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MFIs AT THE CROSSROADS
Macro Challenges Of Micro Lenders Caught between shareholder pressure for profits and competition from rural-bound banks,microfinance institutions will have to innovate to keep their original objectives relevant,says Gayatri Nayak THE BUSINESS of microfinance in India is at a tipping point.Large microfinance institutions (MFIs) are under pressure to generate steady quarterly profits following their decision to go public or issue shares to private equity investors.Also,while raising capital,many have told stakeholders about their ambition to get a banking licence.If they do get a licence they will become even more a part of mainstream lending,as the Reserve Bank of India (RBI) is unlikely to create a special dispensation for MFIs.At the other end,MFIs risk losing their turf to banks who are under strong pressure to reach out to every unbanked customer because of the governments thrust on financial inclusion.
Microfinance has been recognised as a distinct branch of lending since the past 25 years.The tipping point came after Bangladeshs Mohammed Yunus,through his Grameen Bank,proved that lending to those with neither adequate income nor collateral can be profitable and lift people out of poverty.The idea has since caught on in poor countries across the world.In India microfinance lending was started by nongovernment organisations(NGOs)and has picked up in the last decade as these institutions found support from businesses keen on fulfiling their social responsibility.These include corporates social responsibility programmes or entities with mandated social sector obligations like in the case of insurance companies who are required to sell a portion of their policies to the poor.The change came when MFIs began to consolidate their position by reconstituting themselves in the form of for-profit non-banking finance companies (NBFCs) rather than non-profit NGOs that most MFIs started out as.As a result more than 80% of MFI lending is now concentrated with such NBFCs.
So how do MFIs fulfil their conflicting obligations towards shareholders and borrowers According to Royston Braganza,CEO,Grameen Capital,The socially conscious MFIs work on a double-bottomline model,ensuring sustainable profits while increasing outreach to the poor.Impact assessment tools such as Grameen Foundations Progress Out of Poverty Index enable MFIs to track social performance and client impact that in turn help MFIs develop client-centric products/solutions,which support the sustainability of their model and adherence to its social focus.
Despite the banking industrys ambitions on financial inclusion,numbers indicate that there is opportunity for MFIs too as they cater to only about 20% of the unbanked households.MFIs reach out to a segment where the transaction sizes are too small for traditional loan products to be affordable.These transaction costs are,therefore,piled up on loans in the form of higher interest rates.Banks cannot add these charges on to interest rates as these are capped for small loans.
As a result,yield on advances are almost double of that for a successful MFI.For instance,weighted average yield on advances for commercial banks is 10.8% against 20-24 % for MFIs.Even after discounting a 6-8 % higher operating costs and other costs,returns are still attractive.Also,from the borrowers perspective,this rate is far too cheaper than what they would pay a money lender,which could sometimes go up to over 100%.Over the years these MFIs have achieved expertise in almost 100% loan recoveries in this business,which is essentially cash-based.However,according to Samik Ghosh,a former Citi banker and founder of Ujjivan,which is a RBI registered NBFC MFI:
Considering the similar nature of unsecured lending,a fair comparison would be with interest rates charged on credit card dues by banks where interest rates are around 36% per annum. Even as there is a debate on whether interest rates should be capped for MFIs,there is a possibility that banks would be given the freedom to price smallticket priority sector loans.The jury is still out on whether there will be a cap on interest rates.Many experts like Mr Yunus are not in favour of profit-oriented MFIs and are keen on government intervention on an interestrate cap.The governments proposed draft Microfinance Bill has not come out clearly on its stand on interest rates.
The recently-formed Microfinance Institutions Network (MFIN) prefers to rely on market forces to determine rates.MFI chairman Vijay Mahajan,who is also the promoter of Basix and among the early players in the business of lending to the poor,said the body wants the price discovery to take place through play of market forces rather than by restricting them.He added that competition will ensure fair pricing of lending rates.
Over the years many MFIs have managed to cut rates by attaining scale and pruning costs.According to Mr Ghosh: There was a significant dip in interest between the pre-Andhra crisis,during which some Andhra-based MFIs faced government action and post crisis by about 6% to around 24% per annum. Subsequently,MFIs have reduced rates but perhaps not enough by those who attained scale and cut operating costs, he added.
MFIs are now tapping mainstream sources like any high-street bank.These include,equity,loan sales and securitisation.Already,one of the largest players,SKS Microfinance,has filed Red Herring prospectus for a public listing.
Big money has started flowing into MFIs only after they started selling the story of money at the bottom of the pyramid.The MFI concept has received support from thinkers in the west such as the late CK Prahlad,who has included this with other innovations of the developing world.One industry estimate is that private equity investments have touched $200 million.
But can scale be a measure of success in microfinance MFIs have been talking about innovations in technology such as biometric cards and mobile banking to reach out to newer borrowers.But it now looks like banks will beat them to it using these new tools.To a large extent MFIs are hampered by regulation,which does not allow them to partner banks or become banking correspondents.Allowing MFIs to be business correspondents in financial inclusion and work with banks more closely would also give impetus to financial inclusion and getting more poor into the banking fold and help MFIs reduce their operating costs, says Mr Ghosh.
Ultimately,a new age NBFC MFI should ideally be the one with a back office of a world-class bank and front office like a worldclass NGO,says PN Vasudevan of Chennaibased Equitas.
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