When a dog bites a man, that’s not news because it happens too often. But if a man bites a dog, that’s news. In the financial world, borrowers knocking at the doors of lenders is the norm, but when lenders start chasing consumers, that’s something unusual. We had seen this in urban India in 2007 and early 2008 when Indian banks aggressively chased consumers with offers of credit cards, auto loans and mortgages as if there was no tomorrow. They stopped doing that and even started shrinking their retail loan book for fear of piling up non-performing assets after the global credit crunch hit the financial system hard in the wake of the US subprime crisis. But one sector that remained insulated from this is microfinance, or the business of giving tiny loans to poor people. What commercial banks did in the metros, the (MFIs) have been doing in select pockets of rural India.
In fiscal 2009, MFIs in India added 8.5 million consumers, taking their consumer base to 22.6 million—an increase of 60%. The growth in their loan book was even more spectacular—around 97%—from Rs5,950 crore to Rs11,734 crore. In terms of consumer acquisition, Spandana Sphoorty Financial Ltd recorded the highest growth rate, 104%. Bandhan Financial Services Pvt. Ltd and SKS Microfinance Pvt. Ltd expanded their consumer base by 91% and 87%, respectively. SKS and Spandana grew their loan books by 214% each and Asmitha Microfin Ltd by 111%. Also, the relatively bigger MFIs have been getting even bigger. For instance, in 2008 there were 21 MFIs whose loan books were worth Rs50 crore or more. In 2009, 27 MFIs joined the Rs50 crore loan book league.
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Are we seeing a bubble in the Indian microfinance industry? Will it lead to another subprime crisis? (After all, MFIs cater to subprime borrowers.) At a recent panel discussion on this subject in Mumbai, I was happy to note that almost all MFIs were willing to look at the mirror, something they did not do until a journalist for The Wall Street Journal filed a report in August from Ramanagaram, a silk making city in Karnataka, where borrowers had stopped repaying their loans. The loan repayment revolt was seen also in Kolar, another town in Karnataka. I have not been to either of these places, but after talking to many people who closely track the industry I am convinced that MFIs in India have bothered more about expanding their loan books than about asset quality and knowing their customers. At Ramanagaram, Kolar and quite a few other places, they chased borrowers and gave them loans beyond their repayment capacity.
Theoretically, nothing can go wrong with such loans. This is because they are tiny loans, not beyond Rs25,000, and in most of the cases such loans are repaid in weekly instalments. Moreover, these loans are given to a group in which each member makes sure that others do not default. Since the average per capita income of an Indian is about $1,000 (around Rs46,900) a year, a rural household has $5,000 of annual income since, typically, each family has five members. So, nothing can go wrong with Rs25,000 of exposure and no one can default. Statistically, the default rate in large MFIs is around 1%.
But the reality is very different. Too many MFIs chase the same set of borrowers and, as a result of this, many borrowers end up borrowing Rs1 lakh and even more. Since there is no credit bureau, MFIs do not have access to the credit history of their clients and cannot stop a borrower from accessing multiple loans from different MFIs. Also, the real annual income of many borrowers is less than $1,000. So, the default rate is bound to go up. In fact, I sometime wonder that if the default rate is only 1%, why do MFIs need to charge their borrowers 24-36% when their cost of money is around 12%. Indeed, there is a huge intermediation cost for tiny loans, but it’s very difficult to justify such a high loan rate when default risk is so low. Either they are making too much of profits or not making a full disclosure of their non-performing assets.
Why do MFIs want to grow at a scorching pace? They want to drum up their valuations. With a fatter loan book (and there is no resource crunch as banks are always willing to give them money), their valuation goes up and private equity funds make a beeline to invest in them. In the past one-and-a-half years, such funds have invested around Rs850 crore in MFIs and more money is in the pipeline. Some of the investments have been made valuing Indian MFIs at about seven times their book value against the global norm of 1.5-2 times. Quite a few MFIs have been posting 30-40% return on assets. This cannot go on forever.
Those who are involved in the MFI movement in India often cite the example of the growth in mobile telephony and other consumer sectors to justify the scorching pace at which they are growing. This is not the right comparison. As JPMorgan’s Nicholas O’Donohoe, who has been closely following this segment, puts it, in finance, unlike in consumer goods, intense competition does not necessarily make the product cheaper for consumers but the quality of assets gets affected as players start compromising on underwriting. Indian MFIs must know their customers before they lend. If they do not curb their irrational enthusiasm, they will end up killing the goose that lays the golden egg.
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