The relationship between cause and effect is usually a fascinating one – and often also a cruel one. Severe distress and economic hardship currently being felt in the villages of Andhra Pradesh in Southern India is a case in point.
Many small businesses are on the point of ruin because their credit lines are drying up. This might seem surprising, given the fast rate of industrial growth in India over recent years – much of it in Andhra Pradesh. And one of the reasons for that growth has been the availability of microcredit, the provision of which has increased at a rate of about 70% a year in recent times.
Now many of the microcredit lenders are using rough tactics to call in their loans. There are two primary reasons for this. One is that those institutions are finding it harder to borrow money on the international markets to re-lend to small borrowers. But the other factor is one that this column has warned about in the past – the takeover by profit-orientated businesses (with investors demanding high returns) of a market sector that was pioneered by mutuals.
The Grameen Bank founded by Muhammad Yunus was, and still is, a true mutual. It transformed much of rural life in Bangladesh, improving vastly the quality of life for many thousands of women, in particular. But its success in starting small and becoming vast led to many traditional banks and even a few DelBoy entrepreneurs to see a new market opportunity.
Around the world, some of the largest banks have loaned to microcredit institutions. Some of those institutions are legitimate, others are little more than loan sharks masquerading as friends of the small trader. What we are now seeing in Andhra Pradesh is the long-standing relationship between lenders and poor borrowers – pay up or else. Extortionate penalty interest rates are being accompanied by physical extortion.
The situation in Andhra Pradesh has reached a crisis, with thousands of small rural businesses on the point of collapse. Lenders themselves are faced by a worsening problem as rumours amongst borrowers are leading to increasing rates of defaults, as borrowers begin to expect the state government to take over the microfinance institutions, to prevent their closure. Large banks operating in India fear they could lose billions of dollars if the sector goes into meltdown. In Andhra Pradesh alone – and the problem has spread much more widely than one state – there are $2.7bn in outstanding microloans, affecting about 6.7 million borrowers.
This crisis was predicted and warned against by Muhammad Yunus, who suggested that too many big organisations were moving into the sector, motivated only by the potential high returns and that it had become very vulnerable to credit loss arising from the global financial crisis. His warnings have now come true. The related fear must now be that the many mutual microcredit institutions will be unfairly blamed for a crisis not of their making.
Meanwhile, it is become clearer what is intended for another sector of mutuality that is suffering from changes in the financial environment that are largely not of its own making. The proposal from Kent Reliance Building Society and the private equity house JC Flowers is for the KRBS business to be transferred into a PLC, which is jointly owned by KRBC and JC Flowers. That PLC vehicle could be used to buy-up other financial institutions – possibly starting with Northern Rock and going on to takeover various building societies – and subsequently to float, with JC Flowers selling its stake at that time.
This arrangement would be intended to produce a significant return for JC Flowers. Possibly KRBS would also be quids-in. One advantage of the structure is that it allows substantial additional equity investment into the operations of KRBS, thus enabling it to meet the requirements of UK and global financial regulators. It is the obligation of those regulators – not least under the Basel III requirements now agreed – to increase capital liquidity that has driven this review of financial structures. The capital liquidity requirements are very damaging to mutuals, which can meet them by either building-up retained profits (which typically takes a long time), or else by demutualising.
KRBS has gone for a different approach, using a hybrid structure that involves partial demutualisation. It is a model similar to that adopted in France by Credit Agricole and Credit Mutuel, which are generally regarded as co-operative/mutual banks, despite being partially owned by outside shareholders.
Whether KRBC’s moves amount to progress or defeat for the mutual and co-operative sector is a matter of interpretation and personal viewpoint. It also depends on what the alternative is. It is, by some way, better than KRBS being closed down for want of liquidity. If I were a member of KRBS, I’d want to understand very clearly the financial position of KRBS before I voted on the proposal and I would consider whether other options were available.
I’ve never been a fan of hybrid forms of mutuality. It feels like a means of managed decline. Worse still, this particular hybrid vehicle could be a Trojan horse to swallow many other parts of the traditional mutual sector. Please excuse me if I don’t join the celebrations.