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Perhaps some regulation…..kartik Desai
Andhra Style populism is wrong way to address concerns about microfinance
Why is microfinance in India facing so much flak? For most honest observers of microfinance, this situation has been in the making for some time as the “social-commercial balance” of the sector has been under stress from the unparalleled commercial success enjoyed by the for-profit NBFC microfinance model, which generates return on assets (ROAs) in excess of 4 per cent and has thus attracted mainstream private equity and now, with the successful IPO of SKS, the public’s money as well. While MFIs have scaled up their operations and achieved this commercial success, many of them have indeed drifted away from their social mission — which can be seen in the uneven geographic spread of microfinance across India, with many MFIs choosing to focus on the southern states like Andhra Pradesh (the epicentre of the current problems) rather than venture into underpenetrated markets, and the lack of product diversification, with most MFIs currently offering only a limited basket of highly profitable simple loan products.
But it’s incorrect to suggest that Indian microfinance does not serve the critical social goal of financial inclusion. Indeed, in just a few years Indian MFIs have brought over 30 million low-income women and their families into the formal financial system and out of the clutches of unregulated moneylenders and unscrupulous relatives, and that’s no small achievement. Also, in a global context microfinance in India is one of the most socially conscious and professional, because of the low average ticket size of loans (Rs 10 to 15 thousand), the relatively lower interest rates charged (as high as 50-80 per cent in other markets) and the professional background and social motivation of many MFI promoters active in the sector for the last decade.
But financial inclusion is not the same as poverty alleviation, which involves a more holistic intervention beyond providing credit (for example, livelihood support or vocational training). And it’s this fundamental mismatch of expectations — often driven by MFIs themselves who claim to be reducing poverty rather than just addressing the inclusion issue — that causes a backlash when people see MFIs and their backers make a lot of money while the clients continue to remain poor or suffer at the hands of MFI’s supposedly high interest rates and aggressive collection practices.
It is important to understand that even among for-profit NBFC MFIs, which are governed by the RBI and distinct from NGO MFIs or the self-help group system, there are two models of microfinance — high ROA and medium ROA. High ROA MFIs that are focused on the efficient delivery of a limited suite of credit products will have lower operating expense ratios and, despite pricing their loans at relatively lower yields of 25-30 per cent, still be able to generate ROAs in excess of 4 per cent.
However MFIs that are more focused on expanding to virgin markets, developing new products needed by customers and improving the level of service — all of which happen at some initial hit to profitability — will tend to have lower ROAs and need to charge interest rates in the range of 30-35 per cent to cover their costs. Thus an interest rate cap as was recently proposed by the finance ministry would have the perverse effect of causing most damage to those MFIs that are doing a better job of achieving social-commercial balance and benefit those MFIs that are following the business-first approach to microfinance. The interest cap becomes even more untenable when one considers the proposal to remove priority-sector lending status to MFIs, which would drive up their borrowing costs and further reduce their profitability and the scope for interest rate reductions.
There is plenty the government can and should do to regulate the microfinance sector instead of trying to cap interest rates; for example, by issuing a set of simple requirements for governance, transparency, HR and customer protection and putting in place a microfinance regulator with enough teeth to ensure compliance and punish the guilty. It can enforce much more stringent and regular reporting requirements, on something as basic as the effective interest rate charged to clients, which many MFIs are still reluctant to disclose, as well as on HR issues like disclosing management and employee compensation. Most importantly, it can codify customer protection principles — which already exist and are followed on a voluntary basis — and enforce their implementation through the new regulatory body, which ideally should cover not just for-profit MFIs but all entities engaged in microfinance operations, for it is often the unregulated operators and not the MFIs that give the sector a bad name.
Ultimately MFIs themselves need to recognise that they are doing a social business, and thus profit optimisation rather than maximisation ought to be their objective. Even with a 30-40 per cent annual growth in the sector, less than half the scorching growth experienced so far, MFIs can sustainably operate at 3 per cent ROA levels and still generate healthy 25 per cent IRRs for their investors at book multiples of 2-3x. But this requires a tempering of commercial expectations beyond these levels. As they gain scale and profitability, several large MFIs have already embarked on a path of gradual rate reductions. And all the large for-profit MFIs have come together under a newly formed industry association in an attempt to self-regulate, share data on customers to prevent over-lending, and present a unified face to the outside world. It is thus wrong and unfair to paint all MFIs as purely self-serving.
Now it’s up to the government to also show some maturity and address sceptics’ genuine concerns not through populist measures like interest rate controls or withdrawing subsidised funding but by actually defining what it means to be an NBFC MFI and then regulating these companies strictly to ensure good governance, transparency, HR practices and customer protection.
The writer is vice president at Lok Capital,a social venture capital fund investing in Indian MFIs. Views expressed are personal.
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