The Andhra Pradesh microfinance crisis should hopefully reopen the debate on financial inclusion.

It was not considered proper in polite society to question any aspect of the new religion because such doubts would betray a lack of empathy for the poor. What the snowballing crisis in Andhra Pradesh has shown us is that microfinance has a dark side that has resulted in growing indebtedness in poor communities and some questionable recovery practices.

Also Read Niranjan Rajadhyaksha’s earlier columns

The crisis invites extreme opinions. But the reality is complicated. Microfinance is neither a magic wand against poverty nor a fiendish trap set up by loan sharks. The little empirical work done on the impact of microfinance would satisfy neither its extreme supporters nor its extreme opponents.

Meanwhile, attempts to solve the problems in Andhra Pradesh through interest rate controls or exhortations to the poor to default are plain wrong. An earlier instalment of this column had noted: “But the current rush to smother it with price controls and criminal action is likely to hurt poor borrowers, either denying them access to credit or sending them back to moneylenders."

People need access to modern financial services to smoothen cash flows, since earnings and spending do not always move in step. You can either draw down your savings or take a loan to buy a car or a house, for example. The traditional way of doing this was to build a pool of savings to be used for large purchases or emergencies; borrowing for these requirements is a growing trend in urban India.

The poor need similar options to finance lumpy spending and lubricate their small businesses. The main focus of microfinance companies has been to help the poor by offering them loans, often with an aggression that has finally backfired in areas such as Andhra Pradesh.

Far less attention has been the other half of financial inclusion—encouraging the poor to save in the formal financial system. Roughly half the adult population in India does not have access to a bank account. A recent book, Portfolios of the Poor, which tracked the financial decisions of 250 families in the slums of India, Bangladesh and South Africa, who were encouraged to keep a record of their financial decisions in a diary, shows that even the most poor families try to keep aside some of their incomes to meet future financial needs.

The problem is that the poor do not have access to viable financial options and, hence, tend to keep their wealth in physical goods such as cattle or gold. A publication by the National Council of Applied Economic Research—How India Earns, Spends and Saves, by Rajesh Shukla—shows that a quarter of urban families and more than 40% of rural families consider keeping money at home as the preferred form of cash savings. That’s millions of people treating the mattress at home as their bank.

While microcredit does have a role to play in advancing financial inclusion, more attention needs to be paid to microsavings. In an article published in March, The Economist cited a survey of 166 microfinance institutions in 2009 by the Microfinance Information Exchange, which showed that all offered credit to the poor, but only 27% had savings products. Grameen Bank is one of those that offer savings options to members.

Indian policymakers have been keen on this form of financial inclusion, pushing banks to open no-frills accounts and trying to route all payments made for work done in the Mahatma Gandhi National Rural Employment Scheme through banks. There are also some initial moves to promote financial transactions through mobile phones, an area that has huge regulatory complications but potentially useful in a country such as ours, where there are more mobile phones than bank accounts.

Maintaining low-value bank accounts for the poor will be commercially profitable only if banks are able to drop costs through the smart use of technology. In January, the Bill and Melinda Gates Foundation decided to provide grants worth $38 million “to help microlenders explore ways to make savings accounts available to 11 million poor people across 12 countries in Africa, Asia and Latin America over the next five years," Joyce Lehman, a programme officer at the Financial Services For The Poor unit of the Gates Foundation, said at the time.

The crisis in Andhra Pradesh is about one part of the microfinance story—loans given out to the poor. Despite the political grandstanding and regulatory overreach on this front, there can be little doubt that microfinanciers offer cheaper loans to the poor compared with moneylenders. But there is a broader lesson as well. The poor also need access to savings products and this can be a profitable activity only when the cost of servicing low value accounts collapse because of the smart use of technology.

It is time for a more rounded debate on the benefits of financial inclusion, both as microcredit and microsavings.

Niranjan Rajadhyaksha is managing editor of Mint. Your comments are welcome at