Macro problems plague microfinance industry

As the formal banking system has failed to reach out to the poor and landless in the rural areas, the emergence of the microfinance industry – right from providing ‘branchless banking’, to easy-access of money — was seen as the best thing to have happened to the poor and un-banked in the country. 

 Gradually, the micro finance institutions (MFIs) had become a ‘poster boy’ of financial inclusion in the last decade having built up a robust base of 2.6 crore clients and a sizeable impressive credit off-take.  A latest report by Intellcap, an independent industry research firm, puts the total estimated demand for micro-credit in India at $ 51.4 billion (equivalent of Rs 240,000 crore). Another report by Bharat Microfin said the total outstanding loan portfolio grew from Rs 3,456 crore in 2007 to Rs 11,734 crore in 2009.  
Above all, MFIs took the very benefit of ‘credit-access’ to some of India’s most isolated communities, what the nationalised banks could not achieve with its four decades of existence. With such phenomenal growth every thing went hunky dory for the microfinance sector which enthused investors of all classes to pour their dear money into the first IPO from from MFI industry floated by SKS Microfinance. That was ‘party time’, for the MFI industry. SKS’s IPO was a resuonding succes as the issue was oversubscribed 13 times and raised Rs 1,300 crore even though the share price was fairly high at Rs 985. Lured by the response to SKS, other MFIs were also gearing up for similar exercise.
But that was till about two months ago and then came the unexpected jolt from the very leader to the sector. With the unfolding of huge controvery created by the unceremonious dismissal of SKS’ CEO Suresh Gurumani and the lack of transparency from its management, the credibility of the whole industry became a big question mark. And to top it SKS chairman Vikram Akula’s former wife also accused the management on poor corporate governance issues.

 A big let down
With all these negative news SKS scrip took a hit on the bourses and gradually the listing premium of SKS began to decline. Against the issue price of Rs 985 per share the SKS scrip has nose dived to around Rs 650, shedding almost one-third of its issue price. But this was only one of the many problems MFIs is plagued with.  

 A series of suicides by borrowers in Andhra Pradesh became a political whirlwind for MFIs and the blame-game ensued furiously. First it was high interest charged by the MFIs, then they were blamed for ‘coercive recovery’ method deployed which alleged to have triggered series of suicides in AP. To stop further loss of life, the AP government rushed in with an ordinance imposing restrictions on MFIs and threatening criminal proceedings against coerced recovery. While the MFIs borrowed funds from banks at 9-14 per cent, they alleged to have charged interest rate between 32 and 42 per cent, to provide finance to the poorer sections of the society such as artisans, farmers and small time businessman.

 Union Finance Ministry was also quick to step in and asked the state-run banks to cap the interest rates charged by MFIs in the range of 20-24 per cent as a precondition to access bank finance. Top-5 MFIs including the only listed MFI SKS Microfinance, Basix, Spandana, Share Microfin and Asmitha Microfin agreed last fortnight for slashing interest rates to 24 per cent initially to borrowers in AP. About 85 per cent of the loans given by MFIs to poorer sections in rural areas came from banks and as of September quarter, the micro-lenders have lent over Rs 30,000 crore ($6 billion) to over 3 crore customers, it is said.  

Regulator steps in
One of the reasons why MFIs could get away by changing exorbitant interest rates is that there is no one to regulate them. But the Reserve Bank of India (RBI) now has set up a panel headed by J H Malegam which will submit its report on the issue of MFIs using coercive methods for loan recovery as well their interest rate practices by January-end.
When the adverse news spread, some borrowers stopped making even their usual repayments. There was talk of removing MFI loans from the priority sector category. The stock market regulator SEBI was also probing on SKS Microfinance, especially the way it sacked its CEO, that triggered the SKS stock price to crash spoiling hopes of other MFIs to raise money from the capital markets. 

 Like it or not, the microfinance sector has been gripped with a crisis of macro proportions.  And the problem don’t seem to go away in a jiffy like one would want it, which explains why MFIs were trying hard for emergency funding from banks. “We have not refused to fund MFIs, but have asked them to hold for a while. We are not turning down their proposals for funding, but we would rather wait for the RBI’s Malegam Committee report as there will be more clarity after that. Besides, multiple lending created a bubble,” says Axis Bank President (Agri & Rural banking) S K Mitra. 

As if that was not enough, problems have been mounting up on the sector from various other quarters. To start with, the Andhra Pradesh Government has intensified its move against questionable practices of MFIs and asked RBI to probe whether banks had adhered to its guidelines on micro-credit while lending to MFIs. It also asked the central bank to probe the role of Small Industries Development Bank of India (Sidbi) – a independent DFI meant for the growth of MSME – which is a major lender to MFIs. Said Rural Development Principal Secretary in the A P Government, R Subramanyam: “There is prima facie evidence that some banks violated RBI guidelines while giving loans to MFIs.”
 With a slowdown in business and hurdles in recovery, MFIs found it difficult to raise cheap funds by securitising their existing loans due to paucity of superior ratings from rating agencies as a consequence of the unique risks they face now. Securitisation is all about conversion of existing assets or future cash flows into marketable securities. Initially, the hype over MFIs’ reach and ability to affect the poorer sections of the society held sway. Nobel laureate and Bangladesh Grameen Bank Chairman Yunnus Khan also made an impact to some extent on India during his visit in July this year when he said: “We look our balance sheet not from the profit perspective, but from the ‘social capital’ angle.  How much lives we could affect with our activity.” But, MFIs for whatever compulsions, overlooked the social aspect and pursued the aggressive growth path. Says microfinance pioneer Vijay Mahajan: “All these years, we had told everyone that as we cut costs through scale and efficiency, we will pass on the benefits to the consumers. The regulators tolerated our interest rates on that promise. We let them down because we did the first, but we’re not doing the latter. Instead we have made extra normal profits.”

Misleading borrowers
Various studies have pointed out that microfinance is not a magic wand that can automatically lift poor people out of poverty and access to credit is only the first step.  But then the poor need the entire gamut of financial services from savings to insurance and livelihood services that span health, farming practices, education and financial literacy to break the shackles of destitution which calls for lot of innovations executed in large scale across the country.

Against this backdrop of growing criticism about MFIs charging very high interest rates and the coercive recovery methods deployed by them, the high-powered Prime Minister’s Economic Advisory Council (PMEAC) early this week strongly advocated for regulatory mechanism for the sector. The reason why there is a strong need for reform in the microfinance sector, is that MFIs are already linked to the banking system. And if this link is to be strengthened then the MFIs need to modify some of their lending practices.
Though the Government is slated to bring a bill on MFIs regulation in the Parliament, a number of suicides by poor borrowers in Andhra Pradesh were blamed on functioning of MFIs and their usurious interest rates. RBI also set up a sub-committee to study the functioning and interest rate structures of MFIs, which prompted the government to defer the bill so that it could incorporate the recommendations of the RBI panel into it.

Many critics are of the view that the cost of lending indicated by MFIs in their advertisements (generally around 18 per cent) don’t add up the charges they put while advertising their low interest rates. “Over and above, they charge an upfront insurance fee, application fee which brings the effective rate to as high as 30 per cent (in the case of SKS),” according to Society for Elimination of Rural Poverty (SERP) CEO B Rajasekhar.
At the same time, MFIs are looking at banks, they need about Rs 1,000 crore, to bail them out hoping against hope. MFIs raise 75 per cent of their funding from (bank) borrowings and the remaining from equity and cash securities. Banks, which already have an exposure of over Rs 30,000 crore in MFIs, are shying away from funding MFIs after the recent controversy over malpractices in the sector involving poor borrowers being led to a debt trap and suicides, making it difficult for the micro-lenders.