The life, death and resurrection of Indian microfinance5 min read . Updated: 18 Sep 2015, 12:24 AM IST
Eight of the banking licence recipients are from the microfinance industry, which was on the verge of a collapse five years ago
After giving licences to 11 payments banks in August, the central bank on Wednesday announced a fresh set of 10 licences—this time for the so-called small finance banks. Eight of them are from the microfinance industry, which was on the verge of collapse just five years back.
Some 17 microfinance institutions, or MFIs, applied for licences and nearly 50% of them succeeded in convincing the Reserve Bank of India (RBI) about their ability to offer banking services to the masses in Asia’s third-largest economy. It’s an economy where—according a 2012 working paper by the World Bank—half of the adult population does not have access to formal banking services.
Indeed, the RBI has been liberal in opening up the sector. One new universal bank launched in August and another will see the light of day next month. Yet, 21 more banks with a special focus on certain segments of business will open shop over the next year-and-a-half. Seen against the backdrop of 13 banks opening in the past two decades—quite of a few of them do not exist today—this is a banking revolution.
Equally importantly, it is the resurrection of the microfinance industry, nearly buried in scandal in 2010, when the Andhra Pradesh government promulgated an ordinance to curb its activities.
MFIs expanded recklessly after the highly successful listing of SKS Microfinance Ltd in July 2010, encouraged not only by a strong demand for loans from borrowers neglected by the banking system but also by investors eager to put money into the industry at a high valuation.
This was short lived: after allegedly coercive debt collection practices drove many poor borrowers to suicide, the government of Andhra Pradesh made it mandatory in October 2010 for MFIs to specify their area of operation, rate of interest and recovery practices. It also became mandatory to seek the state government’s approval before issuing any fresh loans.
In the preceding five years, between 2005 and 2010, the Indian microfinance sector had become one of the largest in the world. After the 2010 ordinance, the operations of all MFIs in the southern state came to a grinding halt. The ripples from the crisis were felt in almost every state. Bad loans piled up as borrowers refused to service their debts and banks stopped lending money to MFIs.
About 9.2 million borrowers in Andhra Pradesh—India’s fourth largest state by area and fifth largest by population—defaulted on their loans from MFIs, the largest number of defaulters in any single location in the world. The MFI industry’s total exposure to Andhra Pradesh was around ₹ 7,200 crore in 2010 but it was able to collect only 10% of this money from the borrowers. Even MFIs that did not have direct exposure to Andhra Pradesh were shunned by banks. The outstanding loan book of the industry, ₹ 30,000 crore in October 2010, had shrunk to half that size in a year.
Since then the RBI has stepped in, putting in place regulations for the industry, capping the margin between the cost of borrowing and the price at which loans are given and defining loan norms.
Credit bureaus have been formed to help MFIs take appropriate credit decisions and arrest multiple lending. The introduction of a code of conduct, diversification of the product basket and adoption of new practices to focus on customers’ needs have combined to ensure governance and client protection, and created an ecosystem for responsible lending.
The industry has now expanded to other geographies, paring the concentration risk.
The granting of eight licences to MFIs for small finance banks signals that all is well now with the industry. Indeed, MFIs play a critical role in countries such as Bangladesh, Pakistan, Indonesia and the Philippines—and some of them become banks.
Nowhere in the world has the industry seen such a dramatic turnaround.
Of the eight MFIs that have been given licences, two each are in Chennai and Bengaluru, and the remaining four are headquartered in Guwahati, Navi Mumbai, Ahmedabad and Varanasi—well spread out across India. All eight have over 99% standard assets. The founders of at least four of them are former bankers: Ramesh Ramanathan of Janalakshmi Financial Services Pvt. Ltd (Citibank), Samit Ghosh of Ujjivan Financial Services Pvt. Ltd (Citibank and HDFC Bank Ltd), P.N. Vasudevan of Equitas Holdings Ltd (DCB Bank Ltd), and Govind Singh of Utkarsh Micro Finance Pvt. Ltd (ICICI Bank Ltd).
Once these eight MFIs become banks, the for-profit MFI industry will shrink by around 40%. After the erstwhile Bandhan Financial Services Pvt. Ltd became a bank with around ₹ 10,500 crore loan assets, the industry shrank to ₹ 32,000 crore. These eight MFIs collectively have a loan book of close to ₹ 13,500 crore. This means that once again, the industry size will shrink to around ₹ 18,500 crore.
But nobody will complain.
There will be around 45 for-profit MFIs after these eight become banks. Around 200 not-for-profit MFIs have a collective loan book of close to ₹ 5,000 crore. Sri Kshetra Dharmasthala Rural Development Project (Karnataka) and Cashpor Micro Credit (Uttar Pradesh) constitute 90% of the loan book of these MFIs.
Among the relatively large for-profit MFIs that have not got an RBI nod for becoming small banks are SKS and Satin Creditcare Network Ltd. Another name is Arohan Financial Services Pvt. Ltd, even though it does not have a large loan book. Of course, there are others who fell by the wayside, bearing the brunt of the Andhra crisis: Spandana Sphoorty Financial Ltd, Share Microfin Ltd, Asmitha Microfin Ltd and Vijay Mahajan-promoted Bhartiya Samruddhi Finance Ltd—India’s oldest MFI.
Small finance banks can function almost like any other commercial bank but on a smaller scale. They will be in the mass market and 75% of the loans given by these banks should qualify for the so-called priority sector loans.
The maximum loan exposure to a single or group company is capped at 10% and 15% of their capital respectively, and small loans of up to ₹ 25 lakh should constitute at least 50% of the loan portfolio.
There are challenges ahead. The successful candidates will need to meet all the conditions of the regulator to get the final nod in the next 18 months. It will not be easy to scale up, acquire market relevance and become commercially successful, but the industry should savour this moment and celebrate.
In due course, the successful small banks can graduate to universal banks. In the meantime, MFIs who have failed to make it this time should not lose heart. If those who have got the licence can demonstrate success, others will join the league when the RBI puts banking licences on the tap.
That day’s not far away.
Tamal Bandyopadhyay, consulting editor of Mint, is adviser to Bandhan Bank, India’s newest bank. He is also the author of Sahara: The Untold Story and A Bank for the Buck.
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