Kolkata: Village Financial Services Ltd, one of the oldest microfinance institutions in India, is looking to sell a 10% stake to raise “growth capital" as lenders like it face pressure from those that have turned into banks to reduce their costs of funds. This is the first time the founders of the privately held Village Financial will dilute their ownership in the company.

Agreements have almost been finalized with “a high net worth individual and a domestic private equity fund", and the share sale will be concluded by 15 February, said Kuldip Maity, the lender’s chief executive and managing director.

Village Financial was earlier planning to go public through an initial public offering. A decision on the IPO will be taken after this round of fund raising, he added.

Maity expects the loan book of his company to swell to Rs700 crore by March and to Rs1,200 crore at the end of the next fiscal year.

Village Financial currently operates in Uttarakhand and the eastern states of West Bengal, Bihar, Jharkhand, Odisha, Assam and Sikkim. By 2020, the management is aiming to expand into 10 more states, Maity said.

Several microfinance institutions such as Bandhan and Ujjivan have turned themselves into banks and have started to receive public deposits, which are significantly cheaper than bank loans.

Because of the huge difference in the cost of borrowing, it will be difficult for microfinance institutions to remain viable going forward, said Samit Ghosh, managing director and CEO of Ujjivan Small Finance Bank.

Cost of funds for the likes of Bandhan and Ujjivan is 7-8% whereas it is 12-14% for microfinance institutions. Whereas Bandhan and Ujjivan make small loans at 18-19%, their competitors which do not have access to public deposits lend at 22-24%.

Though the difference in cost of funds may not be a concern immediately, it will be a “huge challenge" for microfinance institutions in 2-3 years, said Chandra Shekhar Ghosh, managing director and chief executive officer, Bandhan.

P. Satish, executive director at Sa-Dhan, a self regulatory organisation for microfinance institutions, said borrowers will at some point start migrating to banks such as Bandhan and Ujjivan because of the lower interest rate. Though these lenders have turned themselves into banks, bulk of their business still comes from their earlier clientele.

Bandhan’s Ghosh said though his bank is looking to pare its dependence on small unsecured loans, such loans still account for at least 90% of its assets. In August 2015, Bandhan turned itself into a bank. Ujjivan followed suit in 2016 after obtaining the licence to start a small finance bank.

In the past two years, at least three microfinance institutions have been acquired by banks. In 2016, Kotak Mahindra Bank acquired BSS Microfinance Pvt. Ltd, and IDFC Bank acquired Grama Vidiyal Microfinance Ltd. Last year, IndusInd Bank took over Bharat Financial Inclusion Ltd and RBL Bank took a small equity interest in Utkarsh Microfinance Pvt. Ltd.

There are some 225 microfinance institutions in India, of which one has become a universal bank and eight have turned themselves into small finance banks, according to Satish of Sa-Dhan.

Maity of Village Financial, however, said borrowers of microfinance institutions are not migrating yet and that the market was large enough for everyone to expand. Echoing him, Kartick Biswas, managing director of Uttarayan Financial Services Ltd, said some lenders such as his own, operate in remote villages where banks do not have much access.

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