $31.6 billion.

Worldwide, microlending’s tremendous reach, once heralded as its greatest strength, now looks like a deep liability. From humble roots as a charitable movement more than 30 years ago, the sector has morphed into a global enterprise covering 140 million borrowers — 80% of whom are women — with about $124 billion in debt, according to a 2019 report by the Microfinance Barometer.

Most borrowers are small traders, street hawkers, and daily wage laborers, the people most vulnerable to the economic shocks of the pandemic as well as to the virus itself. In India many decamped from urban slums to rural villages soon after the lockdown in late March 2020 with no idea when or how they’ll be able to support themselves, let alone pay their debts.

Today about 96 microlenders operate in India. Banks and nongovernment organizations also provide microfinance loans. Microfinance institutions, or MFIs, can be set up with only 50 million rupees ($685,000) and can lend as much as 125,000 rupees per borrower. The microlenders themselves borrow from banks and nonbank lenders at an average 14%, then charge interest rates of as high as 22%.

With India’s economy set to contract the most since 1952, many borrowers are becoming trapped in never-ending debt cycles. This problem leaves them with excruciating choices as they try to avoid being blacklisted by lenders. Some have sold the tools of their trade to meet obligations, compounding a virus-induced loss of income with a more permanent loss of livelihood. In this male-dominated society, women borrowers in particular risk being ostracized within their communities.

Although the pandemic isn’t the first crisis for the country’s microfinance industry, it could be its biggest. After heavy loan demand and loose regulations led to a spate of suicides among poor borrowers in 2010, regulators drew up stricter rules for the sector, including capital requirements as well as limits on loan exposure and interest rates. But they did little to slow demand.

“Until this pandemic, there was no trigger for any self-doubt for the lenders,” says former Reserve Bank of India Governor Duvvuri Subbarao, a strong advocate of financial inclusion during his 2008 to 2013 tenure, adding that lenders should now focus on raising capital and bolstering their balance sheets. Although the microfinance industry helped lift millions from poverty, he says “irrational exuberance” may have undone some of the social benefits, as lenders became increasingly exposed to defaults and capital loss.

Amid the pandemic, India’s central bank has taken unprecedented steps to help borrowers, including a six-month loan moratorium that ended on Aug. 31 and special loans to refinance MFIs. Prior to the onset of COVID-19, repayment delays affected about 2% of all loans; by the end of September, that number had risen to 20% before easing to 10% to 15% in December, says Manoj Nambiar, managing director at Arohan Financial Services Ltd., India’s fifth-biggest microfinancier. “In the last few months we were focused on collections. Now we’re looking at stepping up lending,” he says.

Transformed industry

Arpita Das’ predicament is a far cry from the vision of Muhammad Yunus, the 80-year-old former economics professor who won the Nobel Peace Prize in 2006 for his pioneering microfinance work in Bangladesh. Over the years, the MFI boom attracted private capital seeking growth and high returns.

With default rates across India soaring on the mainly unsecured loans, the virus is undoing the business models of dozens of MFIs as funds dry up. Unlike conventional banks, these institutions don’t have access to public deposits and rely on market borrowings to keep their businesses running. During the initial days of the pandemic, as microlenders struggled with defaulting borrowers, banks curbed lending to MFIs. When the economy reopened, consumer demand picked up, improving income opportunities for the poor.

Still, collection rates dropped to 85% to 90% of loans in November, from about 98% before the pandemic. Given that the industry exists on extremely tight margins, such recovery levels aren’t viable in the long term.

With borrowers unable to repay their loans, MFIs, in turn, can’t afford to pay back the banks. As a result some microcreditors are cutting back on lending to conserve capital and limit defaults. From April to September, MFIs in India provided only 111.87 billion rupees in loans, 68% less than during the same period in 2019. Arohan’s Nambiar says he expects MFI credit growth in fiscal year 2020-21 to be half of what it was in the previous fiscal year.

Experts say an inevitable churn will mean that a leaner industry emerges from the crisis. It will also be increasingly digitized, more closely regulated, better capitalized, and bound by stronger consumer protections.

To keep growing, microlenders are calling for tighter risk management practices to contain even more defaults and easier capital-provisioning rules for MFIs, which are now stricter than those for banks. “The need of the hour is to provide fresh credit and save the basic livelihoods of poor people,” says Alok Misra, chief executive officer and director of MFIN, which was authorized by India’s banking regulator to ensure compliance in the MFI sector.

‘Where will I get the money?’

Before the pandemic arrived in India, Bandana Maurya, a 30-year-old widow, was living in a tiny asbestos-covered shanty in a Mumbai slum. The mother of three was making $100 a month packing drugs at a pharmaceutical company. Hoping to make a little extra money, she’d taken out a $410 microfinance loan to buy a sewing machine. Then came COVID-19. The drug company was forced to close. Maurya lost that job and suddenly found herself unable to keep up with her loan repayments. Struggling to pay for food, electricity, and medicine for a child who was ill, Maurya went to stay with her family in a village in Uttar Pradesh.

Since then she’s been getting almost weekly calls from her microfinance lender. “I feel let down and angry when they call,” she says, sitting in her sparsely furnished room. “I have never defaulted before, but who would have known that there would be such a virus and we would lose our livelihood? The bank should be more considerate. Where will I get the money?”

In late September, Maurya returned to Mumbai to look for work and get treatment for her daughter’s brain tumor. She stitched clothes for less than $2 a day and relied on her brother for food.

Maurya has discovered that in difficult times microlending is no more forgiving than macrolending. Das, in West Bengal, has come to the same grim conclusion. “I am now a defaulter,” she says. “Had I known there would be a lockdown, I would have not borrowed.”