Ramesh S Arunachalam
Rural Finance Practitioner
In this three-part article, I try to highlight the impact of the current crisis on micro-finance in India – from reckless burgeoning growth in 2006 to 2009/10 to corporate governance failures, state intervention, deteriorating asset quality because of the above factors leading to a bubble bursting like situation…The first part deals with the perspective of commercial banks, large MFIS and small MFIs. The second part relates to the viewpoints of clients. The last part deals with issues of getting the incentives right…Read on and comments are most welcome…
The current state of micro-finance in India therefore, offers challenges as well as opportunities going forward. If things continue as they are, here is what I anticipate could (will) happen:
How are Commercial Bank’s likely to View Micro-Finance in India Going Forward?
1. Banks after having seen this crisis, may (now) perhaps assume that microfinance has serious inherent political and operational risks so much so that a default crisis could occur in flash
2. The will result in the risk perception of microfinance going (further) up and banks may become very cautious – in fact, some of them may get into a shell
3. This could result in banks lending only to large MFIs that have a (good) requisite amount of equity. And these would primarily be the large for-profit MFIs.
4. The irony would be that, although a small socially MFI or a livelihood oriented MFI might be doing good work working with the poorest clients in the most remote regions, as far as the banks are concerned, such an MFI could be a risky bet. In case of a crisis in the future in the region where the specific small MFI works, the localized nature of the MFI may make it appear even more risky for the bank. Thus, small socially focused MFIs and their poorest borrowers could get increasingly excluded from the system.
What is the likely perspective of large for-profit MFI’s going forward?
1. There will be heighted pressure on the larger for-profit MFIs to give the anticipated returns to commercial investors such as Private Equity firms. This will be due to:
a. Reducing interest rates: Interest rates will decrease all over India due to the heightened public opinion after the Andhra Pradesh situation and the spread of the same elsewhere
b. Losses in Andhra Pradesh: Several large for-profit MFIs are likely to report losses in their loan portfolio in Andhra Pradesh because of borrowers not paying back, both due to multiple lending and the political climate.
2. But since investors are still going to demand their anticipated financial return on MFIs (irrespective of the impact of the AP situation) and especially those who were not directly affected by it could push the large MFIs to consequences that are not going to be very desirable:
a. The bigger for-profit MFIs will try to expand even more vigorously outside Andhra Pradesh. It they have adequate funds, there could be a rush amongst the larger MFIs to reach out to as many borrowers as fast as possible before other MFIs come in and restrictions are put on multiple lending, interest rates etc all over the country. Such an accelerated growth may will help many large for-profit MFIs to attain critical size and perhaps go for an IPO in the future (if not near future) – unless things and events change even more drastically, I still see MFIs tapping the primary market, although there would be some time gap from the present day (as they say, time would be the best healer)
b. Pressure to reduce operational costs: While the lending is already reasonably efficient, further reduction in operational costs may well mean less time spent in doing client due diligence and building a relationship with the client. There goes relationship micro-finance…
c. Bundling of consumer products to clients to increase margins: It is quite likely that from now on, consumer products such as cell phones, televisions, gold etc. may be bundled with a loan to increase margins for MFIs. While each of these products may have a utility, bundling it with a loan will make the pricing of the micro-loan and the consumer product even more opaque.
3. To recover the initial cost of client acquisition, large MFIs may create exit barriers for clients and prevent them from going to other MFIs, SHGs or work with banking correspondents. While the SHG model and banking correspondent model have advantages, they are not as easy to scale or as nimble as the microfinance model. Clients will also continue to be attached to their original MFI because of exit barriers and the choice of default option excellently identified in behavioural economics. Thus, the SHG model and banking correspondent model may not reach the critical mass necessary, as compared to the microfinance model.
What is the likely perspective of small microfinance institutions going forward?
1. Since banks are likely to become even more cautious lending to small MFIs, many of these small MFIs will find it very difficult to get loans from banks.
2. Small MFIs all over India are likely to be affected severely by the turn of events and as a result the poorest clientele in the most remote regions who are often served by such institutions may be severely affected.
3. MFIs who also provide livelihood support and other services will be severely affected by this situation.
In summary, I see the smaller MFIs suffering the most from this crisis and tomorrow, I will share the client perspective on the present crisis…Good Day to All!