Microfinance: A new road to banking redemption

At a time when microfinance institutions (MFIs) are getting into the banking business, commercial banks too have developed a liking for lending directly to the poor -- an area until now dominated by traditional MFIs and informal lenders. 

 

In the past, banks had stayed away from offering micro-loans in rural areas because of the high operational costs involved; if at all they were seen in action in the rural areas, it was seen as part of their commitments to meet their priority lending targets.

Since the government at the Centre prioritised its focus on financial inclusion in the last couple of years, cosmetical banks have started using the 'business correspondent' route to re-enter the segment. 

Business correspondents are agents of banks operating in far-flung areas of the country, where only MFIs used to operate earlier.

 

So, the domestic micro-lending industry in the country is now witnessing resurgence in interest from commercial banks in targeting low-income borrowers. 

Of course, these banks are simply replicating the traditional MFI operational model of micro-lending, right from charging a high interest rate to no-collateral policies for giving out small loans. 

Besides, the tenures of these loans offered by banks is between one and three years and they lend in the range of Rs 15,000  to Rs 25,000.

 

Why the shift from MFIs to banks?

 

For one, commercial banks have the advantage of offering loans at interest rates ranging between 20-24 per cent, lower than the 26-27 per cent charged by MFIs, including the processing fee. 

 

Though banks charge interest rates of 20-24 per cent, the final returns for them will be markedly less, at around 12-13 per cent, after paying off commissions to the business correspondents, said a banker who focusses on low income borrowers. 

In some cases, where the borrower is represented by a group, banks accept a group guarantee.

 

Most banks engaged in microlending have built their portfolios over the past 2-3 years, after traditional microlenders were plunged into crisis after the erstwhile Andhra Pradesh government promulgated a law severely restricting their activities because of alleged coercion to recover loans. 

For example, infrastructure lender IDFC, which is now foraying into the banking sector, already has an exposure of 22 per cent of its advances to microlenders.

 

Currently, banks focusing on low income borrowers include HDFC Bank, IndusInd Bank and IDBI Bank to mention a few. 

To begin with, IndusInd Bank has expanded its microlending book to somewhere between Rs 400 crore and Rs 500 crore in the past three years from about Rs 100 crore, says Srinivas Bonam, head of inclusive banking group at IndusInd Bank. 

 

“The idea is to take the direct lending of micro loans in rural segments and ensure that the end-client has access to financial services at an affordable rate in a sustainable manner, compared with products offered by microfinanciers,” Bonam says.

 

IndusInd Bank uses its business correspondent network to reach out to borrowers while lending at about 24 per cent. Such loans will have a tenor of one year for loans of less than Rs 15,000 and two years for loans of higher amounts. 

IDBI Bank has doubled its direct microlending book from what it was three years ago, points out a top official at the state-run bank, who is directly involved in the business. 

Its total loan book to the low income segment, which include loans to MFIs, is around Rs 1,000 crore, he says.  

“With business correspondents coming in, we are using this model to expand our portfolio,” the IDBI Bank official said. 

As on March 31, 2013, Indian banks had deployed about 1,95,380 business correspondents covering 2,21,341 villages, according to Reserve Bank of India data.

 

Analysts said larger banks such as HDFC Bank have become active in the micro loan segment.

HDFC Bank has significantly grown its portfolio in recent years but has declined to trumpet its achievements or the quantum of success in the micro loan business. 

 

Meeting priority sector targetsFace it, micro loans are helping banks meet their so-called priority sector targets, analysts affirm. 

RBI norms mandate that banks have to lend 40 per cent of their loans to the so-called priority sector, which includes agriculture, micro-credit, exports and the economically weaker sections. 

 

Analysts are of the view that using business correspondents to garner loans may not be a good strategy in the long run. “From an asset quality perspective, using business correspondents to get loans is riskier than bank staff directly going and lending to borrowers, because there is a possibility that business correspondents may push products to earn commission without following due diligence,” says Hatim Broachwala, analyst with Karvy Stock Broking Ltd. 

“This has happened in other financial sectors like mutual funds, insurance, after all.”

 

As on January 24, 2014, Indian banks had micro credit outstandings of Rs 17,500 crore compared with Rs 15,100 crore during the same period a year earlier.

“In microfinance, you’ve not even seen the tip of the iceberg,” says Rajesh Dedhia, director, Vantage Institute of Financial Markets adding that past repayment statistics have been encouraging. 

An estimated 130 million Indian households could potentially be served through microfinance, with money lenders and other informal sources accounting for more than 80 per cent of borrowings. 

 

Informal credit in rural India is estimated at $5.4 billion, according to the All India Debt and Investment Survey. 

This potential has also attracted India’s top lender State Bank of India, number two lender ICICI Bank and even private sector lender YES Bank, among various others, to look at serving India’s 600,000 underserved villages. 

“The earnings potential per rupee is higher though the size is small,” said an analyst with a foreign brokerage, adding the market would expand in the next 3-4 years. 

 

In 2011, the Reserve Bank of India decided to step in and help. It came up with a regulatory framework for microfinance companies that included capping the interest rate as 26 per cent.

The steps bought uniformity to the industry, and more importantly, signalled that the RBI still considered microfinance a legitimate industry despite what a few politicians were saying. 

“The intense engagement of the government and RBI have helped change risk perceptions,” according to Alok Prasad, chief executive of the Microfinance Institutions Network, an industry group.

 

The apex bank’s backing renewed the commercial banks' confidence in these companies (MFIs) and they resumed lending to them. 

Total lending by microfinance institutions grew 30 per cent in the quarter ended September 30 compared to a contraction of 15 per cent a year earlier, according to MFIN. In short, the resurgent microlending sector has a new profile right now. 

 

Andhra Pradesh, once the largest market for microfinance companies, may have put off microlenders who are still struggling with suspicious government regulators after the state government slapped new restrictions on what lenders could charge and required them to get government approval before giving new loans. 

 

To top this, politicians told borrowers that they didn’t have to pay back their micro loans. 

So, the MFI's focus shifted from Andhra to the eastern state of West Bengal and southern state of Tamil Nadu which are now the biggest micro loan markets.

 

Banking industry observers say that a lot of good has happened since 2011 after RBI brought micro loan companies under its purview for the first time, leading to confidence that the central bank controls have fixed the lenders, which in turn enthused the country's large banks to again start lending to microfinance firms, breathing new life into the industry.

 

So much so, that the thinking in most banks now is that if they can take exposure in micro loans through MFIs, why not take the exposure directly by lending to the poor who, -- as opposed to some corporates -- are at least not 'wilful defaulters'? 

Parallelly, this helps achieve the twin objectives of serving the rural segment and pushing financial inclusion.  

 

Now that MFIs (Read Bandhan Financial) are entering the banking business, the mainstream banks will target a greater share of the micro loan pie by giving women in villages a helping hand with start-up funds to start their businesses.

 

More often than not, India’s regulations — seen as stifling or paralyzing — are blamed for the country’s troubles.

 

The resurrection of microfinance with the active participation of commercial banks will be a telling example of how the right rules can sometimes save an industry — in a country where a majority of the 1.2 billion population lack access to basic banking services.