Microfinance Institutions- the holy cow of financial inclusion

………Pratik Shah

The ups and down of MFI’s is what we have been hearing in the news and media. Just thinking of why suddenly we have started focusing on these institutions. They have been in town for many years now. All credit goes to the stock market listing of SKS microfinance; the first MFI to list on the bourses in India. So what has changed? The change is that the story of MFI success is out in the open with series of events happening like a bumper listing for SKS followed by sacking of its CEO Suresh Gurumani in a power struggle, allegations by Vikram Akula’s wife on him of misappropriation and pending court cases. This was a parody to the entire MFI industry. Many MFI’s like Spandana, Baxis, etc had made plans to list themselves on the bourses trying to emulate the so called success of SKS. Many foreign investors like Soros fund, Catamaran (Mr Murthy’s PE) had invested in SKS at 300 and 600 levels giving this company alarming valuation. Other MFI’s are now playing the wait and watch game.

I use to always talk to my colleague when the IPO offer of SKS had come and wondering that how can this company quote at such a high premium. It is not worth it. It is a MicroFinance institution and their role is to build social capital and promote financial inclusion. They are not here to make money. However, knowing the inside story, we know that how these MFI’s are enjoying higher margins than banks and how they are able to maintain such lower NPA’s. I advised him to subscribe the issue only for listing gains given the euphoria around the issue. Today when I am penning my views the stock is quoting below its IPO price. Its real worth will now be unfolded.

Thinking deeper what has caused all this mess- It is not only the MFI’s, but the government, Banks, politicians are also responsible for this madness. From an objective of being non profitable they are solely existing for making profits & competing with the money lenders. There is money in madness but when the madness ends money disappears. I have some points to share:-

• The biggest financial inclusion measure was taken by the government when it nationalized 14 banks in 1969. In 1992, the Self Help Group (SHG) concept floated with the help of NABARD and Banks was a big success. It today supports 86 mio households who are really below the economic line and has lent INR 23000 crore. The difference is that SHG’s used to lend against savings as collateral whereas MFI’s are carrying out unsecured and aggressive lending.

• Banks had to meet their Priority Sector Lending (PSL) norms and they wanted to avoid taking on the tail portfolio on its books. The best way was to fund MFI’s who in turn will fund Self Help groups (SHG) or teams at very high interest rate. For example banks fund these MFI’s at 7-8% and MFI’s in turn fund at 24-40%. The NPA’s were low as SHG or team of borrowers also had the responsibility of ensuring repayment. If somebody does not repay that person would be ousted from the group and will not be eligible for loans in future. The MFI had a transactional relationship with the borrower rather than an informal and in-depth understanding of the borrower.

• The greed increased and MFI’s started lending to people who were on daily wages apart from borrowers having steady income flows. This started the subprime lending in MFI industry. Villagers became smart due to the prevalence of multiple MFI’s and all chasing common borrowers. The credit culture changed and villagers stopped repaying (guided by local politicians). They started borrowing from multiple MFI’s and then defaulting. Today, there is no common database for MFI borrowers like CIBIL in banks. Earlier MFI’s used to cajole the villagers to take loan and today they have become smart enough to shun MFI’s if the rates are not in their favor. Choice of lenders provides more flexibility to the borrowers.

• The highest share of MFI lending is in Andhra Pradesh. The new ordinance passed by AP govt to register MFI’s and put a cap on its activities is acting as a big dampener to their business. Also the govt has put a cap on the NREGA employment mandays to 100 which restricts employability in AP. In AP, there are two types of land; farm and non farm. In farm land people had other options to earn by selling coconuts, bananas, etc. In non farm, people live on single produce. Due to heavy rains and cap imposed by NREGA the income stopped which lead to defaults

Today the situation is that the revenue model of these MFI’s will undergo a big change as the government has started intervening to ensure that credit is available at lower interest rates and it indeed leads to financial inclusion. We have seen SKS cutting rates to 24% all inclusive from the high’s of 32%. This shows that there was unprecedented pricing in this industry. We hope that sanctity prevails and MFI’s continue to do the good work with a noble cause.