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Spread of microfinance evokes risks of subprime in the East………Ruth David
Savita Ramesh Rathore stood at the door to her dimly lit workshop in Mumbai’s Dharavi slum, filled floor-to-ceiling with bundles of old clothes, and tallied up the cost of her son’s wedding last year.
“Jewels, clothes, food, the town hall,” said Rathore, 50, who makes towels from discarded clothes. She borrowed Rs 30,000 from moneylenders charging 60% interest and took additional loans from friends to pay for the wedding.
Three months ago, she got a Rs 10,000 loan from urban lender Hindusthan Microfinance to repay some of that debt.
Rathore is one of 25 million Indians who have taken so-called microfinance loans, often without adequate documentation or collateral, according to Micro-Credit Ratings International Ltd.
As Hyderabad-based SKS Microfinance plans to become the first such lender to go public in the country, an industry credited with helping alleviate poverty may come under pressure to tighten loan standards to avoid a pile-up of bad debts.
“Globally, microfinance is showing characteristics of the western financial markets before the collapse,” said Sanjay Sinha, managing director at Micro-Credit Ratings in New Delhi. “In the US, homeowners were given loans at 120% of the value of their properties. In rural India, people are being lent to at 150% of the value of their enterprises.”
The implosion of the US market for subprime mortgages to people with poor credit histories helped trigger a financial panic and almost $1.8 trillion in losses and writedowns at financial institutions worldwide.
Microfinance, which focuses on loans in poor areas largely shut out from traditional banking services, gained prominence globally when Muhammad Yunus won the Nobel Peace Prize in 2006 for his role in founding Bangladesh’s Grameen Bank. Yet the past two years have been marked by surging defaults in some countries.
Microfinance markets in Nicaragua, Morocco and Pakistan have seen default levels climb to more than 10%, the threshold that marks a “serious repayment crisis,” according to a February report from Washington, DC-based policy and research firm Consultative Group to Assist the Poor.
While there has been no evidence of a “widespread repayment crisis” in India, “a number of industry analysts have highlighted industry vulnerabilities,” the report said.
Indian microfinance firms have reported bad-loan ratios of about 2.5% on average, Micro-Credit’s Sinha estimated. Actual levels may be higher, in part because some lenders roll over loans to struggling borrowers to avoid defaults, he said.
Most microfinance loans in India range from Rs 5,000 to Rs 20,000, according to an October 2009 report by Crisil Ratings. The country, where more than 600 million people live on less than $1.50 a day, is the world’s largest microfinance market, according to a March report by CGAP and JPMorgan Chase & Co.
Interest rates range from 18% to 33%, according to Vijay Mahajan, chairman of Hyderabad-based Basix Group and president of the Microfinance Institutions Network, an industry lobbying organisation.
Indian banks typically don’t lend directly to microfinance customers.
Microfinance lending in India may surge by about 40% annually over the next few years, said Sinha, whose company provides ratings services to potential investors.
SKS, betting the potential for growth will attract investors, sought approval from India’s capital markets regulator in March for an IPO and picked Kotak Mahindra Capital Co, Citigroup Inc and Credit Suisse Group AG to manage the offering. The company hasn’t said when it will sell stock.
Sequoia Capital began buying shares in SKS in March 2007. It plans to sell less than a third of its holding in the IPO, according to the filing SKS made in March.
“The market is only 15-20% penetrated today,” Sumir Chadha, managing director of Sequoia Capital India, said in a May 6 interview. “So even though microfinance has been growing at stupendously high growth rates for the last four to five years since we first invested in the sector, we expect it to continue to grow at very high rates for the foreseeable future.”
SKS, which mainly provides loans to poor women in rural areas, said its number of borrowers climbed almost 20-fold to 3.95 million in the three years ended March 31, 2009. Loans outstanding increased more than 18 times in the period, to Rs 1,420 crore, and profit jumped almost 49 times to about Rs 80.2 crore, SKS said in the March filing.
Runaway growth at microfinance companies masks an erosion of lending standards and a lack of regulation that may help spark rising defaults, said Micro-Credit’s Sinha.
India doesn’t have a nationwide system for tracking borrowers’ credit histories, making it hard for lenders to check whether clients have multiple loans.
Increased regulation may force lenders to boost provisions, hurting profits, said Sandip Sabharwal, head of portfolio management services at Mumbai-based Prabhudas Lilladher Pvt.
If “there is more transparency, whether profitability will be the same remains to be seen,” he said. “From an investor standpoint, the risk is that the huge profitability we see today may not remain going forward.”
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