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Microfinance, macro problems?……..Abheek Barman
The microfinance market is booming and is likely to grow to a staggering $50 billion soon, but it’s fuelling a lot of worries in the states and New Delhi. Are micro lenders getting out of line Is it possible to make money while helping people out of poverty? In the last five years or so, one business, microfinance, seemed to suggest that the answer was yes. Look at the numbers: from merely $12 million in 2003, the market for lending tiny amounts of money mainly to groups of women has grown to more than $7 billion now. And analysts expect this to grow to a staggering $50 billion soon.
It’s easy to understand why. Many people in rural India don’t have access to loans from formal banks. In any case, procedures are cumbersome, paperwork intimidating. That explains why people go to moneylenders, who charge them upwards of 50% for loans. Microfinance, based on a model borrowed from Bangladesh, was supposed to change all that.
Micro-credit institutions would make small loans to groups of women at rates lower than what moneylenders charge. These would go into productive investments and defaults would be kept low because the entire community, or a group of women borrowers, would keep an eye on each other to make sure that the funds were used properly and repayments were on time.
Today, it’s reckoned that women’s selfhelp groups (SHGs) reach about 50 million people. Another 20 million are covered by microfinance institutions (MFIs). That leaves about 100 million people who still rely on moneylenders or relatives for loans. That’s a huge untapped market, which explains why analysts are falling over each other to talk up microfinance.
A few months ago, India’s largest micro-credit company, SKS Microfinance, had a hugely successful listing. But now, the whole micro-credit story seems to be fraying at the edges. And that’s even if you discount the churn at the top in SKS. What’s worrying many people is whether it’s possible to keep poor borrowers happy while growing profits fast enough to keep shareholders smiling as well.
In June, the governments of Andhra Pradesh and Kerala asked MFIs to comply with local rules that regulate the money lending activity. A handful of MFIs are contesting this in court. And last week, Andhra Pradesh passed an ordinance to regulate MFIs, one which stops short of capping interest rates.
These southern states are worried about two things: the interest rates charged by the institutions and the possibility that borrowers could be coerced by goons hired by MFIs to make repayments. Andhra Pradesh has good reasons to worry about micro lending. Numbers from the Reserve Bank of India (RBI) show that over 53% of loans there are sourced from moneylenders. Tamil Nadu follows, with moneylenders accounting for 40% of all borrowings. Moneylenders account for more than 30% of all lending in four more states: Bihar, Manipur, Punjab and Rajasthan.
MFIs borrow from banks at around 12% and lend at anything between 25% and 30%. This can be hugely profitable. The return on assets, a ratio used to measure profitability of financial institutions, is 6.8 for SKS Microfinance; it’s 1.7 for HDFC Bank and 1.1 for SBI. Over the years, profits have grown at a fast clip: in the last two years, earnings per share at SKS shot up by 346% and 59% respectively; they expected to rise to 79% by March 2011.
These profits are a powerful magnet for many players to enter the microfinance industry. Apart from India’s largest banks, SBI and ICICI Bank, which were early birds, smaller banks like OBC have entered; and a great many non-bank finance companies are also in the fray. By last fiscal, there were more than 300 MFIs in operation. Lots of companies competing to lend to poor people can have a huge positive impact, broadening the spread of micro lending across India and keeping rates in check through competition.
The reality is different. Much of this lending is concentrated in a few states or regions. For example, the largest MFI, SKS, concentrates on five states where it lends over 70% of its funds. Andhra Pradesh alone comprises 29% of its portfolio. West Bengal comes second, with 14% of SKS’s total lending.
There’s a reason for this kind of concentration. All MFIs would like to lend to borrowers who’re good investors and prompt in repayments, but the only way to find these people is through trial and error. Once they find good borrowers, MFIs tend to stick with them. In that scenario, an increase in the number of MFIs can turn into a problem, with most players trying to poach each other’s better borrowers and trying to muscle in on the same territory.
But isn’t this competition good for borrowers? Initially it could be, as the same SHG or small businessman gets bombarded by loan offers. But this could, and sometimes has, lead to people going on a borrowing spree, overloading on loans and then finding themselves unable to pay. Liquidity makes markets; too much liquidity makes bubbles.
In some states, local politicians and powerful people are beginning to worry about the effect MFIs could have on the existing lines of credit and patronage. This is not a bad thing, but there’s a risk. If a few MFIs emerge as alternatives to moneylenders and local dadas, there will be a backlash with unpredictable outcomes.
The disquiet over MFI lending is spreading from the states to New Delhi. The finance ministry is busy looking at the numbers and could soon start drafting legislation to create a watchdog for the sector. It’s also suggested that lending rates ought to be capped at 24%. The RBI recommends that MFIs should be taken out of the list of borrowers who’re classified as ‘priority sectors’ for banks by 2012. If that happens, banks will have lower incentives to lend to MFIs. That’ll make the liquidity pool shallower.
As the industry explodes, microfinance players must get their act together in their own best interests. The nearly 350-player sector must find a way to keep checks on each other’s lending and recovery practices. Many believe that this is impossible in a sector that’s high growth, fiercely competitive and operating in markets where the rules of play are different from formal credit markets. Well, if cooperation and selfregulation fail, then MFIs must face up to the alternative. The government will yank some of its regulatory levers.
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