Over the last ten years, microfinance institutions in India have been transforming the business of lending to the poor, with the leading players among them attracting banks and private equity. Some entities that began as non-governmental organisations or NGOs turned into giant microfinance institutions, or MFIs. At least one, SKS Microfinance, was adding 100,000 clients a week, and the sector was growing at 50-70 per cent a year in terms of loans outstanding. Doing good had become a hugely profitable business.
Suddenly, in October, the government in Andhra Pradesh, the crucible of the MFI business, said: Let there be an Ordinance. It was reacting to media reports attributing the suicides of over 50 people to the allegedly coercive collection practices of some MFIs. It was as if the industry had run into a brick wall, a collision with the government and local politicians.
Operations were almost paralysed. There had been some indications earlier in October that all was not well in the industry when the SKS Microfinance board, soon after the company's successful share float in August, sacked Suresh Gurumani, a banker it had appointed as managing director and CEO. But the AP ordinance was the shocker. SKS shares had lost 55 per cent from their peak by mid-November.
Mar 2006: Andhra Pradesh cracks down on MFIs in Krishna district. MFIs begin slashing interest rates, from peaks of 40 per cent then to around 28 per cent now.
Feb 2009: Reports of defaults from Kolar district of Karnataka prompt some MFIs to form a self-regulatory body.
Oct 4, 2010: SKS Microfinance board ousts Suresh Gurumani, a professional banker, from the post of managing director and CEO.
Oct 15: Andhra Pradesh issues an ordinance to "regulate" MFIs.
The ordinance made it mandatory for all private MFIs to register with the government at the district level, specify their area of operations and rate of interest, among other things. They also had to shift from weekly to monthly collection of repayments, and do this at the panchayat offices.
All eyes are now on the state. "With Rs 9,000 crore in total outstandings, Andhra Pradesh accounts for over a third of the sector's total outstandings of Rs 30,000 crore or so," says Vijay Mahajan, an industry veteran and founder of BASIX, a leading MFI. The state accounts for a quarter of the total MFI clients in India, and the major players are from this region. Andhra Pradesh also became prominent because of the big investments made by the state in subsidising financial inclusion through government-led self-help groups, or SHGs.
In the SHG model, a bank lends to a group that in turn lends to its 15-odd members. The private MFIs follow the joint liability group, or JLG, model, adapted from Bangladesh's Grameen Bank, the pioneer in the business worldwide. Money is lent directly to the individual based on a group guarantee. MFIs had been racing ahead of the government by offering micro-credit or financial services at the doorstep of clients.
For now, the biggest worry for the MFI players in the state is the disruption of normal activities and the need to get a fix on the non-performing assets, or NPAs, once operations resume in full swing.
But veterans of the sector say the latest turmoil could be a good thing overdue. Some like G. Padmaja Reddy, Founder and Managing Director of MFI Spandana, believe that such events help shake an industry out its comfort zone. Spandana is attached to a non-banking finance company, or NBFC.
"Perhaps the events now will streamline all those involved in the sector," says Reddy. She says even the interest rate cut announced by some of the top NBFC MFIs is good as it will make the players look for more operational efficiencies.
A correction will also address a big worry in the sector, which is that the MFIs were also losing their traditional edge over banks by focusing only on growth. MFIs had attracted the poor because they were better at handholding and offering advice, but that edge has been blunted of late. Nancy M. Barry, former president of Women's World Banking, a global network of institutions led by women working in microfinance, says MFIs focusing on commercial growth had distanced themselves from their clients and so become vulnerable to political interference.
Barry does not think that MFIs are behind any farmer suicides or that they charge usurious rates, but concedes that they may have become too aggressive at collection time. She notes that the poor have not come out openly to back their MFI lenders. "The low-income clients of the MFIs in Andhra are not taking to the streets. They are not saying 'do not mess with our bank'. They are not saying 'these MFIs have transformed our lives'," says Barry. This is a telling comment on a sector in which almost all players proclaim how they make a difference to the lives of the poor.
Sanjay Sinha, MD, Micro-Credit Ratings International
Sanjay Sinha, Managing Director of Micro-Credit Ratings International also welcomes the jolt. "While there have been a lot of wild allegations, a jolt like this may actually be helpful in making the players realise that they need to do something about the problem areas," says Sinha. The issues, he says, are not so much about collection practices as about the speed at which the sector has been growing. Control systems are becoming weak and there is a lot of overlap. Sinha says the players also need to focus on product design, which ought to be led by demand rather than be driven by supply.
Barry points out that MFIs have been slow to incorporate insurance products beyond the cover for the loan in the event of the borrower's death. "MFIs in India are not the engines of innovation in building the multi-product offerings and innovative distribution systems needed by low-income customers," says Barry, who has founded Enterprise Solutions to Poverty to engage the industry in building inclusive growth strategies.
One way of improving the quality and competition is to broad-base the bank support to the sector. M. Ernest Paul, CEO of NGO MFI Saadhana Microfin Society, says this can be done by sensitising at least the public sector banks and getting them to begin supporting the most deserving NGO MFIs. As Barry says: "Banks are increasingly seeing the potential in inclusive finance and building products beyond micro-loans." This may trigger a change for the better.
For now, the next milestone ahead is the report of the subcommittee headed by Y.H. Malegam. This was set up by the Reserve Bank of India to study the areas of concern in the microfinance sector. The report is due in January 2011.
"We will have to wait for the Malegam report," says Vijayalakshmi Das, Managing Director of Ananya Finance For Inclusive Growth, promoted by the Friends of Women's World Banking, or FWWB. Das is also a board member and former CEO of the FWWB, which backed most of today's big MFIs in their startup days. "Perhaps it will bring out some stipulations on governance, the KYC [know your customer] norms may become more strict, and there could be guidance to banks," says Das.
Until then, MFIs would do best to take stock, and coast along.