If you want to do a quick health check on India’s Microfinance sector, look no further than the stock price of SKS Microfinance. The Hyderabad-headquartered firm became the only publicly-listed micro-lender (who provides loans to poor people who either do not have access to/aren’t eligible for loan from a bank) in India when it listed its shares on BSE (and NSE) in a dream debut on August 16, last year, logging a listing gain of a hefty 18% and soon went on to touch its all-time high of Rs. 1490.70 (as against the IPO price of Rs.985). The stock closed at Rs. 638 on January 6, down nearly 35% amidst growing concerns about the popular (read also: political) backlash, possible regulatory tightening (already recent AP government’s Ordinance has nailed the sector down) and shakeout, which looks more or less inevitable.
However, only until a few months back it was not so. The sector was once touted as one among the sunrise industries in India by analysts and industry experts alike. Lured by the promise of quick and hefty returns, investors (mostly private equity firms) came in hordes from India as well as overseas; many of the investors in MFIs include several high-profile US-based PEs. In the run up to and soon after the spectacular launch of SKS’s IPO, stories of how CEOs and top brass of these MFIs earned 7-digit salaries and bonuses flooded the market, vindicating investors’ faith in India’s microfinance success story.
A recent spate of unfortunate incidents of farmers’ suicides linked to their microfinance debts (aggravated by MFIs’ exorbitant interest rates and brutal recovery methods of their recovery agents) in Andhra Pradesh, in particular, and crackdown by the government, in response, has, however, put a big question mark over the very existence of the microfinance industry in India.
What led to the crisis?
Ingredients are common such as lack of (or lax) regulatory oversight, which in turn increased greed, opaque often unethical business practices, high commissions etc., which are generally found in every crisis. So, it is no different this time as well. More specifically, though, the answer to the above question has been best described By Dr. Y V Reddy, the former Governor of Reserve Bank of India who is credited with successfully shielding Indian economy from the global financial crisis in 2008. “They (MFIs) are no better than money lenders,” said the ex-Guv of the country’s apex bank in an interview. “If you look at it, the resource is leveraged. It is not just money-lending business. The moneylender normally lends out his own money, whereas here the MFI is actually borrowing money from depositors and lending the money. So fundamentally, he is a moneylender, but a leveraged moneylender,” he added further. Emphasizing on the need for regulating the sector, Dr. Reddy said, “Micro finance is a respectable area, and the impressive profitability of our profit-seeking MFIs has attracted investments from private equity funds globally. There may therefore be merit in a detailed analysis in a sort of supervisory review, to check any incipient tendency towards irresponsible usurious lending by such profit-seeking MFIs.”
Andhra Pradesh (AP), which accounts for about 30% of India's $6.7 billion in microfinance loans, is at the epicenter of the current crisis gripping the microfinance industry in India as the State’s average outstanding microfinance debt per household is Rs. 65,000 as compared to national average of Rs.7,700. Critics observe that the high growth and high profits of the industry has resulted in abuses and greed into micro-lending, which exceeds the number of borrower accounts served by the Regional Rural Banks by as much as 50% and represents 40% of the total number of micro-borrower accounts in the entire financial system in the country. Besides, other factors like the practice of giving multiple loans to a single borrower and the fact that in majority case these loans were given for consumption purpose and not for starting a new business or improving productivity too are blamed for the current crisis at India’s Rs. 25,000 crore MFI sector (see chart: Consumption-driven).
Consumption-driven: Usage of Loan Money by Type of Lender
Bank | MFI | SHG | Informal | |
Start new business | 2.0% | 2.5% | 1.9% | 1.1% |
Buy agricultural inputs | 57.5% | 13.2% | 19.3% | 19.9% |
Purchase stock | 3.0% | 9.9% | 4.2% | 2.7% |
Buy livestock | 2.7% | 6.0% | 5.6% | 1.7% |
Purchase land | 0.8% | 0.9% | 0.7% | 0.6% |
Home improvement | 9.7% | 22.1% | 13.0% | 14.2% |
Repay old debt | 14.6% | 25.4% | 20.4% | 7.0% |
Health | 11.4% | 10.9% | 18.6% | 25.3% |
Education | 4.1% | 4.4% | 5.7% | 5.3% |
Marriage | 4.3% | 4.8% | 2.2% | 12.2% |
Funeral | 0.1% | 0.2% | 0.5% | 1.7% |
Other festival | 0.6% | 3.5% | 3.6% | 4.8% |
Unemployment | 0.0% | 0.0% | 0.1% | 0.8% |
Purchase jewellery | 0.5% | 0.6% | 1.6% | 0.4% |
Other consumption | 26.5% | 31.6% | 49.9% | 24.9% |
Source: Centre for Micro Finance
The fallout
In the aftermath of SKS controversy, there was a conflux of woes for the sector when the AP government came up with legislation aimed at curbing MFIs’ operations. Besides, banks also pulled back on lending fearing wide-scale defaults from MFIs. Banks such as SBI, ICICI Bank and Axis Bank are estimated to have lent Rs 16,000 crore to micro-lenders. According to data from CARE, the credit rating agency, ICICI’s lending is at Rs 2,000 crore, SBI’s at more than Rs 1,000 crore and Sidbi’s at Rs 4,000 crore. Experts say that even if a single microloan defaults, it might have a trickle-down effect on the entire sector. According to N Srinivasan, who consults on the industry for the World Bank, around 70% the 260 MFIs are likely to collapse in coming months, as banks halt lending to them to curb risks. MFIs with stronger net worth have a possibility of survival for a period of time. Srinivasan is of the view that collapse of MFI would have a devastating effect on the poorest borrowers in remote regions. A slump in microfinance loans might trigger a chain reaction of defaults by borrowers with multiple debts. He compares the condition just like managing juggling balls, if we remove a ball, the right in the middle of it; suddenly there is no ball to throw. A lack of microfinance loans might force borrowers to turn again to moneylenders, who operate outside the formal credit-delivery system and charge usurious interest rates. In words of Dipak Gupta, Executive Director, Kotak Mahindra Bank, “Money has stopped and a borrower is used to getting that money and circulating it. If you don’t create an alternate system or don’t allow the system to rotate, he will go back to the moneylender.”
According to Dilip Mookherjee, Professor of Economics, Boston University, “Institutions need to be more diligent in their lending – but politicians also need to be wary. In taking aim at the occasional overstep, they may inadvertently destroy microfinance itself. That would be a disservice to the world’s poor, and their hopes of climbing out of poverty.” C Dr. Rangarajan, the former Governor of RBI and currently the Chairman of the Prime Minister’s economic Advisory Council, has asked microfinance institutions (MFIs) to overhaul their ‘flawed’ business model for sustainability. He has suggested that MFIs should lend more for productive purposes and not just for consumption-related expenses, adding that the bulk of the current MFI lending was for consumption.
However, Prof. H.S. Shylendra of Institute of Rural Management, Anand, Gujarat, believes that there is a need for a structural change. He does not feel the federal state government’s decree will make much of a difference, he was quoted as saying by Radio Netherlands Worldwide. "I believe it’s (ordinance) mainly intended to make the government look good. There are different kinds of MFIs, and there are so many rules and regulations that the federal state can impossibly enforce them all. We have already seen a large number of MFIs change their legal status to a Non-Banking Financial Company to evade state oversight." He reportedly added, "Each year, hundreds of farmers in Andhra Pradesh commit suicide. It’s a structural problem, which has several causes. Most farmers have borrowed from a number of sources before they commit suicide."
While opinions vary, there is no disagreement over one thing. That is, India’s microfinance sector needs a fix or, shall we say, quick fix.
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