Microfinance | Weighing growth, vulnerabilities

Microfinance | Weighing growth, vulnerabilities

Till recently, India’s Rs20,000 crore microfinance industry had a great run, growing at a scorching pace and being chased by private equity investors. SKS Microfinance Ltd, the largest of them, tapped the capital markets in a successful initial share sale in 2010, signalling the acceptance of the industry by investors.

Then the bottom fell out. The passage of an ordinance and subsequently a law by the Andhra Pradesh government that tightened controls on microfinance institutions (MFIs) sent them into a tailspin. Andhra Pradesh, critical to the 16-year-old industry because it accounts for close to one-third of the total business and is also home to most of them, cracked down because of allegedly coercive loan recovery tactics and suicides linked to this.

“There was a lot of mismanagement and lack of governance, some people might have got greedy. Certainly, some of the promoters got very greedy," said Samit Ghosh, managing director and chief executive officer of Ujjivan Financial Services Ltd, one of the largest MFIs in India. “When you are successful, it is difficult to figure out what is going on and everyone got carried away by such a massive growth."

The crisis that started in the southern state took a toll on all MFIs. Repayment rates fell to as low as 5-10% in Andhra Pradesh and there was adverse impact on other states as well.

Fund squeeze

Risk-averse commercial banks stopped lending to MFIs, heralding an imminent funds squeeze. MFIs provide tiny loans to the poor at an interest rate of 24% or above and source the funds at half this rate from commercial banks.

Indian banks have lent Rs24,178 crore to small borrowers directly and indirectly through MFIs as well as self-help groups as of 29 July, with Small Industries Development Bank of India (Sidbi), State Bank of India and ICICI Bank Ltd having major exposure to the sector.

Industry officials forecast large-scale consolidation in the next decade, especially among small and relatively inefficient companies, which will leave few of them standing.

Mergers will also be forced by new regulations, including new Reserve Bank of India (RBI) guidelines for larger non-banking financial companies (NBFCs) and the recent national legislation that empowers the apex bank to regulate microlenders, they said.

“In the next one decade, there will not be more than 15 MFIs and these will be serious players, from around 900 now," said Kishore Kumar Puli, managing director and chief executive officer of Andhra Pradesh-based Trident Microfin Pvt. Ltd, and state chief of the Microfinance Institutions Network (Mfin) lobby group. The industry is already readying for consolidation.

“My sense is that there will be mergers even among the top 10 NBFC-MFIs also," said Mathew Titus, executive director at Sa-dhan, an association of Indian microlenders. “Consolidation is unavoidable."

According to Trident’s Puli, economies of scale will dictate consolidation. “The bigger the companies will be, the lesser will be their operating costs," he said.

India has close to around 900 MFIs and a majority are incorporated in the form of non-governmental organizations, trusts or cooperative societies, according to various estimates. Smaller MFIs constitute about 10% of the industry in terms of business, while the rest consist mostly of large MFIs in the form of NBFCs. Of the total, only around 350 MFIs are listed with industry associations.

The larger firms, especially those based in Andhra Pradesh, have resumed the process of merging operations to stay afloat or selling stakes to banks and private investors to maintain their net worth.

Merger plans

For instance, three of the leading MFIs in Andhra Pradesh—Spandana Sphoorty Financial Ltd, Share Microfin Ltd and Asmitha Microfinance Ltd—have plans to merge, while Vijay Mahajan-promoted Bhartiya Samruddhi Finance Ltd (BSFL), India’s oldest MFI, said on 27 July that the company was on the verge of closure under the burden of bad loans.

This was largely due to the refusal of borrowers in Andhra Pradesh to make repayments, the microfinance company said, and added that bad loans are growing and threatening to wipe out its entire net worth and reserves. However, a host of lenders and private investors later threw a lifeline to BSFL by offering funds.

“Every industry, when it grows beyond a threshold level, consolidates in three-five years. This should ideally happen in that time. If you see in microfinance, the sector has seen huge growth, but not consolidation and that leaves a gap of four-five years," said Chandra Shekhar Ghosh, chairman and managing director of Bandhan Financial Services Pvt. Ltd. “Given that signal before us, we should automatically progress to consolidation now."

Many of the large MFIs have seen a sharp erosion in assets and net worth since the crisis hit the industry, and according to industry officials, this scenario could worsen on account of the ensuing write-offs.

For instance, the loan book of BSFL has shrunk to about Rs1,117 crore from Rs1,808 crore in September last year, when the crisis hit the industry. Since then, the firm’s net worth has dropped to Rs201 crore in May, from Rs229.4 crore in September 2010, on account of huge provisions for its mounting bad loans, drawing down from its reserves.

During the period, BSFL’s share of loans in Andhra Pradesh to its total loan book also rose sharply—around 35% as against 31% in September 2010—due to the shrinkage in its loans outside the state, which came down to Rs727 crore from Rs1,244.8 crore.

SKS, too, has seen its loan book contracting to Rs4,111 crore in March from around Rs5,000 crore in September last year. Its Andhra Pradesh portfolio, which has declined steadily, now forms about 20% of its loan book, as against 26% late last year.

Business diversification

Due to a steep fall in interest income, MFIs are now devising models to diversify their revenue stream by increasing the focus on other business segments. SKS, for example, has chalked out plans to diversify operations largely into the gold loan business in view of the current market scenario. It plans to open around 200 branches across India by March to broad-base the company’s revenue stream, chief financial officer Dilli Raj said in June.

In the last quarter, the company’s repayment rate, that at which loan instalments are collected from borrowers, crashed to 10.5% in its home state of Andhra Pradesh from more than 97% prior to the crisis. The SKS stock has declined by almost 75% since its August 2010 listing.

Many MFIs, having started with microlending operations, sought to transform themselves into financial services institutions without understanding the business, said Mfin chief executive officer Alok Prasad. “If you want to get into a financial business and if you don’t understand it, you have a problem," he said.

Loan recast

Following the MFI crisis, RBI allowed banks to recast loans worth about Rs5,000 crore made to five microlenders via the corporate debt restructuring (CDR) programme. This calls for banks restructuring the loans of distressed firms by lengthening the repayment period or reducing interest rates.

MFIs admitted to the CDR process in Andhra Pradesh include Trident Microfin, Share Microfin, Asmitha Microfin and Spandana Sphoorty.

“The CDR package was offered only to a few big institutions," Prasad said. “The smaller ones are struggling for survival. In general, they are almost dying."

A section of the industry said that MFIs admitted to CDR may also see banks taking significant control over operations, including the appointment of key executives and monitoring of daily cash flows.

For instance, a group of banks led by Indian Overseas Bank has already agreed to acquire a 72% stake in Trident Microfin by converting debt into direct equity. Trident is based in Hyderabad with a loan book of Rs136 crore and 200,000 borrowers.

MFIs say they have implemented measures that should see the industry regaining some its former vigour.

“Whatever the doctor has ordered, we have done," said Raja Vaidyanathan, managing director and chief executive officer of Asirvad Microfinance Pvt. Ltd.

The move to recovery should be helped by new rules that are set to be implemented.

New regulation

In early July, the Union government unveiled a draft legislation on microfinance regulation that accorded sole regulatory power to RBI. According to the Bill, MFIs registered with the apex bank won’t be treated as moneylenders, thereby keeping them out of the purview of the Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Act, 2010.

But, according to industry executives, while the proposed Microfinance Institutions (Development and Regulation) Bill offers a sound framework, the situation will get worse because of the time it will take for the legislation to be put in place.

“It is like saying there is a nice long highway which has been built. But the entrance to that highway has a big gaddha (pothole)," Mahajan, chairman of Basix group of which BSFL is a part, said in July. “And that gaddha is the losses caused by the AP (Andhra Pradesh) situation."

Early this year, RBI issued regulations to govern MFIs operating as NBFCs, based on recommendations of an expert committee headed by noted chartered accountant Y.H. Malegam. The new regulations capped the interest rate MFIs can charge at 26% and made a minimum two-year tenure mandatory for all loans above Rs15,000.

While the panel looked into operational issues, the new Bill provides an overarching framework, signalling the government’s stand on the importance of the industry, said Sa-Dhan’s Titus.

Once the fresh rules are in place, private equity investors may come back to the sector.

“Private equity investors’ interest was in a fast-growing sector and not necessarily towards the activity of microfinance," said Vineet Rai, founder of Aavishkaar and Intellecap, which have invested around Rs200 crore in MFIs. “They were looking at risk diversification and high returns." “Now, when the crisis came, the sector turned unattractive to the investor as political risk outweighed the return expectations," he added. “Private equity firms do not want unpredictable risk."

It will take some time for investors to look at the sector again, according to Rai.

“My sense is that they will wait for two-three years to regain a significant interest," he said. “This interest will largely be limited to large MFIs and there has to be a significant mitigation of regulatory and political risks. Investors will now look for a growth of 30-40%."