Home / Money / VCs wake up to risks in microfinance funding

Bangalore: Judging from the number of microfinance institutions (MFIs) that received funds from venture capital (VC) and private equity (PE) firms between May and July, MFIs that typically lend to the unbanked poor seem to be the next “must-have" on investors’ list.

Experts, however, caution that the run may soon be over because the liberal cash inflow may bring new problems such as over-indebtedness and malpractices in pre-loan disbursal scrutiny.

Hyper growth: With easy access to MFI loans, the risk of defaults and multiple lending is higher. Ganesh Muthu / Mint

MFIs, which extend small loans to the so-called bottom of the pyramid population in both rural and urban areas who have no access to traditional banking services, raised around $68 million (around Rs330 crore) of funding from VC and PE firms during May-July. The money is substantial in an industry where the loan size could range between a few hundred and a few thousand rupees.

Micro loans outstanding more than doubled in 2008-09, totalling Rs11,734 crore, according to Sa-Dhan, a New Delhi-based industry association.

While the huge unmet demand as of now may not precipitate a compulsion to lend, analysts say that in a saturated scenario this may happen, particularly if there are too many MFIs operating in the same region and they all are equally cash-rich. “A larger part of the problem could be due to high operational costs, multiple lending because of more capital infusion and competition," said Manohara Raj, business head, microfinance, HDFC Bank Ltd.

“We cannot take our eyes off the loan portfolios of the firms we consider investments in," said Mohit Bhatnagar, managing director, Sequoia Capital India, which has backed MFIs such as SKS Microfinance Pvt. Ltd and Ujjivan Financial Services Pvt. Ltd. “When there is too much of cash on hand, that’s when you need to partner with good companies. With access to capital, people may take short cuts (to boost customer base). Whether you have capital or not have it, you cannot drop the hat on diligence."

SKS Microfinance, which has raised multiple rounds of funding, believes the fears are not unfounded. “If there is too much money, everyone gets excited and starts lending. This gives rise to a risk of unplanned lending and defaults," said Suresh Gurumani, chief executive, SKS Microfinance.

VC firms say that the 200-300% year-on-year hyper growth is not necessarily a good thing. “You develop bad habits if you focus too much on growth," said Bejul Somaia, managing director, Lightspeed Advisory Services India Pvt. Ltd. “Also, there are fears of unscalability after hyper growth. What’s next?"

Meanwhile, investors such as Aavishkaar India Micro Venture Capital Fund say while too much capital infusion may result in a saturated market in certain pockets, this would not spread to the entire country due to the pent-up demand. “Over-indebtedness may happen as banks also extend credit. It happens in all lending business. Over-borrowing is difficult to measure," said Vineet Rai, chief executive, Aavishkaar India, adding that a credit bureau is needed to check over-borrowing.

To be sure, investors will become more discerning as the MFI sector matures. MFIs have unique opportunities for diversification and those extending financial services such as insurance are set to become hot property. Also, firms offering products such as mobile handsets on loan instalments could be attractive. Firms assisting financial inclusion through unique facilitating technologies such as mobile phone remittances will also attract investors. Also, consolidation is expected among smaller MFIs. Aavishkaar India plans to keep aside a chunk of its corpus from its next fund to facilitate mergers and acquisitions.

“We also see many of such investors adopting an ‘angel investor’ role, creating innovative funding structures," said Robin Roy, associate director, PricewaterhouseCoopers Pvt. Ltd.

MFIs operating exclusively in states such as Andhra Pradesh, Karnataka and Tamil Nadu may have difficulty in scaling up unless they have unique offerings, said Venky Natarajan, managing director, Lok Advisory Services Pvt. Ltd, a firm which provides technical advice and due diligence for investments to Lok Capital Llc, a Mauritius-based venture capital fund. MFIs operating in Rajasthan, Madhya Pradesh and Maharashtra will attract more equity, he said.

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