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Microfinance grapples with success………Subir Roy
Microfinance is in the news, again for the wrong reasons. Five years ago, it was tension over multiple lending and coercive recovery in Andhra Pradesh. Now it is Muslim community leaders in a couple of districts in Karnataka issuing a fiat to their members to renege on microfinance institution (MFI) loan repayments as they do not approve of such borrowings. What’s worse, the Reserve Bank of India (RBI) has issued a severe warning to MFIs against wrong practices. RBI’s main concern, reports indicate, is benami lending, re-lending to cover up bad loans and poor governance.
But these are not the ultimate concerns. If this was all then the large number of unhealthy and unprofessional MFIs would wither away, ending the sector’s exponential growth. The bigger problem, say insiders, lies not with failures but successes. The original founders of the industry are increasingly exiting in favour of private equity (PE) funds, enabling some founders to encash at $100 million or more and thereby establishing MFI valuations at even half a billion dollars! The PE funds are seeking at least 20 per cent return on equity. If anybody dreamed of microfinance becoming mainstream and getting global funding then this is it.
Some of the best MFIs are hiring top managers, who have seen their prospects dimmed by the global financial crisis, at annual compensations of Rs 8-9 crore. Some of the best professionally-run MFIs are getting ready to come out with public issues, which will allow a partial, highly-profitable exit for the PE funds.
The entry of PE funds into the best and the biggest MFIs brings in resources and professional management practices. This aids growth and a fall in costs, leading to the high rates of return. RBI is upset that the fruits of healthy growth are not being passed on to the borrowers via lower lending rates, which remain in the 26-30 per cent range. If this continues, the central bank threatens, it will stop categorising loans to MFIs as priority-sector lending, thus making it difficult for them to access bank loans at around 12 per cent and onlend.
Also in the space are the less controversial self-help groups (SHGs) linked to commercial banks, borrowing from banks and onlending at marginally lower rates. But they retain their earnings which go to meeting a slightly higher rate of default and whatever is left enhances capital stocks. Experts say the 98 per cent recovery rate that has given NBFC MFIs a stellar reputation is unsustainable. The very poor who take MFI loans are inevitably buffeted by business, climate and health risks, and when they can’t meet a repayment schedule, they turn to local moneylenders who charge twice the MFI rates, or more. No wonder, say the critics, private money-lending is thriving even as the MFI footprint is growing exponentially — the number of borrowers going up annually by around 50 per cent and loan outstandings by around 70 per cent.
Controversies cannot be resolved in a day, particularly when they involve such a remarkable social-cum-financial innovation as microfinance, which is still evolving. But a couple of benchmarks are indisputable. First, Bangladesh (since the launch of the Grameen II model by Grameen Bank) and Latin America, two major practitioners of microfinance, have moved away from the group guarantee model. It is peer pressure that mostly leads the way to moneylenders in India. Latin America has the benefit of credit bureaus to check multiple borrowing which India does not, but that does not make group guarantee any better.
Second, Muhammad Yunus, founding father of Grameen Bank and someone who has not lost sight of the essential spirit of microfiance, offers a benchmark of lending rates not exceeding borrowing costs plus 10 per cent cost of disintermediation. If a high return on equity didn’t go with this, then lower lending rates than current would prevail. At least one prominent MFI founder has claimed that costs have been brought down to 5-6 per cent. That should leave a substantial something for equity holders even at 20 per cent lending rates. And not all PE funds are the same; some like Sequoia are willing to wait for more than five years to exist, some like Bellwether settle for a lower rate for return.
Multiple borrowing (one borrower taking loans from several MFIs) is inevitable when there is near-insatiable hunger for affordable loans at the bottom of the pyramid and there are smart job-hopping loan officials around to facilitate it in a booming market. And when you have the two, window dressing of bad loans is inevitable.
What can RBI do other than issue dire warnings? One is to issue banking licences to the best, enabling them to garner cheap deposits. SEWA, for example, runs a cooperative bank. The other is to open a concessional credit window, again telling the best that it will refinance at 2-3 per cent less than what banks charge provided they put a cap on return on equity. The ball is in RBI’s court too.
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