One-and-a-half decade ago, state-run Indian Bank came very close to a collapse when its accumulated losses wiped out its equity and reserves. The Chennai-based lender had made huge losses as it had to set aside money to provide for its bad assets. Now, Vijay Mahajan-promoted Bhartiya Samruddhi Finance Ltd (BSFL), India’s oldest microfinance institution (MFI), is also collapsing under the burden of bad loans.
But the similarity between the two ends here. Indian Bank’s bad assets swelled because of indiscriminate lending by its management and the lack of monitoring of bad loans. But in the case of BSFL, popularly known as Basix, borrowers in Andhra Pradesh are refusing to pay, encouraged by a state law.
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Some of Indian Bank’s peers in the mid-1990s celebrated its impending demise and put up billboards in Chennai, asking depositors of Indian Bank to migrate to them, but Basix’s ill health has spread a pall of gloom across the Rs 20,000 crore microfinance industry as other MFIs with big exposure to Andhra Pradesh may face the same fate. Out of 14 million small borrowers in India’s fifth largest state, 9.2 million have turned defaulters.
Under banking law, once a borrower is not able to repay for a quarter, or 90 days, the loan turns bad and banks have to provide for it at least 70% of the loan amount. For profit-making microlenders, categorized as non-banking financial companies (NBFCs), a loan turns bad when a borrower does not pay for 180 days. Initially, an MFI needs to set aside 10%, but if the loan is not serviced for two years, the entire exposure needs to be provided for. As of 30 June, BSFL’s net worth was Rs 128 crore, down from Rs 230 crore in September 2010, and this will be completely eroded in the next 18 months or so because of accumulated bad loans of Rs 450 crore.
BSFL’s loan book has shrunk from Rs 1,800 crore to Rs 1,000 crore, and Andhra Pradesh accounts for around Rs 450 crore of this. Since repayment in the southern state has dropped to 10%, the only way to increase income would be to aggressively lend in other states where repayments are assured. But BSFL cannot do so as banks are not giving it fresh money.
MFIs borrow from banks and lend to the poor, keeping aside a margin. Mahajan has been looking for a $100 million (Rs 442 crore) equity infusion and a Rs 1,000 crore bank loan for survival.
Andhra Pradesh passed a law in October to control moneylending, after a spate of reported suicides following alleged coercive recovery practices adopted by some of the microlenders. Among other things, the law restricts MFIs from collecting weekly repayments and makes government approval mandatory if a borrower takes more than one loan. Early July, the Union government released the draft of a proposed legislation to govern MFIs that seeks to take them outside the purview of state law and to give more powers to the Reserve Bank of India (RBI) to regulate MFIs. But the battle over regulating MFIs is far from over, with Andhra Pradesh remaining firm on retaining its own law.
The state finds the self-help group (SHG) model more cost-effective for poor borrowers than the MFI model. There are about a million SHGs in the state with 12 million members. The state has spent $600 million in World Bank money to develop SHGs. The Centre also plans to develop SHGs across India under its National Rural Livelihood Mission for which the World Bank recently offered a $1 billion long-term soft loan.
Typically, SHGs get bank loans at a concessional rate of 8-9%, but the actual cost for the borrowers is much less as the state government offers a huge subsidy. Andhra Pradesh has spent around Rs 4,000 crore so far to subsidize such loans. The MFI model, where a microlender borrows money from banks at 12-13% and offers small loans to poor borrowers at 24-26%, is based on recovery of cost in contrast to the highly subsidized SHG model, but the actual cost for both is almost the same.
Andhra Pradesh accounts for at least one-quarter of the MFI industry, and if borrowers do not repay, it will deal a blow to the industry. Even the SHG channel is disturbed now, with the recovery rate dropping to 40%.
There are reasons behind MFI concentration in the southern state. The profile of rural economy in Andhra Pradesh is different from other Indian states as farmers here shifted from subsistence farming to commercial crops ahead of others—groundnut in southern Andhra (Rayalaseema) and cotton in the northern part (Telangana), even as the eastern part, or coastal Andhra, continues to produce paddy.
Besides, after they won the anti-arrack (country liquor) movement and forced then state chief minister N.T. Rama Rao to announce prohibition in the state, agitating women in the southern state were looking for a different cause to channel their energy and organizational skill, and podupu lakshmi (savings and credit) offered that platform. When N. Chandrababu Naidu replaced Rama Rao as chief minister, he nurtured the movement to reap political mileage. Now, there are around two million borrowers from MFIs, many of whom are members of SHGs, too.
Allowing multiple channels to work and compete with each other is the best solution to the MFI problem. Besides, RBI can force them to reveal their cost of funds and justify the loan rates, cap investors’ stakes in MFIs at 5%, and make its approval mandatory for the emolument of the top brass—norms that banks follow. Both the Centre and the state also need to look for a political solution to the Andhra impasse before it’s too late. Half of India’s population still does not have access to banking services.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to email@example.com