Subir Roy: Lessons for micro-finance from 2010

The year 2010 was a tumultuous one for micro-finance institutions (MFIs) in India. It began with the highly successful SKS Microfinance public issue, which prompted other prominent MFIs to announce similar plans. It ended with the tumult in Andhra Pradesh which was marked by the state’s legislation to regulate the sector, severely impairing its ability to survive. MFI recoveries are down and they, in turn, have fallen behind in their repayment to banks. What are the lessons?

  First, all the trouble is in Andhra Pradesh. MFIs are working smoothly in other states. Those with a broader reach and more dispersed operations across states are less affected. The basic flaw with the MFI phenomenon is its excessive concentration in one state (Andhra) and more broadly in the south. If large for-profit MFIs were to go by the fundamental principles of management, they would have started to de-risk their business long ago by spreading it more widely. So everything apart, their managements have performed poorly on this score.

Second, it is all about large for-profit MFIs. They are the ones who matter, accounting for a lion’s share of MFI operations. There are innumerable self-help groups all over the country, many of them linked to banks, which are outside the pale of the controversy. Micro-finance began with such groups and will continue with them, as long as we have the poor with us. The issue is whether for-profit MFIs, a late entrant that revolutionised micro-finance and held out the promise of rapid expansion by streamlining procedures through modern financial institution practices, will survive.

With hindsight, two realities are clear. Market mechanisms, induction of risk capital and servicing of such capital can go counter to the basic goal of attacking poverty as the marketplace has its own frailties. Besides, it should be clear to all that micro-finance on its own cannot remove poverty. It can at best make a dent in income poverty. A setback, be it a flood or drought or illness, can and does take a family back to destitution. For a for-profit sector to anchor its whole business model on a 98 per cent plus rate of recovery is to provoke serious scepticism. If to this you add group guarantee and peer pressure on a defaulter, you know why suicides can happen. MFIs rightly say that not a single suicide has been investigated and linked to coercive recovery, but in the public mind the case against them rests on grounds of plausibility.

All this does not mean that the for-profit model should be abolished. It alone has brought a sea change in efficiency which has given micro-finance both scale and viability. So, it is good to be driven by the profit motive but only up to a point. Investors in micro-finance should be happy with a lower than the market-determined rate of return.

Third, there is urgent need for effective regulation. Two entities have failed to deliver this. One is the Micro-finance Institutions Network, representing the for-profit MFIs, which has been in existence for nearly a year but is yet to bring out norms by which all can know what is the effective rate of interest charged by an MFI. This inability to promote transparency must damage the reputation of the whole tribe.

The apex institution which has failed to enforce effective regulation is the Reserve Bank of India (RBI) which is mandated to regulate for-profit MFIs that are registered as non-banking financial intermediaries and come under its supervision. These are the big boys who matter and the poor are suffering because of the absence of effective regulation. The wrong things that happened in Andhra did so under the RBI’s watch. Worse is the role of the banks. They were happy to lend to MFIs, buy loan portfolios from them to meet their priority sector lending targets and when the trouble began, wanted to stop lending. Neither is the role of NABARD becoming. It wants to be both a regulator and promoter of micro-finance.

Fourth, the issue of excessively high rates of interest charged by for-profit MFIs is a red herring. A short-term income-generating loan, say to a vegetable seller, can be nominally high but not so to her because of the resulting income. What is important is return on assets. By this measure, MFIs outperform banks. So they, in the aggregate, are making good money but again it is really the large MFIs which are doing so. It is RBI that has to monitor them individually and there aren’t that many of them to track. The top ten account for a large share of the market.

Fifth, the regulation that we now have in Andhra is badly put together and flawed. It asks for a degree of grass roots-level registration of micro-finance operations that is impractical and hugely cumbersome. The Andhra reaction came about for two reasons. The state functionaries got hopping mad as the field agents of for-profit MFIs began poaching on the client base of the state-sponsored micro-finance initiative which pre-dates the advent of the former. The troubled politics of the state after the death of Rajasekhara Reddy led to micro-finance-related suicides being widely publicised, forcing the government to be seen to act.

So, large for-profit MFIs and their regulators will put controversy behind them provided they make the following new year resolutions: stop picking on low-hanging fruits in Andhra, come clean on the effective rate of interest, stop taking group guarantees and ensure hands on regulation that keeps an eye on MFI earnings so that the poor get a share of them via declining interest rates.

Courtesy: Business Standard

Castrate the for-profit MFIs to Recast the Sector!

The die has been cast with the introduction of the Andhra Pradesh Micro-Finance Regulatory Bill in the State Assembly yesterday. The Bill to replace the ordinance passed by the government in October 15th is scheduled to be discussed this coming Tuesday and passed as an Act by Wednesday, tightening the noose around MFIs.  Before its introduction, the Micro Finance Institutions Network (MFIN), demanded radical amendments to the Bill. [MFIN is an association of 50 for-profit micro lenders among its members, which account for more than 85% of the microfinance market in India.] According to the Indian Express:

“MFIN president, Vijay Mahajan said:  If those modifications are not made, there would be major repercussions not only for access to finance but also for the banking system.”

The bill, copies of which were circulated Friday, proposed no amendments to the ordinance, as demanded by microfinance institutions (MFIs) who say if their concerns if not addressed, may force them to shut operations in the state. Mahajan told MoneyControl.com: “If beyond a point the model is rendered unviable due to an act of law or something beyond the court of law, then basically one would have to reconsider the whole thing."

The Economic Times further quoted Mahajan to give an insight to this crisis as the industry like the public to see it: “According to Vijay Mahajan, president, MFIN, their business activity came to a grinding halt and collection rate dropped to 20% from 95% after the state government passed the ordinance. `This can have far reaching implications on the entire credit system as MFIs borrow money from banks to lend it to their customers, said Mahajan. He pointed out that during the last 45 days 12 lakh loans worth Rs 1,200 crore could not be disbursed due to the hostile conditions. We are unable to collect Rs 7,400 crore from our borrowers. If it continues it will affect the entire Rs 24,000 crore given to MFIs by banks. Besides, it is also demoralizing our 2 lakh staff, he said.”

It is apparent that the stock of MFI credibility and influence, both within the country and internationally, seems to have fallen to such low ebb that their demands for change in the bill have literally fallen on deaf ears. India’s Reserve Bank further indirectly accused Mahajan of resorting to gross exaggeration when RBI Deputy Governor Subir Gokarn said the sector was only under some amount of stress, but there was no threat to their survival.

That the industry is living in a state of denial is illustrated by Mahajan in another interview to CNBC-TV18 suggesting that the MF industry was depending on the outcome of their writ petition in the High Court to bail them out. He further conceded that rather than the ordinance it was politicians who encouraged people to default on overdues which proved the main obstacle for normalcy of operations:

“Our writ petition at the high court which was against the ordinance remains absolutely alive, and that's equally valid for the bill if it gets passed into an act because it is the same language. So that’s the first recourse. Right now what is stopping us is not the ordinance. It is the statements of various political leaders such as Mr Chandrababu Naidu saying that loan of MFIs should not be repaid. We think this is highly irresponsible because it foments credit indiscipline.”

If the MFIs are looking at the High Court for ultimate relief, then it is analogous to a drowning man clutching at straws. In India, litigation may stretch several years and time is exactly not what this heavily leveraged industry has on its side. Further, even if the judiciary upholds the industry’s contention, all it needs for the government to give a policy shock is to give a directive to public sector banks to avoid credit to MFIs by treating the whole sector as one asset class. Besides, a judicial win for MFIs does not wish away the grim reality that politicians of different shades would not be willing to play ball, in letting normalcy to prevail.

As for repercussions on the banking sector in the event of the MF sector collapsing, this is totally blown out of proportion by the MF industry, used as a scare tactic in the hope of getting leniency from the system. Banks have a collective exposure of about Rs 24,000 crore to MFIs.  In Andhra Pradesh the total outstanding loans amount of MFIs is Rs 8,000 crore, of which, Rs 5,000 crore is funded by banks. Yet for public sector banks, their total MFI exposure as a percentage of their total lending in the country is just a small fraction of 1%. Accordingly, repercussions if any in the event of a MF sector collapse would be no more than a ripple in an ocean. 

The powerful All-India Bank Employees' Association (AIBEA) could be another obstacle in the way of MFIs. "RBI should not accept it ... Banks should not give loans to MFIs under priority sector category," said AIBEA general secretary, C.H. Venkatachalam. "PSBs should (instead) go for large-scale micro lending through more number of rural branches."

Besides, the issue of financial inclusion is reflected in a national goal to provide banking services to 100 per cent of citizens living in villages with a population of more than 2,000 by March, 2012. The progress on this goal may not be much to talk about at present. But, in the next two years, we should see the UPA government giving more impetus to realization of this national goal which in turn reduces MFIs strategic importance in promotion of financial inclusion.

So all things considered, portends are that the MFI industry may have no options but be forced to enact their threat to close shop in Andhra Pradesh.  In 2006, during the Krishna crisis wherein MFIs faced a similar situation, they wriggled out of confrontation with the government by promising to adopt a Code of Conduct, which we now know that they had practically no intention of adhering to. This time round too, they are promising to turn a new leaf by the series of steps they claim to have undertaken including interest rate reduction; uploading credit data of borrowers in two RBI licensed credit bureaus; conciliatory meetings with government, commissioned a study on suicide and sensitivity trainings of their staff against coercive collection practices.

The MFI industry for some time now has been blaming rogue members within its own fraternity as being responsible for the present crisis. In his latest statement, Mahajan has once again resurrected this bogey but he is not telling just who these rogues are.

So why cast a shroud over the identity of these rogue MFIs we can ask?

In our archive post, we found that it is most likely that the Akulas (SKS) and Mahajans (BASIX) are resorting to this tactic in order to deflect blame from their own organizations to those smaller in size within the industry. We then asked, what kind of MFIs attracts higher plausibility to go rogue? Logically it points to MFIs with mind boggling, mushrooming growth and profitability. So just who are they likely to be? We found it was most likely the six biggest MFIs in the country who control 94% of the market share that meet these criteria.  Among these six are SKS of Vikram Akula and Basix of Mahajan. Rogue MFIs accordingly could then well be a euphemism for these six MF biggies in the country.

The blog Candid Unheard Voice of Indian Microfinance gives additional data of such burgeoning growth facilitated by large scale equity infusion:

"- 6 MFIs added US $ 2.18 billion during 24 months (April 2007 to March 2009).

- Equivalent to Per Month Addition of Portfolio of US $ 90.81 Million (or Rs 4177 Million for all 6 MFIs.

- Equivalent to each MFI adding a portfolio of US 15.135 Million (or Rs 696.25 Million) every month, this is certainly a lot of money.

Contrast this with their growth during the period April 2005 to March 2007 when they added just over US $ 1/2 a billion (0.504 billion US $ to be exact) and this is about 18.79% of the total portfolio added during the period April 2005 – March 2009.

- Adding 1/2 billion US $ over 24 months is equivalent to these MFIs adding portfolio worth US $ 21 million (or Rs 966.15 Million) every month for 24 months. That is about 1/4th of the monthly portfolio addition done by the same MFIs during April 2007 – 2009”

The table and figure are rather self-explanatory…Equity investments from April 2007 onwards until July 2010 (A whopping US $ 646.97 Million) are almost 20 times the size of equity investments prior to April 2007 (which are a miniscule US $ 32.51 Million). In many ways, April 2007 appears to be a watershed…with regard to equity investments.

In fact, the burgeoning equity investment in Indian micro-finance has prompted experts like Mr N Srinivasan (Author of The State of The Sector Report) to suggest that perhaps ‘micro-finance was the preferred sub-sector of choice in the financial sector for investment bankers.

During the period April 2007 – March 2009, the top 14 Indian MFIs (with 6 AP Headquartered MFIs) added almost 75% of their total portfolio of 2009. In numerical terms, this is approximately US $ 2.799 Billion, which is huge by any standards.

During the same period, the Big 6 AP Headquartered MFIs also increased their gross loan portfolio by almost US $ 2.077 Billion during this period {in other words AP headquartered MFIs accounted for almost 74.19% of the total portfolio (US $ 2.799 Billion) increase during April 2007 – March 2009}.

The period, April 2009 – March 2010, which succeeds the fastest growth period (of April 2007 – March 2009) as of now shows the highest equity investment in Indian micro-finance (US $ 390.72 Million)?”

Significantly the explosion in equity infusion came during a period where globally the financial sector was experiencing the sub-prime crisis, with many banks and companies going bust or needed to be bailed out by their governments to prevent insolvency.  Presumably, many Private Equity (PE) and Venture Capitalist (VC) investors had either burnt their fingers in this crisis, sitting with huge losses and/or found avenues within the financial sector for investing highly contracted. The unregulated MF industry in India thus became their natural destination where they looked to recoup their losses or as an alternate investment avenue within the financial sector. For MFIs this increased PE/VC interest came as manna from heaven as after the Krishna crisis (2006), commercial banks in the country were slightly reluctant to lend to them.

If it takes two to tango, the offspring was the AP crisis! Once PE and VC investors burst into the scene, the MFI promoters found themselves no more in complete control of their companies. The Akulas and Mahajans became more and more the front of their companies. It was these investor stakeholders with no social equity commitment that literally slave drove these MFIs to achieve stupendous growth targets through charging usurious interest rates, multiple lending to already overburdened customers instead of seeking new ones and coercive recovery practices.

The fact is that while the normal portfolio investments of PEs and VCs gave them hardly 20% return, it was the micro-finance sector in India that gave them mind boggling returns between 50-500%. So no wonder  the sector became the "preferred sub-sector of choice in the financial sector for investment bankers” as accurately observed by N Srinivasan (Author of The State of The Sector Report). This situation perhaps prompted Xavier Reille of CGAP in his paper Are MFIs in India overvalued?, to comment:

“Overvaluation might be driven by excess capital flows.  A significant share of equity investment in India comes from investors whose objective is to realize profits by floating or otherwise exiting their investments in a relatively short time frame. In many cases in the past this type of capital has produced overvaluation of equity prices in the short term and disappointment in the long term. After all, India is the only microfinance market that has attracted large private equity funds.”

So when the Akulas (SKS) and Mahajans (BASIX) blame rogue MFIs for the AP crisis, to use the old adage, they are probably the wolves in sheep clothing. It is these six for-profit MFI biggies that look most plausible to be the rogues than the rest of the industry. Put another way, it is most likely for the misdeeds of these six biggies that the entire MF industry now faces a sectoral backlash that threatens their very existence.

In terms of lobbying, MF sector apparently found only support from Montek Singh Ahluwalia, Deputy Chairman of Planning Commission. According to a WSJ-Livemint report, Montek wrote to the Prime Minister Manmohan Singh and sought intervention of the Reserve Bank of India (RBI) to save the microfinance sector in Andhra Pradesh from falling apart. Commenting on the microfinance ordinance Ahluwalia said, “If implemented as it stands, it will lead to the collapse of the MFI sector”.

But Montek’s clout within the government and the ruling Congress Party is extremely low and latter is more likely to listen to the likes of YV Reddy, ex-RBI Governor. Y V Reddy likened MFIs to moneylenders, stating that most MFIs are either registered or unregistered NBFCs, he said they are following a flawed business model by lending to consumption-related spends. YV Reddy called for the total recast of the industry.

Meanwhile, in his latest book Fault Lines: How Hidden Fractures Still Threaten the World Economy, Raghuram Rajan, former chief economist of the International Monetary Fund and an economic adviser to India’s Prime Minister, said, “Although microcredit has a promise on a small scale, history suggests that when scaled up, and especially when used as an instrument of government policy, it will likely create significant problems.” So Raghuram Rajan, another influential economic adviser to the government takes a more neutral stance.

The fact that the ruling Congress high command permitted their state unit to introduce the Andhra Pradesh Micro-Finance Bill is an indication which way the wind is blowing. It does suggest that the Central Government is in the mood of “recasting” the micro-finance industry, suggesting the YV Reddy line has prevailed.  The RBI had in fact finalised in a July-August report, which recommended withdrawal of priority sector status to microfinance institutions (MFIs) for public sector bank loans. But before the regulator could act on the report, the sector was mired in crisis. Meanwhile RBI appears also concerned about PE funds investing in Microfinance Companies.

“RBI officials told CNBC-TV18 in an interview that they are yet to take a view on how to treat private equity investments in Microfinance Institutions. For decades microfinance in India was always seen as a not for profit function with a social purpose  but this has changed drastically in the last few years with many foreign based private equity funds pouring money into this sector. The central bank has said it views microfinance as a key part of its drive for financial inclusion, and clarified that while it was not contemplating a cap on interest rates charged by microfinance institutions (MFIs), there was a need to regulate the rates.”

Recast is simply a euphemism for the restructure of the industry. Winds of change that are blowing suggest that future policy environment would castrate the growth of the for-profit MFIs, particular the six biggies by depriving them of priority lending status; clamp down on PE investments in the sector and control of interest rates indirectly by  leveraging the power of discretion in sanctioning credit to the sector. At the same time, government policy would focus to reduce MFI strategic significance in promotion of financial inclusion by expanding bank coverage, giving a fillip to SHG-Bank linkages by NGO or government initiatives and encouraging public sector banks to directly enter micro-finance activities.