India’s finance minister Pranab Mukherjee says the government doesn’t want to “strangulate” the microfinance industry that is in the business of giving tiny loans to poor people. At the same time, he asserts that the industry should bring down interest rates to a “reasonable” level and stop using “coercive methods” to recover loans. Mukherjee is also in no hurry to act. He wants to wait until a panel, appointed by the Reserve Bank of India, prepares its report on the state of affairs in the sector by December-end even as many feel that the Rs 33,000 crore industry, involving 30 million consumers, is facing a grave crisis that is intensifying every day.
Shares of the country’s largest and only listed microfinance firm, SKS Microfinance Ltd, last Thursday lost nearly 20% to close at Rs 641, less than half the stock’s lifetime high of Rs 1,491, recorded in September. In August, it raised money from the public at Rs 985 per share.
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The stock fell after the company sent a note to the stock exchanges saying there could be a “material impact” on its earnings and asset quality because collections have fallen sharply over the last one month due to the changes in rules for microfinance companies in Andhra Pradesh. An ordinance in the southern state, which is yet to become a law, seeks to check alleged coercive methods used by microfinance institutions, or MFIs, prohibits them from taking their business to doorsteps, giving multiple loans to borrowers and collecting weekly repayments.
The day after the free fall, SKS issued another statement, saying it is confident that the regulation will actually strengthen the industry and benefit well-funded ethical lenders like SKS. Its chairman Vikram Akula said the company had dropped the interest rate to 24.5% from 26.7% as it has benefited from economies of scale. The 2.2 percentage point difference was for insurance cover for which the borrower was earlier paying, and the company will now absorb the cost.
Following the promulgation of the ordinance, the MFIs are able to collect repayment for only 70% of their loans in Andhra Pradesh. SKS is not too worried about this because the state accounts for only a little over one-fourth of its loan assets and the company operates in 18 other states where its collection record is 99%. But there is no guarantee that the Andhra Pradesh experience will not spill over to a few other states. The Indian government’s Rs 70,000 crore farm loan waiver in fiscal 2008-09 encouraged many small and marginal farmers not to repay bank loans. Those who track the microfinance industry closely say the Andhra Pradesh ordinance will push up the default rate in other states as well, sooner than later, as borrowers of tiny loans will not be in a hurry to pay up.
The ordinance and the finance ministry note that has advised banks not to give loans to microfinance units unless they bring down their loan rates to a reasonable 22-24% band will change the face of the industry. Public sector banks that roughly account for about 70% of the Indian banking industry have been giving tiny loans through the self-help groups, or SHGs. There are about five million such groups and 70 million consumers across India. In Andhra Pradesh, loans given by banks to the SHGs is around Rs 78,000 crore.
Most of the MFIs follow the joint liability group, or JLG, model. Here, loans are given to individual households but the liability is collective when it comes to repayment. The MFIs borrow money from public sector, foreign and private banks, and lend it to JLGs, keeping a margin. Typically, five women form a JLG, and six to eight JLGs form a centre. Such centres meet every week at the same time and same place and loan repayment instalments are collected. The MFIs have about seven million customers in Andhra Pradesh and their per-customer exposure is between Rs 12,000 and Rs 14,000. Now, every three out of 10 such customers are not paying back.
Worried banks are going slow in giving money to MFIs. The equity flow to the sector will also dry up as there aren’t too many investors who are willing to take political risk. There are about 40 for-profit MFIs that are all non-banking finance companies (NBFCs). The big ones are SKS, Share Microfin Ltd, Spandana Sphoorty Financial Ltd, Bandhan Financial Services Pvt. Ltd and Bhartiya Samruddhi Finance Ltd (their consumers base varies between 1.8 million and 7.4 million). The rest of them are small (an NBFC needs only Rs 2 crore of capital), but they have been dreaming of making it big. Now, they will be left with no choice but to get merged with the relatively stronger NBFCs as it will not be easy to get fresh equity, 90% of which come from foreign funds.
They will also need to change their business model. Most MFIs have been giving money to landless and marginal farmers and women labourers, who are at the so-called bottom of the pyramid, and the repayment cycle is daily or weekly, in sync with their cash flow. Now they will have to reach out to the petty traders and non-farmer entrepreneurs and contract farmers whose cash-flow cycle is longer, and hence, it will be easy to shift to the monthly repayment schedule. This will bring down the transaction cost and help MFIs pare their interest rates.
Finally, they will also need to focus on fee income by selling microinsurance, mutual funds and other financial products along with giving loans. For survival, the industry needs to consolidate and curb its obsession for growth. As one microfinance expert puts it: it needs to figure out which way to grow—as a eucalyptus tree or a teak tree? The eucalyptus grows faster, but teak wood lasts longer.
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