No poverty of ideas

Microfinance institutions are finding new avenues to raise funds. But are they enough to allow the poor to borrow at lower rates?

On January 8, the halls of the College of Agriculture Banking in Pune bore witness to a rather unusual commune. Around 250 senior bankers, government officials, and the brass of the Reserve Bank of India (RBI) had gathered, along with representatives of leading microfinance institutions (MFIs) and self-help groups.

One of the questions raised during this meeting was the vexing one of how were the MFIs maintaining a repayment rate as high as 98 per cent and yet clocking a mind-boggling 90 per cent rate of growth in loan disbursals over the past four years. The private sector bankers present attributed the spike to aggressive lending at lower rates by their public sector brethren; the SHGs lamented that they were headed for extinction because of the dominance of the MFIs.

The New Sources...

PRIVATE EQUITY (PE): Rs 2,000 crore in the last 3 years

NON-CONVERTIBLE DEBENTURES (NCDs): Rs 400 crore since March2009

SECURITISATION: Rs 520 crore since 2009

... And the Old

Rs 11,400 crore term loans outstanding for the year ended March 2009

Whatever the answer, the message that was coming through loud and clear was that there's no stopping the MFIs. Having disbursed Rs 11,400 crore to 22 million people in the hinterland in the year ended March 2009, MFIs have not only become a lender's delight, they are becoming an asset class that institutional investors are finding difficult to ignore.

Even though bank loans to MFIs have more than trebled since 2007, and continue to be the largest funding source, the sector has been tapping alternative funding sources as well. Private equity (PE) funds— mainstream as well as those dedicated to MFIs— have pumped close to Rs 2,000 crore in MFI institutions over the past three years. Since 2008, MFIs have also been able to raise funds through non-convertible debentures (NCDs), commercial paper, and securitisation of their loan receivables.

Bank treasurers, mutual fund managers, insurers and high net-worth individuals have also developed an appetite for such debt offerings as these products are being rated by credit rating agencies such as CRISIL, Fitch and CARE Ratings.
PE Money is Chasing Microfinance…
Source: Venture Intelligence
... With a Number of PE Funds Making Sizeable Investments.
  • In December 2009, Grameen Koota got Rs 27.5 crore from MicroVentures Investments, MicroVentures SpA, Incofin and Aavishkaar Goodwell.
  • In the first round, in 2008, Grameen Koota received Rs 10 crore from Aavishkaar Goodwell.
  • In August 2009, Temasek invested $50 million in Spandana Spoorthy Financial Ltd.

Clearly, the demand for funds by MFIs will increasingly be met by new sets of investors. In the process, dependence on banking channels will reduce. So, will that mean their cost of funding and operations will come down? If that happens, borrowers— typically low-income and daily wage earners—will get a chance to borrow at lower rates. Currently, MFIs give loans at interest rates ranging between 25 and 30 per cent.

The increased appetite of MFIs has been triggered as much by the sector's hunger for growth as it has by regulation. When the global liquidity crisis heightened in 2008, the RBI increased the capital adequacy ratio—the ratio of capital to risk weighted assets—for non-banking finance companies (NBFCs) and MFIs from 10 to 12 per cent by March 2009. This will further increase to 15 per cent by March 2010. So, if MFIs have to grow (by lending), they need to maintain a higher cushion of capital against those loans. Hence, the rush to raise funds and diversify the sources of funding.

End-2008 was also a time when PE funds were looking to de-risk their portfolios after buying at peak valuations during the bull run. Microfinance was one opportunity to reduce risk. Mainstream PE funds like Sequoia Capital picked up stakes in top-tier MFIs, and a clutch of social sector-dedicated funds started looking at the second-rung players, too. For example, India Financial Inclusion Fund, the second MFI-focussed fund from the Hyderabad-based Caspian Advisors (their first fund was Bellwether Microfinance Fund) raised $90 million from foreign investors in 2008 and $30 million of that has been invested in five MFIs (and two low-cost housing financing companies).

"The idea was to add new dimension to our portfolio by increasing the geographical spread. That's why we invested in entities like Sahayata Microfinance in Rajasthan and Sonata Finance in Uttar Pradesh," says Mona Kacchwaha, Director (Investments), Caspian Advisors. Another relatively young MFI, the Chennai-based Equitas Microfinance, which started operations in 2007 and has a loan book of Rs 500 crore, has been able to attract PE investments in two tranches; a third round may take place soon. "If we were to meet a capital adequacy ratio of 15 per cent, it's achievable through equity fund-raising only. And right now PE investors are the only class of investors that can provide equity capital to us," says S. Bhaskar, COO, Equitas.

Padmaja Reddy, MD at Hyderabad-based Spandana Spoorthy, points out there is huge competition amongst PE players to invest in MFIs. She should know. Spandana, the second-largest MFI with a loan book of Rs 12,000 crore, raised more than Rs 500 crore in three tranches from domestic and foreign PE firms—including the likes of Temasek Holdings—since 2007. In addition to term loans from banks and financial institutions like SIDBI, whose rates range in the 11-13 per cent territory, MFIs also resort to "portfolio buyouts" to raise funds. In a portfolio buyout, an MFI transfers its loan portfolio to a bank as a bilateral transaction. The buyouts are done at an 8-10 per cent rate. But as Prasad Koparkar, Head (Structured Finance Ratings), CRISIL, points out, the problem with portfolio buyouts is that they don't happen all round the year.

Reason: For banks, that's the quickest way to meet priority sector lending targets as stipulated by the RBI, but this need arises only towards the close of the financial year. MFIs, thus, have no option but to look out for other fund-raising avenues. One product that has caught the fancy of bankers of late is the securitisation of MFIs' loan receivables.

The Securitisation Avenue
February 2009ICICI BankSKS Microfinance200
March 2009Not disclosedEquitas Microfinance15.70
March 2009YES BankShare Microfin49.5
April 2009YES BankSKS Microfinance100
April 2009IndusInd BankBandhan75
November 2009Dhanalakshmi Bank, ICICI Prudential, AxisEquitas Microfinance48.17
January 2010Dhanalakshmi BankSahayata Microfinance, Satin Creditcare Network,
Asirvad Microfinance, Sonata Finance
Source: Company releases; published reports

Apart from a few banks, institutions such as the Chennai-based IFMR Capital and the Mumbai-based Grameen Capital India (a collaboration between Washington based-Grameen Foundation and Citicorp Finance India Ltd) have designed different structures whereby the loan receivables are divided into smaller pools, are rated by credit rating agencies and then transferred to a special purpose vehicle (SPV); the pools are then bought out by investors. So, unlike a term loan, which is counted as indirect exposure to the priority sector, the securitised pool is a direct exposure for banks. Depending on the rating, the interest rates can vary between 6.5 and 10 per cent—a significant discount to term loan rates.

So, what's in it for banks? "There is a trade-off to be made—the tenure of such instruments is shorter and interest rates tend to be lower, but such transactions are more secure as MFIs have to keep aside a cash collateral in case there is default," says Tilisa Gupta Kaul, Head (MFI and Agriculture Business), Dhanalakshmi Bank. Last year, the bank, along with ICICI Prudential MF and Axis Bank, took exposure in Equitas Microfinance's securitised paper of Rs 48 crore. More recently, it took an exposure of Rs 31 crore to a multioriginator pool of four mid-sized MFIs, including Sonata Finance and Sahayata Microfinance.

For other institutional investors, MFI debt opens another short-term investment avenue as loans are given out for 6-15 months durations. Chaitanya Pande, Head (Fixed Income), ICICI Prudential Asset Management Company, says his fund would rather look at the securitised pool route to take exposure in MFIs than invest in commercial paper or other debt issuances of MFIs. Sucharita Mukherjee, CEO, IFMR Capital, a firm that initiated the concept of rated securitised paper and sets benchmarks for structuring such transactions, feels that exposure to a new class of investors will make MFIs more disciplined as more financial information will enter the public domain.

For borrowers, however, it may be premature to expect interest rates on their loans to fall as MFIs may not be willing to pass on the benefits immediately. The newer sources of funding constitute a minuscule portion of their loan book. For instance, Equitas securitised Rs 50 crore worth of loan at a rate of 3.5 per cent (which is 3.5 per cent lower than the borrowing cost from other sources), but that's just 10 per cent of its loan book of Rs 500 crore.

Interest Rates on Microcredit
Bangladesh8-22 (Grameen Bank)
Sri Lanka30-50
*Ceiling of 1% monthly flat rate on MFIs. Source: Govt websites; industry documents
Bhaskar hopes to do more such transactions and bring down the loan rates for its 7 lakh customers by at least 1 per cent. It currently gives loans at interest rates between 25 and 28 per cent. Adds Suresh Krishna, COO of the Bangalore-based Grameen Koota, which raised Rs 28 crore from PE funds in November and recently placed NCDs worth Rs 20 crore with an FII: "We haven't seen a significant drop in our funding cost yet. If we manage to bring the cost down by at least 2 per cent, and also reduce our operating cost on a large scale of business, we will be in a position to pass on the benefits to our customers."

One fear amongst experts is that access to lower-cost funds may put pressure on MFIs to turn out a higher return equity—to boost valuations— rather than bringing down interest rates, thereby adversely influencing their social orientation. The MFI industry, for its part, still has to come to terms with its high-growth potential. Reports of robbery (cases of money being snatched away from the MFIs' field officers), multiple loans, and untrained staff keep emanating from various parts of the country. The industry players have got together to take several steps such as forming a credit bureau to share data on borrowers, defining a minimum ticket size of loans (at Rs 50,000).

Bosnia with a population of just 3.5 million may not be a good comparison, but it's important not to ignore what happened in the MFI sector there. The industry grew rapidly over the past few years as foreign investors poured money into the local MFIs. The result was unchecked growth, multiple loans and then defaults due to a fall in the income of borrowers.

The industry had to fall back on a $110-million bailout package from the investment arm of the European Union to remain afloat. It's unlikely that Indian MFIs will suffer a similar fate, but the warning signals shouldn't be ignored. Lower-cost funds are welcome, but if they don't translate into benefits for those who need them most, the raison d'etre of microfinance itself will be defeated.