Four summers back, the plain-speaking Reserve Bank of India deputy governor KC Chakrabarty declared in a Kolkata conference that micro lenders may become irrelevant if banks turn efficient. Come 2017, with four of the 10 largest microfinance companies turning into small banks, and the second largest— Bharat Financial Inclusion— set to dissolve into IndusInd Bank, Chakrabarty’s words are turning out to be prophetic.
Two decades after India-born American citizen Vikram Akula founded SKS Microfinance, which was rechristened as Bharat Financial, the industry that delivered livelihood to millions of poor is facing its pincer moment with private banks giving a big push to micro lending.
The business model — propounded by Nobel laureate Mohammad Yunus and successfully implemented in India by Akula and Chandra Shekhar Ghosh — still remains profitable, but the vagaries of regulations and populist politics like farm loan waivers keep them on the edge.
The tiny size of these institutions makes them vulnerable to even a small adverse development as their finances remain fragile. Unlike banks, which have multi products and an assured deposit base, micro lenders are dependent on markets for funds, which turn hostile at the smallest of events that affect business.
“Today banks are equally in the microfinance space as much as we are,” says MR Rao, managing director with Bharat Financial Inclusion. “So, banks are looking to partner MFIseither as subsidiary or by way of strategic stakes. As MFIs grow, they too need capital badly to remain on the growth path. It will be difficult for pure-play MFIs to grow independently without support of an anchor investor.”
Microfinance institutions (MFIs) came into being in the 90s as banks’ reluctance to lend to those without credit history provided an opportunity to those willing to take risk and organise rural communities.
India has some 223 MFIs, including societies and NGO-run entities, and 168 of them are registered with Sa-Dhan, the association of community development finance institutions. There are 47 non-bank finance company-micro finance institutions (NBFC-MFIs) registered with Microfinance Institutions Network (MFIN), an industry body, covering 90% of the portfolio While the top 10 find it easier to get equity or bank loan, the smaller ones are always at a disadvantage.
At a pan-India level, micro credit reaches to not more than 20% of the total households through a variety of channels, including banks and NBFC-MFIs. They have catered to some four crore households by way of 6.3 crore microcredit loans in a country of over 130 crore people, while World Bank estimate suggests that about 24%, or 28 crore, live below $1.25 per day on purchasing power parity.
Given the extent of financial exclusion, MFIs may have a few more years of opportunity left, but the fancy 50-80% growth rate may well be history. The key to even survive independently would be to get backing from the investors, which may be hard to come by.
“Selection of investors is critical for survival of MFIs. If you allow investors with a mere aim of achieving high returns to come in, you are in for trouble. History has taught this many a time,” says Chandra Shekhar Ghosh, managing director of Bandhan Bank, which was at the top in its earlier avatar as MFI and was backed by World Bank’s private investment arm, International Finance Corporation, since 2011.
Micro lenders also face policy barriers with their margin capped at 10%, while Equitas Holdings or Ujjivan Financial, which converted into small finance banks shedding their micro lender status, theoretically can lend at higher rates by virtue of being a bank. MFIs don’t have access to deposits which are low cost, putting them at a disadvantage to bank converts.
“It is obvious now that the regulator wants microfinance through banking channel,” says Vishal Mehta, co-founder of Lok Capital, a venture capital fund started in 2004 with a focus to invest in financial inclusion. “They have allowed NBFC-MFIs work as business correspondents and has awarded eight small finance bank licences to them. These are signals that the regulator, while valued MFIs’ work in providing the last mile connect, is more comfortable in dealing with banks.”
As of June, banks are the largest provider of micro credit with a loan outstanding of Rs 38,486 crore, taking their share in micro-credit business to 36%, according to MFIN. Bandhan, the MFI-turned bank, with its Rs 21,400-crore loan portfolio, is a major contributor to this. The bank-led micro loan includes Rs 10,131 crore of indirect lending through business correspondent partnerships in FY17.
“This (working as business correspondent) is the best way to optimise capital and the only option for smaller ones that lacked it,” says HP Singh, chairman, Satin Creditcare Network. “When raising capital turns difficult, it’s better to grow your off-balance sheet exposure through banking partnership and survive.”
NBFC-MFIs as a group is the second largest provider of microcredit with a loan outstanding of Rs 32,820 core, accounting for 31% of the total industry portfolio, followed by small finance banks with Rs 28,634 crore and a share of 27%. NBFCs account for another 5% and non-profit MFIs for 1%.
The microfinance industry shrank 0.3% in the June quarter to Rs 1.06 lakh crore from the previous quarter. It is estimated that this loan roughly represents over 90% of the total industry portfolio, excluding self-help group-linked bank loans.
RAY OF HOPE
All is not lost for the micro lenders as there are still investors keen to fund them with both business interest as well as with charitable outlook. The micro lenders as there are still investors keen to fund them with both business interest as well as with charitable outlook. The NBFC-MFI industry has attracted equity worth over Rs 1,300 crore in the last few months despite demonetisation shaving off their business. That reinforces the importance as well as the attractiveness of the model.
“Things are not as bad as people think. MFIs deserve their place in the sun,” says Ratna Vishwanathan, chief executive of MFIN. “Mainstream banks only have limited appetite for microfinance. They are there when the going is good. We have seen in the past that in bad times banks just withdraw themselves.”
But the sector needs an equally demanding fresh equity of Rs 1,500 crore and debt funding of Rs 20,000 crore, going by a conservative growth estimate of 25% for FY18. Investors typically look for stable entities with strong growth potential, robust risk mitigating systems and procedures in place.
“The number of such NBFCMFIs is very limited now,” says Manoj Nambiar, managing director of Arohan Financial Services, which plans to list at stock exchange next year. “So, interest from investors is pretty high for this limited lot.”
Investor interest can cut both ways – help build business but at the same time overstretch to show growth that backfires. “The market today is not entirely empty like yesteryears,” says Bandhan’s Ghosh. “If MFIs want to survive in this new set of circumstances, they need to find new pockets of unbanked customers. Most importantly, MFIs need to invest in capacity building even if they aim to achieve a relatively modest 20-30% growth. Trying to grow beyond one’s means always proves disastrous.”
Vikram Akula, founder of SKS Micro (now Bharat Fin), on the developments in microfinance industry
ON BHARAT FIN’s PLANNED MERGER WITH INDUSIND BANK
Microfinance Institutions emerged to fill a gap. Banks were not lending to the poor. My larger goal was to bring the poor into the purview of the mainstream, as credit-worthy customers for the banking sector. MFIs did that first by borrowing from banks, then securitising loans to banks, then serving as business correspondents for banks. The logical next step was to become a bank or merge with a bank.
The RBI took a bold step by not only creating small finance banks (SFBs) but also payments banks. Such a network of differentiated banks have, and will continue to accelerate financial inclusion. Having said that, there is still a long way to go, and as such, there is still an important role for NBFC MFIs.
ON MFIs FUTURE AS A STANDALONE ENTITY
Certainly, in the long term, it appears that MFIs should either have a plan to merge with a bank or become an SFB. However, at present and probably in the medium term, there is still a gap in financial inclusion. NBFC-MFIs can help bridge this gap. Eventually, it would be good to see the RBI accelerate the next round of SFB licences so that all stand-alone MFINBFCs move under the umbrella of a bank either by becoming SFBs or merging with a bank.