Microfinance, India's sub-prime crisis, Vivek Kulkarni

Imagine that your maid borrowed Rs 30,000 from you, promising to repay within a year from her monthly wage of Rs 4,000. Do you think you could cut Rs 2,500 from her monthly wages, every month? 

First of all, do you expect her to repay anything? Would you charge any interest on your lending?

Most likely, you might write off the entire amount, considering her child's education and husband's health problems.

Microfinance Institutions (MFI) are in a similar situation. According to the Government of Andhra Pradesh, more than Rs 25,000 crore has been lent to over 80 lakh poor families. On an average each family owes Rs 30,000. Most MFIs charge 27 per cent interest on loans. Some MFIs seem to use strong-arm tactics in loan recovery, with a few reported suicides. The Andhra Pradesh Government reacted with an ordinance to regulate MFIs. Most likely, the MFIs might be forced to write off a big chunk.

HOW IT UNRAVELLED

First, MFIs were in a hurry to grow fast. SKS Microfinance, a listed company, has grown 90 per cent annually for the last four years (see Table), from just two lakh members to 40 lakh members in less than three years.

The loan disbursements have gone up from just Rs 150 crore to over Rs 4,400 crore in three years. Growth prompted investment grades from rating agencies. Whenever loans are disbursed in haste, one can anticipate problems later.

Second, the concept of self help group (SHG) was not followed. The concept involves forming groups of 15-20 women, who meet regularly, understand each other's problems and bond for a while. They are expected to save a small amount, keep the money in bank and earn interest.

A member could borrow when she falls ill and can't go for work. She would return the money with 18-24 per cent interest to the group. The recovery is almost certain, due to peer pressure and bonding with the group.

Such group formation and bonding takes a minimum of six to nine months. The MFI did not have so much time and wanted to grow rapidly in tune with their private equity investors. They went in for the Joint Liability Group (JLG) method. Their agents would persuade five women to form a group and each guaranteed the others' loans. Most members of JLG could not develop the special bonding they would have in SHG.

Third, the MFI apparently charged lower interests of 12-18 per cent in JLG, compared with that of 18-24 per cent charged by SHGs primarily run by the PSU banks. MFI interest rates were non-transparent and effective rates often were over 27 per cent, considering loan processing fees, penalties and hidden charges.

THE SUBPRIME BUBBLE

How did the borrowers repay? Many adopted what is now known as ‘ever greening' tactics. They would borrow on Mondays from one MFI and repay to the other MFI on Wednesdays. Since all of them were growing with plenty of funds from the private sector banks, the party went on.

Of late the PSU banks too joined the party. For instance a major PSU bank that had Rs 1,000 crore exposure to SHG based loans, lent another Rs 60 crore to MFIs.

Should we credit the Government of Andhra Pradesh for bursting the MFI bubble? Has the lending reached many subprime borrowers? Prima-facie the evidence seems in favour of the government.

Each poor family seems to have borrowed over Rs 30,000 per year. While every MFI claims that it has lent just Rs 10,000 per family, multiple lending suggests a higher figure.

Most MFIs claim they have lent for income-generating activities. In reality, most lending has been for consumption purposes – buying a TV, repairing a house, paying for school-college fees or for serious illness of a family member.

Thus, indiscriminate lending and irresponsible borrowing was encouraged, leading to the sub-prime bubble.

THE WAY OUT

First, the sector has to be regulated by the state governments. They can, however, go overboard and stifle the sector. Politicians would be too happy to ask people not to repay their loans to banks. The Andhra ordinance expects MFIs to obtain approval to make tiny loans, which is impractical. Hence, regulation has to be tempered by a sensible institution like RBI.

Second, the regulation should encourage bonding their members, with savings, self-help, education, and not just credit. Money has to be lent only when the economic viability of projects is well established. The capacity of a village or a cluster to support income-generating activities has to be worked out to cap MFI lending geographically.

Third, the MFIs who give credit to crores of women groups don't employ women to the same extent. Most show just 3-4 per cent women employees. This percentage must go up drastically. A holistic scheme to help the poor has to include – health insurance, self-help, education, employment and finally credit. Many MFIs overturned this philosophy by concentrating just on credit.

(The author, a former IT Secretary, Government of Karnataka, is founder of Brickwork Group.) 

Courtesy: The Hindu

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