Malegam report on MFIs is a good beginning

Country’s central bank the Reserve Bank of India (RBI) had constituted a committee under the noted chartered accountant Y H Malegam in the wake of controversy following suicides by some borrowers in Andhra Pradesh because of the alleged coercive tactics used by the recovery agents of microfinance institutions (MFI). MFIs also faced criticism over high interest rates, which were as much as 36 per cent in some cases.

But ever since Malegam submitted its report making several recommendations to regulate the hitherto unregulated industry, MFIs have raised several objections to its implementations. MFIs (also known as microlenders) in significant numbers view that they could run into a crisis if certain recommendations are implemented in the current form.

The broad contours of the Malegam panel report suggest a cap on interest rates on microloans and annual income of poor borrowers.  It has proposed capping the interest rate at 24 per cent for individual loans; a ceiling of Rs 50,000 on the annual family income for a person to be eligible to take loans from MFIs, and a Rs 25,000 ceiling for loans to a single borrower all to be to be implemented by April 1, 2011, if accepted.

More than the cap on interest rate, the major worry for microlenders seems to be on the ceilings on income and loan amount. Critics aver by suggesting a cap on loan rate, the Panel is also denying the market forces in shaping the cost of loans. While another school of thought is that the Panel wants MFIs to lend more to those below the poverty line (BPL).

Commenting on the cap Chairman of country’s largest MFI SKS Microfinance Vikram Akula said that setting income limit for lending may wipe-out half its client base. If the suggestions are implemented without changes, the Hyderabad-headquartered firm may lose over 50 per cent of the borrowers, said Akula. “I cannot imagine they would do that, all depends on whether they look at the income limits at the time of joining or at the time of lending,” Akula told reporters.

Other industry insiders maintain that most of the people who borrow from them will not be able to access money if these limits are implemented as a majority belong to families with an annual income in excess of Rs 50,000 and require loans higher than Rs 25,000. Smaller MFIs, in particular, will be hurt severely with these limits, they add.

Vijay Mahajan, founder of Basix and Chairman of Microfinance Institutions Network (MFIN), an industry lobby group, told Deccan Herald that the report is on track in terms of broad framework but it falls short of industry needs. For instance, he points out, the report confines itself to credit services and not savings.

The Panel should have considered the conditions under which non-banking finance companies (NBFCs) could accept savings, as MFI is not just micro-credit it is also about inclusive financial services, he said, adding “Poor borrowers not only need credit, they also need services like money transfer, insurance and savings.”

The report has virtually shut its eyes to the situation in Andhra Pradesh, says Mahajan adding: “Unless, the crisis in AP (where over Rs 7,500 crore is stuck) is resolved, the report will accelerate the slow death of the microfinance sector. For MFIs outside Andhra, the report is not too bad, though.”

Many positives

The rating agency Crisil, however, said the report is a positive step towards enhancing stakeholder confidence in the microfinance institution (MFI) sector, a critical element for long-term sustainability of the sector.

However, when implemented will pose additional operating and compliance-related challenges for the MFI sector, whose growth prospects and profitability will weaken, thereby leading to a possible consolidation in the industry, it adds. Crisil expects the decline in the gross interest spreads of the top five MFIs to be in the range of 5-8 per cent, over the medium term.

Bandhan Financial Services’ CMD Chandrashekhar Ghosh says “the downside of the Malegam recommendations is quite severe. For instance, when a person gets microcredit and becomes an entrepreneur, his credit needs will expand and he won’t able to get funding from any other source. Banks normally do not touch such borrowers and MFI is the only source for money. So a limit of Rs 25,000 is not feasible.”

Even implementation of the income cap is a problem as Share Microfin’s Managing Director Udaia Kumar pointed out, “It becomes extremely difficult to assess the family income of the borrower in the absence of proper documentation. Similarly, the loan cap of Rs 25,000 is not practical to implement as the requirement of the borrowers in Andhra Pradesh (AP) is much higher.” This southern state accounts for more than a quarter of the Rs 20,000 crore microfinance industry in the country and has more than 9.7 million borrowers under this segment. 

“These days, even a house maid will have more than Rs 50,000 annual income. As such the poor customer definition has to be widened much further,” says Ujjivan Financial Services’ Chief Executive & MD Samit Ghosh. Ujjivan has an asset base of Rs 675 crore and a customer base of little less than 1-million in December.

Making it more affordable

There are also fears in the industry that the recommendation to cap the interest rate and profit margins could lead to the closure of smaller MFIs whose cost of borrowing is higher than the larger-MFIs. 

Yet, not all microlenders are cribbing over it. Vikram Akula of SKS is excited with the Malegam report that “finally brings some regulatory certainty in the microfinance business.” He sees, at least, three significant take-aways from the recommendations. One is that a separate classification of MFI NBFCs which was the long-felt need.

Second, the priority sector status will be afforded to the MFI-NBFCs which recognises MFIs’ legitimate role in their contributions to financial inclusion. Thirdly, it si good that industry will come under on regulator. Madura Microfinance chief Tara Thiagarjan also feel positive “The margin cap of 10 per cent above cost of funds and rate ceiling of 24 per cent will provide borrowers opportunity for greater success.”

It may be noted that most of the MFIs in Andhra had brought down their rates to around 24 per cent in the last two months after the state government expressed its displeasure on MFIs’  higher interest rates. But smaller MFIs who charge in the range of 27-36 per cent rate to balance their cost component, will suffer.
 
“Smaller ones (MFIs) cannot survive (with 24 per cent rate).  So much of micromanagement was not desirable for the growth of the sector,” says Shubhankar Sengupta of Arohan Financial Services, a relatively smaller MFI with a loan book of Rs 105 crore and 2.4 lakh borrowers. 

But Akula feels including processing fee and insurance cost the rate will be 27 per cent, which it is now in AP.  The recommendations to cap margins at 10 per cent for MFIs having a loan portfolio of Rs 100 crore and 12 per cent for smaller MFIs have also surprised, as the industry says it is difficult to implement especially when the Panel has not recommended any ways to reduce the cost of funds. Margin is the difference between the rate at which MFIs borrow from banks and the rate at which they lend to their borrowers.

Without suggesting any ways to bring down the costs, the Panel has proposed a margin cap which is difficult to implement, the industry contends.  Instead, the larger view is that they (Panel) should have looked at incentivising MFIs by categorizing MFIs in three categories according to the household income, says a member of Microfinance Institutions Network (MFIN), an industry lobby group.

Further, the Panel has said that not more than two MFIs can lend to a single borrower, apart from limiting the membership of a borrower to one self-help group (SHG) or joint liability group. It could also hamper MFI business as most of their borrowers are part of more than one SHG or small groups of six-seven people, according to MFIN.  The rating agency ICRA is of the view that restrictions on the total loan size of Rs 25,000 may not fulfill entire financing requirement of an individual borrower, forcing the person to look at alternate avenues for funding.  Stricter eligibility criteria, ICRA adds, could lead to significant drop in growth to 10-22 per cent a year over the next five years as against over 100 per cent growth seen in last two years.

Even as RBI allows banks to restructure MFI loans for complete provisioning in 3-years, the Malegam panel puts in a medium-term regulatory framework saying it has to be done in 180 days and also raised the capital adequacy to 15 per cent. 

Thus, the sector has to raise Rs 5,000 crore in the next six months.  In this context, Mahajan of MFIN says “no one is willing to give a Rs 50 crore loan, so how will MFIs raise such a huge sum in such a short time?”