What are the downsides to microfinance and micro-crediting?

And what are effective

alternatives to microfinance?

Microcredit is the extension of very small loans (microloans) to those in poverty designed to spur
entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history
and therefore cannot meet even the most minimal qualifications to gain access to traditional credit.
Microcredit is a part of microfinance, which is the provision of a wider range of financial services to the
very poor.

The success of the microcredit model has been judged disproportionately from a lender's perspective
(repayment rates, financial viability) and not from that of the borrowers. It might be expected that
microfinance institutions would provide safe, flexible savings services to this population, but with
notable exceptions they have been very slow to do so. Some experts argue that most microcredit
institutions are overly dependent on external capital. A study of microcredit institutions found that they
were very slow to deliver quality microsavings services because of easy access to cheaper forms of
external capital.

The Wall Street Journal seems to have done a hatchet job on the micro finance sector
of India ?
A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum
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 Kamath, 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, totaling $1.24
billion, according to Sa-Dhan, an industry association in New Delhi.
“We fear a bubble,” says Jacques Grivel of the Luxembourg-based Finethic, a $100 million
investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure
to India. “Too much money is chasing too few good candidates.”
Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change.
Suddenly, in the shantytown where she lives, lots 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 desires for things we didn’t have,” Ms. Taj says. “We all have dreams.”
Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV,
appliances and jewelry, she cut her debt to $94. That’s equal to roughly a quarter of her annual
income.
Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt overload is stirring up
social tension. Many borrowers complain that the loans’ effective interest rates — which can vary
from 24% to 39% annually — fuel a cycle of indebtedness.
In July, town authorities asked India’s central bank to either cap those rates or revoke lenders’
licenses. “Otherwise, the present situation may lead to a law-and-order problem in the district,” wrote
K.G. Jagdeesh, deputy commissioner for the city of Ramanagaram, in a letter to the central bank.
Alpana Killawala, 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.
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.

Lalitha Sharma, top, racked up 10 loans from the many microlenders who have set up shop in her
slum over the past few years. Here she helps with her husband’s snack stand. Like many of her
neighbors in Ramanagaram, India, she can earn about $8 a week, on average, working in the city’s
silk factories.
“We are very worried about this,” says Vijayalakshmi Das of FWWB India, 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.”
Nationwide, 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.
Some observers blame a fundamental shift in the microfinance business for feeding the problem.
Traditionally, microlenders were nonprofits focused on community service. In recent years, however,
many of the larger microlending 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 (totaling
$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 Chennai-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 the 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 microlenders.
“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, and SVB India Capital Partners, an affiliate of Silicon Valley Bank.
As of last December, there were over 100 microfinance-investment funds globally with total
estimated assets under management of $6.5 billion, according to the Consultative Group to Assist
the Poor, or CGAP, a research institute hosted at the World Bank.
Over the past year, investors have poured more than $1 billion into the largest microfinance funds
managed by companies, a 30% increase. The extra financing will allow the industry to loan out 20%
more this year than last, much of it to countries such as the Ukraine, Cambodia and Bosnia, CGAP
says.
Here in Ramanagaram, Lalitha Sharma recalls when the first microfinance firm arrived seven years
ago. Those were heady times for her fellow slum-dwellers: Money flowed freely. Field agents offered
loans to people earning as little as $9 a month.
They came to Ms. Sharma’s door, too.
She borrowed $126. Under the loan’s terms, she said she would use it to finance a small business
— a snack stand she runs with her husband. Many microfinance providers require loans to be used
to fund a business.
But Ms. Sharma, a 29-year-old mother of three, acknowledges she lied. “You have to mention a
business to get a loan,” she says. “There was no other way to get the money.”
She used it to pay overdue bills and to buy food for her family. Ms. Sharma earns $8 a week, on
average, in a factory where she extracts silk thread from cocoons immersed in boiling water.
Over the next four years, she took nine more loans from three different lenders, in progressively
larger sums of $209, $272, $335, and $390, according to lending records reviewed by The Wall
Street Journal.
A spokesman for BSS Microfinance Private Ltd. of Bangalore, another of her lenders, declined to
comment on her borrowing history, citing central-bank privacy rules.
This year, she took another $314 loan to pay for her brother-in-law’s wedding, again saying the
money would be used for business purposes.
She also juggled loans from two other microlenders — $115, $167, and $251 from the Bangalore-
based lender Ujjivan, and another $230 from Asmitha Microfin Ltd.
Ujjivan confirmed it issued three loans. An Asmitha official said he had a record of a loan to a
Ramanagaram resident named Lalitha, but at a different address.
“I understand that it is credit, that you have to pay interest, and your debt grows,” Ms. Sharma says.
“But sometimes the problems we have seem like they can only be solved by taking another loan.
One problem solved, another created.”
Many of the problems in Indian microlending might sound familiar to students of the
U.S. mortgage crisis, which was worsened by so-called “no-documentation” loans and by
commission-paid brokers who critics say lacked an incentive to check borrowers’ ability to repay.
Similarly in India, microlenders’ field officers are often paid on commission, giving them financial
incentive to issue more loans, according to Ms. Kamath.
Lenders are aware that applicants often lie on their paperwork, says Ujjivan’s founder, Samit Ghosh.
In fact, he says, Ujjivan’s field staffers often know the real story. But his organization maintained a
policy of “relying on the information from the customer, rather than our own market intelligence.”
He says that policy will now change because of the trouble in Ramanagaram. The lender will “learn
from the situation, so it won’t happen again,” he says.
It’s tough to monitor how borrowers spend their money. Ujjivan used to perform regular “loan
utilization checks,” but stopped because it was so costly. Now it only checks in with people
borrowing more than $310, Mr. Ghosh says.
BSS checks how loans are being spent a week after disbursing the money, and makes random
house visits, according to S. Panchakshari, its operations manager. The company doesn’t have the
power to insist that borrowers not take loans from multiple lenders, he said in an email.
Lenders also tend to set up shop where others have already paved the way, causing saturation.
There is a “follow-the-herd mentality,” says Mr. Ghosh at Ujjivan. Microlenders “often go into towns
where they see one or two others operating. That leaves vast chunks of India underserved, “and
then a huge concentration of microfinance in a few areas.”
In Ramanagaram district, seven microfinance lenders serve 22,500 women. (Most microloans go to
women because lenders consider them less likely to default than men.) Loans outstanding here total
$4.4 million, according to the Association of Karnataka Microfinance Institutions, a group of lenders
in Karnataka state.
Lenders in Ramanagaram say the loan-repayment revolt was instigated in part by Muslim clerics
who oppose the empowerment of women through microfinance. Most lenders are still servicing loans
to Hindu borrowers, but have stopped issuing fresh loans to Muslims.
“We can’t do business with Muslims there right now,” says Mr. Ghosh of Ujjivan. “Nobody wants to
take that kind of risk.”
The irony is that, for years, Indian microlenders have touted themselves as bankers to the nation’s
impoverished minority Muslim community, which has long been excluded from the formal banking
sector.
A 2006 report commissioned by India’s prime minister found that while Muslims represented 13.4%
of India’s population, they accounted for only 4.6% of total outstanding loans from public-sector
banks.
Islam prohibits the paying of interest, but mosque officials don’t cite that as the reason for the loan-
payment strike. They stressed the overindebtedness of the community, and the strains it’s putting on
family life.
Ramanagaram’s period of wild borrowing irks some residents, both Hindu and Muslim. Alamelamma,
a 28-year-old vegetable seller, says she has benefited from microfinancing and that the profligate
borrowers “have ruined it for the rest of us.”
One gully away, Ms. Sharma, the heavy debtor, has a different view: She would like to see the
microlenders kicked out of the community entirely. “Not just for now, but forever,” she says.

The Microfinance Sector (para 2.2) –microfinance is

more than just credit
It is a historic folly on the part of the Committee to view microfinance in
terms of credit only. The Committee itself in para 2.1 recognizes the multi-
faceted scope of microfinance and yet it chooses to look at the credit
services in vacuum. If the intent is “to assist the poor to work their way out
of poverty” then it is essential that we develop a regulatory regime where a
microfinance institution is allowed to provide comprehensive services to the
poor and not just credit.

Granted that the Committee’s mandate was to look only at entities governed
by the RBI, i.e. Banks and NBFCs, but that does not translate into looking
only at the credit aspect of microfinance.

2. Regulations regarding loan product (para

5.9)– Unnecessarily restrictive
It is my belief that the greatest reason for the success of microfinance has
been its ability to constantly innovate and adapt to the needs of its varied
customer base. Companies have frequently tinkered with the core tenets of
the loan product, like loan amounts, loan tenures, repayment frequencies,
add-on services, group sizes, collection methodology, etc. in a bid to ensure
that their product becomes more palatable to the customer.

The proposed regulations completely restrict this ability of the companies to

respond to market needs and challenges. Such a restrictive regulation can
only harm the sector and would ultimately be detrimental to the interests of
the customer.

Some of the anomalies in the Committee’s recommended loan product are

set out below:-

Annual household income of Rs. 50,000  –

Translates to just over Rs. 4,000 per month for an entire household, with a
typical family size of around five members. That is less than Rs. 1000 per
head per month, or less than Rs. 30 per day per head. By any stretch of the
imagination, this is an extremely narrow view of poverty and would leave
out significantly large numbers of the population which are poor in the real
sense of the term.

Furthermore, it is nearly impossible to conclusively verify and implement

such a limit.

Maximum loan amount of Rs. 25,000  – The number seems to have just
been arbitrarily arrived at. No rationale is advanced for the figure and none
seems to present itself. It is inconceivable to suggest that a Rs. 25,000 loan
may be advanced to a household where the total annual income is only Rs.
50,000. Such a recommendation is cause enough for creating over-
indebtedness.
Fixed loan tenures  – Makes the product too rigid and leaves no scope for
innovation. For example, currently a lot of MFIs give short term loans
(ranging from 1-6 months) for dealing with emergencies like pregnancy,
medical emergencies, some seasonal dip in income cycle of the borrower,
etc. However, all such products would now have to be stopped.
Loan should be unsecured and for income generation only  – I simply
fail to understand why. The idea of microfinance is to improve the living
standards of the poor, that is to say, to make meaningful and sustainable
changes to their lives.
So, say a company wants to extend loans for the purchase of assets like
cycle, rickshaw, clean stove, solar lighting, water purification system, etc.
My vote says such loans are an integral part of microfinance as they would
directly assist in improving the recipient’s lifestyles. However, as per the
Committee’s recommendation they would not qualify.

Similarly, extending low-income housing loans is another desirable as

housing loans are necessary for creating sustained economic growth in the
long term. However, it would not be possible for companies to bring out such
products in the recommended framework of things.

Loan repayment should be weekly, fortnightly or monthly  – It is

another recommendation that is overly restrictive and limits the scope of
future innovation. For example, companies would no longer be able to work
with a daily repayment product or even one with no installment repayment
at all…a loan that works like an overdraft facility. Or for that matter, what is
wrong if a company comes out with a flexible installment facility…something
where the customer pays the principal whenever she has the surplus and
just serves the interest otherwise?
3. Non MFI NBFCs cannot have a significant microfinance portfolio
(para 5.10)  – Restrictive, prevents diversification of existing players
The cap of 10% for non-MFI NBFCs would only serve to restrict the entry
into the microfinance sector of companies with a proven track record in
other financial products. Indeed, companies which have displayed the ability
to maintain sustainable and organized financial operations should be
welcomed into microfinance as it is to be expected that they would bring
their best practices with them.

As per current RBI regulations, there are clear cut directions regarding the
portfolios to be maintained by NBFCs. An asset finance company is required
to keep 60% of its total assets in asset backed loans and the rest can
comprise of other loans.
It is suggested that this existing limit should be allowed to continue. This
would allow existing players to launch microfinance operations, grow them
and then hive them off into independent units once a significant scale has
been achieved.

4. Minimum capitalization of Rs. 15 crores (para 15.3)  –Keeping only

the Wall Marts and shutting down all kirana shops
The Committee has argued that small MFI operations are detrimental to the
customers as they carry higher costs, on the belief that any MFI with an
asset size of less than Rs. 100 crores should be considered small. Hence,
they have recommended a minimum capitalization of Rs. 15 crores.

I agree with the view that there should be some minimum capitalization to
ensure a degree of stability and commitment on the part of the company
concerned. However, to say that anyone with a portfolio less than Rs. 100
crores is too tiny to exist is a fallacy. Yes, they may pale in comparison with
the Rs. 1000 crore plus behemoths, but it is another thing altogether to say
that they cannot function effectively.

It is like arguing that all small co-operative banks, local area banks, rural
banks, etc. should be closed down because they cannot operate in like
manner as the bigger public or private banks.

The net effect of such a high entry barrier is to wipe out all smaller players
and create a monopolistic and anti competitive market for the handful of
bigger players…an end result, which is certainly not in the best interests of
the customer concerned. Nor is it desirable in a country like ours where self-
employment and entrepreneurship should be encouraged.

I would suggest that the existing capitalization requirement of Rs. 2 crores

for a new NBFC should be continued for a new NBFC-MFI also.

5. Interest pricing caps (para 7.11)  – Regressive, against regulatory

ethos
In the beginning of their report, the Committee observes that for the poor,
easy access to credit is more important than cheaper credit (see para 2.3(d)
of the report). This is a very perceptive observation. Unfortunately, having
said that, the Committee fails to follow up on its own observation and
throughout the report no attempt is made to improve the access to credit for
the needy but the focus is on reducing the cost of such credit.

In my experience I have always found that the poor are willing to pay for
prompt and efficient services. Further, they are extremely conscious of the
rates being charged by various companies and are able to exercise a choice
about which company they want to turn to. In such circumstances, it is
imperative that the regulator respect the customer – company relationship
and refrain from specifying the pricing caps.

Competition alone should be the key to bringing the rates down, like in all
other sectors of the economy.

7. Limitation of income heads (para 8.7)  – Limits the potential of the

sector
I fully endorse the view that there should be absolute transparency between
the customer and the company and there should be full disclosure by the
company of the total earnings being made by it.

However, I fail to understand why a company cannot work on providing

additional services. Indeed, to my mind, the need for the regulator is to
ensure that the companies provide moreservices to the poor and
not less. By this recommendation, the Committee has betrayed their
complete lack of confidence in the bottom of the pyramid as a bankable
market which can appreciate and absorb a variety of services.
8. No collections at residences or places of work (para
11.12)– Undermines the entire doorstep delivery model
I can well understand the concern for avoiding coercive means of recovery
and to prevent undue harassment of customers. Yet, it must be borne in
mind that what makes microfinance so successful is its ability to provide
doorstep delivery to clients. Not only does that ensure client convenience
but, in the absence of mainstream banking instruments, ensures timely
collection of installments.
The success of the doorstep delivery model lies in its practicality. No person
is keen to leave their work regularly and travel long distances to pay an
installment of Rs. 230 every week. Yet, if the same installment is collected
from her house / work place without them having to spare more than 10
mins, then the whole transaction becomes immensely more attractive for the
customer.

We must remember that coercive measures and harassment of clients occur

only in cases of persistent delinquencies, which is in turn a result of faulty or
excessive lending by the company. The recommendations in this context
about creation of a credit bureau to improve the credit appraisal and avoid
excessive lending are welcome.

9. A study of 9 large and 2 small MFIs (para 5.1)  – Too small a data
sample to be credible
It is difficult to understand why the Committee has restricted itself to such a
small data pool. The MFI sector is very well researched and there is
significantly more data available than what has been referred to by the
Committee. There are organizations which have taken great pains to collect
data not only from India, but from MFIs across the world and have given
comparative studies. Further, the Committee has looked at only one year
financial results of the said 11 companies.

The Committee’s failure to refer to a broader set of data certainly affects the
credibility of their report. The Committee owes it to the industry to make a
more thorough and accurate assessment of the figures.

India’s once- booming Microfinance industry has fallen into the

crosshairs of the country’s  murky politics. Will the industry survive
and what could be the industry’s possible contours going forward?
 Clients of SKS Microfinance ring the bell at the BSE on listing day.Img-credit:AFP

Microfinance has been very much in the news lately. The financial markets
led by savvy Private Equity funds, started taking notice of and investing in
the industry’s rapid growth a few years back, culminating in the highly
successful first ever IPO of an Indian MFI in August  of  this  year.
Unfortunately,  the   industry’s  fortunes  have  steadily  plunged downhill
thereafter. This paper connects the dots of the MFI industry scenario with
other key economic and political factors playing out in the country. The
views discussed in this paper are strictly non-political, but are an effort to
link various situations leading up to a holistic case for the future.

On the  one  side,  most  of  the  post  crisis  headline  news  on
Microfinance  (i.e.  from September 2010) has been negative. ‘Getting it
right on Microfinance’, ‘Microfinance in India is like subprime lending’,
‘Anatomy of a crisis’, ‘Are MFIs showing Shylockian streak?’, ‘What’s wrong
with Microfinance Institutions in India?’ to name a few, paint a picture  of  an
industry  struggling  to  survive.  On  the  other  side,  there  is  increasing
coverage and focus on Inclusive Growth in India – meaning mainly financial
inclusion, which could be a starting step for some interesting developments
in the midst of  the growing political controversy.

To begin with, MFI industry fortunes can only be understood with an

appreciation for the effect this rapid industry growth has had, where it has
increasingly impinged directly on the agenda of state and federal level
politics in India.

Background of the situation

One of  the  key  mandates  of  our  current  government  is  Inclusive
Growth  –  mainly Financial Inclusion. Unfortunately, our national leaders
have been spending more of their time in handling/ responding to the
several multi- billion rupees scams and digesting poor electoral performance
in a few  key states in the country. The recent controversies in

Andhra Pradesh politics – dispute within the state, Chief Minister quitting,
former Chief Minister’s son  rebellious act and the MFI saga – has led to
some opposition parties playing the political card by urging borrowers not to
repay their loans to MFIs. Andhra Pradesh accounts for around 30% of the
MFI loans in the country and has witnessed an alarming number of suicides
by some debtors, purportedly due to harassment from MFI agents over
repayment.

The Indian MFI industry which has close to Rs 30,000-crore in outstanding

loans to 30 million borrowers is going through a rough tide and has been
challenged ever since the SKS Microfinance IPO. Major Indian Public and
Private Banks – State Bank of India, Bank of India, Indian Overseas Bank,
Punjab National Bank, Andhra Bank, SIDBI, Axis Bank and ICICI have
amongst the maximum credit exposure to MFI firms, estimated to be close
to 70% of the total credit outstanding to the industry.

Some of the figures lent to MFIs by banks, according to data from a rating
company, are as follows-

Bank Amount
SIDBI ~ Rs. 4000 crore
ICICI Rs. 2000 crore
SBI > Rs.1000 crore
Corporation Bank ~ Rs. 600 crore
Andhra Bank Rs 320 crore
Source: CARE rating
In addition to their direct lending to MFI’s, most of the public and private
banks have purchased loan  pools  for  millions  of  dollars  from  MFIs.
These  loan  pools  are  also expected to be under pressure, as the
securitization mechanism exposes the investors to the ultimate borrowers
and a drop in repayment rates will subsequently affect them.

Public Sector —————————- Private Sector

Bank Amount Bank Amount
Bank of Baroda Rs.1.3 crores Yes Bank Rs. 4.5 crores
Bank of India Rs. 2.8 crores Axis Bank Rs. 13 crores
Corporation Bank Rs. 6 crores
IndusInd Bank Rs. 3.6 crores,
PNB Rs. 9 crores
HDFC Bank Rs. 9 crores
Union Bank Rs. 2 crores
Canara Bank Kotak Mahindra Rs. 1.3 crores
Rs. 3 crores.
Bank
Source: Morgan Stanley Asia Pacific Report through Moneylife
THE RESULT
Stocks of banking companies, mainly the private sector have been under
pressure lately after having outperforming the market over the last few
months. Banks with the highest MFI exposure have witnessed the sharpest
fall in their share price in the last week. Shares of Yes Bank fell by around
10% in the three trading sessions last week, while those of Axis Bank and
Oriental Bank of Commerce fell by 9% each. But even though the impact on
ICICI Bank and HDFC Bank is somewhat similar to that on Axis Bank and
Oriental Bank of Commerce, their shares fell at a lower rate of 6% and
3.4%, respectively.

One of main concerns of the investors is the asset quality of microfinance

institutions (MFIs),  which  is  under  pressure  after  measures  taken  by
the  Andhra  Pradesh  (AP) government to tighten regulations governing the
industry which challenges the existing business model – banning of the
weekly collections from the borrowers. This has resulted in a sharp decline in
the repayment of loans across AP and the trend is spreading across the
country mainly in areas such as West Bengal, Madhya Pradesh, Orissa and
Karnataka.

Source Microfinance exposure takes toll on banking stocks through Livemint

Latest Developments – the dots…
In spite of the current crisis, many MFIs have approached banks for
emergency funds amounting to Rs  10,000 Cr, admitting to suffering a
severe liquidity crisis. As some banks in some states have stopped lending to
MFIs, many are worried that the crisis could deepen and threaten a collapse.
As per Vijay Mahajan, one of the pioneers of the Indian microfinance
industry in India and the President of  Microfinance Institutions Network

(MFIN), the MFI industry will collapse and will be finished as early as first
quarter of the coming year in case the banks decline to support and lend to
the microfinance institutions because of the current environment in the MFI
market.

Amid all the chaos, some of interesting developments in the economic and
political environment are:

 The Union Finance Minister clearly indicating not to “strangulate” the

industry and to finalize  the regulatory architecture for microfinance
institutions and the
‘Microfinance Bill’ by early next year

 MFI  bill  introduced  in  Andhra  Pradesh  assembly  and  Karnataka

government planning  to   establish  a  state  funded  microfinance
institution  like  Andhra Pradesh’s SHG-based SERP programme
 MFI regulation panel proposed by Orissa state government
 Nation’s largest lender  – State  Bank of  India announced its 750-
million euro (about Rs. 4,650 crore) five-year bond issue and also
awaiting government’s nod to  come  out  with  a  Rs.  20,000-crore
rights  issue  improve  its  capital  base sometime in late December or
early next year
 Union Bank’s direct entry in the MFI business
 Axis bank’s top management’s apprehension in relation to huge
exposure to the
MFI sector
 Major PSU Banks – Bank of Baroda and Indian Bank sign contracts
with MFIs to rein interest rates, ensuring  MFIs  do not charge interest
rates beyond a certain ceiling from their borrowers
 Corporation bank management’s   mooted thought of   converting the
debt from
MFIs to equity, for safeguarding risks in case of default

 Indian Banks’ Association proposal for roping  in “Bollywood” film stars

for spreading the message of financial inclusion – to educate rural masses
about the benefits of bank accounts and other financial services
 One of the leading NBFC’s from the South, Muthoot Pappachan Group
has tied up with Accion of US to boost lending in microfinance sector and
also in the final stages of acquiring a leading MFI player in the North
The way forward – …Connecting the dots
The microfinance industry which was considered to be an instrument in
realizing the goal of financial inclusion, as they serve a segment of the
population without access to banks, will certainly face regulatory
headwinds. The issue is primarily whether the proposed regulations will be
supportive of an industry that has emerged as a global frontrunner in
combining social and economic  goals –  or whether  they  will  land up
throttling the industry with unviable requirements.

Snapshot of the Microfinance Industry

Time Line –PESTEL Past(Before Present Future
crisis)
Political Low High Moderate
(interference)
Economic (Interest) Very High Low Low*
Social (Objective) High Medium Medium /
High
Technical(Expertise) Low Medium High
Environment (to High Low Medium*
venture into this
business)
Legal (Issues) Low High High
* Depending on nature of regulation that emerges
Going forward, the MFI promoters as well as for the Investors might not
have the best news – at least not to the extent they would have imagined
couple of months back.  In case  the  same  trend  continues-  borrowers
defaulting,  very limited  access  to  capital, regulatory risks, ratings with
negative implications and political resistance, MFI’s would be faced with both
solvency and liquidity challenges. An IPO exit would remain a distant dream
for the players, as well as their private equity investors.

Analyzing and evaluating the sequence of events strategically, along with

some crystal ball gazing, the following might be the way forward for this
industry

Potential  Convergence  between  Banks  and  MFIs:  Although  current

regulations maintain a clear demarcation between scheduled commercial
banks and MFIs (the large MFIs are mostly regulated as  NBFCs), the mutual
advantages to each other are fairly obvious. MFIs can significantly lower
their  cost  of funds, and also remove potential hazards of dependence on
institutional liquidity through conversion to a banking model; banks can get
into the financial inclusion game through best practices from MFIs.
The convergence needs to be initiated through regulatory changes from the
RBI, and the resulting activity could either be organic or inorganic. Though
the business model is different between  Banks and MFIs, there could be
some interest from the Banks to acquire MFIs given their exposure to the
industry and also which could give them access to new and rural parts of the
country. SBI raising funds (may be part of it is to acquire MFIs), Union bank
entry into this business and Corporation’s bank intention to acquire stake in
MFIs might be early signs from Banks intending for consolidation in financial
services space.

It might be premature to discuss the modalities of partnership at this point

in time, but this idea should  certainly be explored by Y.H. Malegam and
team, a sub-committee appointed by RBI to study the industry and
recommend ways to better its practices. This could be a win-win situation for
banks,  regulatory bodies and mainly the customers – provided  the  banks
give  a  decent  valuation  for  the  MFIs.  From  the  government’s
perspective, this could be a one of the best strategies to fulfill the  Financial
Inclusion objective as well as to get the situation politically correct.

Partnership with Regional Rural Banks (RRB):  As per the data till last
financial year, there were 82 RRBs (with a network of 15475 branches
spread over 619 districts in 26
States and 1 Union Territory), of which only 3 RRBs out of 82 RRBs were
incurring losses. In addition, the RRB’s were given a target by the Finance
Ministry to open 2000 branches by March 2011  with the right banking
technology platform as part of their financial inclusion strategy.   Partnership
with MFIs could be one of the routes which could be explored by RRB’s to
have better access to similar client base and to fulfill their mandate of
financial inclusion

Consolidation within the MFI industry: Consolidation amongst existing

MFI players could come about, in the situation that present stressed
conditions continue for a further quarter or two. Larger  MFIs  with good
balance sheet, with appetite for risk till the regulatory framework is worked
out and also having the capacity digest an acquisition in this environment
might look to buyout other small/medium MFIs for their customers and loan
books, at distressed valuations. However, the challenges in this case as
mentioned earlier remain - borrowers defaulting, very limited access to
capital,  regulatory risks, ratings with negative implications and political
resistance.
Investments by Microfinance Investment Vehicles
(MIV’s) / Impact Investors in the Indian MFI space
Investments done by Financial Investors in Indian Microfinance
companies
The above tables give a brief overview of the VC/ PE investments in the
Indian MFI landscape. Indian MFIs have raised more than $450 million
across 66 deals from private equity investors  since  2006,  according to
VCCEdge.  Investors in  the  sector include international DFIs like IFC,
Silicon Valley Bank to venture capital firms Sequoia Capital and Canaan
Partners, social VC firms like Aavishkaar and  Elevar to hedge funds like
Sandstone Capital and Tree Line Asia.
Most of the marquee domestic and international investors  had done multiple
deals /  investments in  the  Indian  MFI.  Being a  capital intensive business,
MFIs demand for capital is no-doubt very high. The investors were very
optimistic  about the growth trends and the MFIs needed more money to
scale-up which resulted in multiple borrowings – both through debt and
equity till September this year.

In the current environment, consolidation amongst the existing MFIs might

not be a bad idea for MFIs wanting to operate on a standalone and the
investee companies of same fund can explore the possibility of partnering
together.

For instance, Matrix Partners – a financial investor which has invested in an

NBFC (Muthoot  Finance) and an MFI (Bhartiya Samruddhi Finance Limited)
might look at closing an internal deal amongst its portfolio companies for
their exit (Muthoot buying stake in the MFI).

The other possibilities could be Muthoot Finance acquiring Swadhaar

FinServe or Saija Finance in which Accion has invested in the past. Muthoot
has recently tied up with Accion to boost lending in microfinance sector, in
case we were to go by the latest developments and the given situation in the
market. Muthoot Finance is planning to raise at least Rs 800 crore ($178
million) from an initial public offering (IPO) soon.

Emergence of Cross – border (inbound) acquisitions / strategic

partnerships: Global microfinance had around $12bn in cross-border
investment by the end of 2009, up from
$4bn three years ago according to CGAP (The Consultative Group to Assist
the Poor, a World  Bank   linked  group).  The  first  table  above  lists
specialized  microfinance investment vehicles (MIVs) like IFC, Oikocredit,
Hovos, Micro Ventures and Incofin to name a few, which have investments in
multiple MFIs across the globe, which may very well turn out to be the
drivers for cross-border consolidation and strategic partnership so that best
practices across the globe are shared and MFIs move towards higher
bargaining
power in countries like India where they are currently at the mercy of
politicians and bureaucrats. In addition, major international MFIs like
Compartamos – a listed Mexican player may be open to exploring strategic
options in India. Globally, there have been few interesting cases of cross-
border acquisitions and given the current environment, Inbound M&A deals
could emerge as a new trend in the Indian MFI space.

Development of  non-institutional  funding  base: MFIs  have  in  some

cases  moved beyond  institutional sources of funding (primarily banks and
MFs) to securitization of loans. As the current crisis demonstrates,
dependence on institutional sources of funding can be a significant risk in
times of stress. Going forward, larger MFIs may need to raise the bar
through innovation in developing a retail  bond/deposit market for raising
their funding.
New Bank / Larger NBFCs and the MFI model – More than a decade
after the Reserve Bank of India issued the last of the two banking licenses to
private sector entities; the government has again started  the process of
allowing non-banking finance companies (NBFCs)  to  graduate  to  full-
fledged  banks.  The  ordinance  for  issuing  new  banking license will be
considered on the thrust given to financial inclusion. The business model
could be required to clearly articulate the strategy and the targets for
achieving significant outreach to clientele in Tier 3 to 6 centers (i.e. in
populations less than 50000) especially in the under banked regions of the
country either through branches or branchless models
– which indeed could be good fit for them to invest/ partner with existing
MFI’s – though the model is  different from banking, the partnership could
create a base by providing better  understanding  of  the  market  and  have
live  business  from  the  starting  point. Reliance Capital, Mahindra, Religare
enterprises, Cholamandalam and Tata Finance have already expressed their
interest in acquiring a banking license, of which Reliance Capital has already
invested in MFI space in India.

Pure Political Card aka Prepare for More Regulation! – This could be
the best part and the might  be the best weapon for the existing government
to win hearts and gain votes. The cynical view is that the ground situation in
AP could very well move towards
waiver of MFI loans as a means of creating a vote bank for parties – and
that      the politician / bureaucrat nexus in the state would not mind killing
the MFI industry for its own benefit. Last year, the government announced
farm loan waiver of Rs. 72,000 crore during the budget and this  year it
might be to waive off the MFI loans which will certainly form a solid platform
for the  general  elections in 2013. In this case we are discussing about close
to Rs 30,000-crore in outstanding loans for 30 million votes. In addition, the
objective of Financial Inclusion is fulfilled – sounds like a good deal to me.
Borrowers or Aam Aadmi (which means “Common Man” in Hindi) is safe and
situation is politically correct. Thus proving the philosophy that most of the
politicians who run this  country follow “As long as the general public is given
what they want, we (politicians) get what we want”

Thankfully sanity might prevail at the federal/national level,and through

recommendations from the Malegam committee. What cannot be escaped is
that the industry will be regulated more tightly – maybe in the form of
interest rate caps, stronger criteria and diligence for disbursement, less
aggressive collections methods. At the end of the day, what is required is a
set of regulations that reasonably protect the borrower/consumer, and at the
same time ensure continued growth and innovation in an industry that  has
emerged  as  a  global  leader  in  combining  societal  and  community
impact objectives with commercial and entrepreneurial drive sourced from
the corporate world.