Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Friday, February 11, 2011

Is Consolidation Good and Appropriate for the Indian Microfinance Industry?

Ramesh S Arunachalam
Rural Finance Practitioner

A recent interview by Mr Yezdi Malegam indicates that consolidation of the microfinance industry may be good as it helps MFIs to grow large and reduce costs for their clients and also reduces the risks for the banks. (http://www.business-standard.com/india/news/qa-y-h-malegam-chairman-malegam-committee/424720/)

That point is well taken broadly but there appear to be several disadvantages to consolidation of the microfinance industry in India and I would like to humbly put across alternative views to Mr Malegam, The RBI Sub Committee and The RBI…

First, the Indian microfinance industry is already highly consolidated with a few large MFIs holding substantial portfolio. Further consolidation will ensure that MFIs may not reach out to hard to reach areas or lower income (poorer) clients who are most often served by smaller MFIs and NGOs.

Second, I am not sure if increasing size beyond a point actually reduces the interest rate to clients (that is my understanding) or reduces risk. Increased size, on the other hand, may pose its own challenges for the MFIs concerned:
-          Need for good middle management: While smaller MFIs may be able to supervise operations from the head office directly, large MFIs perhaps may need to hire several layers of a new cadre of middle management, despite presence of outreach technology. Often this cadre, would have to come from business schools and with the intense competition for such candidates from the all other industries, the salaries need to be much higher than what is paid by MFIs. And it may also be hard to train the field staff to take on this role. CGAP’s paper on growth and vulnerabilities in microfinance (http://www.cgap.org/gm/document-1.9.42393/FN61.pdf) and studies of large scale microfinance defaults in Pakistan indicate that when faced a large scale default, an MFI that paid attention to its internal supervisory capacity avoided the default while other MFIs that did not suffered seriously. Needless to say, similar things have happened in India and please see the following posts(http://microfinance-in-india.blogspot.com/search/label/Microfinance%20Frauds and http://microfinance-in-india.blogspot.com/search/label/Micro-Finance%20Agents)
-          Standardization of products and procedures: Increased size puts greater focus on standardization of procedures and often the organization can get far removed from its clients, as is presently the case and as Mr Vijay Mahajan’s yatra is perhaps likely to demonstrate. Thus very large MFIs may not be able to customize products to meet clients needs.
-          Listening to client needs: In banks, most employees across all levels are from graduates or post graduates and professionally qualified. Thus junior staff are able to articulate their views reasonably well to their seniors. But in an MFI there can be a huge difference in the qualifications and significant difference of power between junior staff and senior management of the MFI. Thus a junior staff at an MFI is likely to find it much harder to get his or her views across to senior management as compared to junior staff at a bank. Thus MFIs run the risk of becoming very top down organizations and head office driven as compared to banks. This could result in situations where field staff may become less sensitive to their clients in the face of too much pressure from the superiors and the head office. Something that has happened during the period April 2007 to March 2009
-          Build excellent MIS systems and processes: As the organization becomes large, the MFI needs to build even more complex MIS systems and establish more intricate processes. This requires more people with specialized skills in areas like IT etc. and that may add to the complexity and increase costs to the organization. I am not sure if technology is a real cost reducer, at least, from the current situation of scale reached and technologies available and operational. Besides, in most Indian MFIs, technology is still at its infancy. Please see related post on that: http://microfinance-in-india.blogspot.com/2010/11/understanding-state-of-management.html

Third creating large MFIs poses challenges for banks to supervise and monitor as well.  This poses a unique set of challenges:
-          Monitoring a large MFI working in multiple states becomes complex: Thus even if the relationship manager of the bank were to monitor the MFI by meeting the MFI’s clients in a few branches, it would just be a few clients or branches located close to MFIS head office or the relationship managers base location. Travelling to multiple MFI locations would be expensive for the bank’s relationship manager and is likely to minimal. I have practically observed this over the last few years
-          Diffuse accountability for the MFI within the bank: Credit decisions for large MFIs tend to be larger and thus decisions on approving credit are likely to be taken up at senior management levels. Thus accountability for anything going wrong with the MFI is diffuse as multiple senior management staff are involved in the credit decision. This also puts a lower accountability on the bank’s relationship manager to monitor the MFI and report any serious incidences to senior management. This is a very practical issue
-          MFIs bargaining power with banks makes monitoring difficult: As MFIs become large, they possess much higher bargaining power with banks making it difficult for banks to monitor them. Some promoters may misuse the power. E.g. It is reported that before the crisis some promoters of large MFIs would not meet relationship managers or in some cases even senior bank personnel. Such meetings were delegated to other managers at the MFI. The MFI promoters would only meet Managing Director of the bank. In such a situation, one can imagine the challenges posed in monitoring large MFIs. My dairy is replete with examples and situations like this. I am sorry but I am unable to share names for obvious reasons…
-          Too big to fail:  Sometimes the organization becomes too large to fail. Its failure could have implications on the balance sheet of its lending banks. Thus the banks are forced to keep the MFI going even if they foresee problems. However in case of small MFIS, the impact due to a failure of a small MFI will be very insignificant on a bank, thus the bank can pull up a small MFIs in case it foresees problems.  This is again something that we have seen in practice in the financial services industry including micro-finance

Fourth, the ability of a client to repay her loan also depends on the livelihood activities of the clients and/or their families. While some large MFIs like Basix are involved in livelihood activities with good intentions, it may not be possible and/or advisable for all large MFIs to adopt this approach for various reasons. (http://www.microfinancegateway.org/p/site/m/template.rc/1.26.9134/).

Prof. Malcolm Harper clarifies this aspect in one of his previous interviews:
The second regret is that BASIX had not focused our activities in fewer locations so that we could say look at this placenot even a district, but even one block or two which had been somewhat revolutionized by our impact. There are good reasons for being all over the place, from Rajasthan to Jharkhand to Tamil Nadu, never mind our center in Andhra Pradesh. But it is expensive, time consuming, and impact-diluting to be scattered although I supported that strategy in the beginning because it is good to take microfinance to underserved places.”

Thus there is considerable merit for smaller MFIs which are very local and that could potentially transform a place by offering a whole range of financial and livelihood services.

Fifth, having a wide variety of MFIs to choose from gives the clients better choice. They could work with MFIs that offer only financial services or work with other organizations that offer financial, livelihood and developmental services.

While there are strong merits for adequate capitalization of deposit taking institutions since depositors need to be protected, increasing entry barriers for entering microcredit such as increasing the capital needed for NBFCs MFIs will largely keep civil society out (which is typically more interested in a developmental and client focused agenda out of microfinance) and make it an activity for pure play commercial players.  Further consolidation of MFIs also may not (therefore) necessarily bring the desired benefits to all the stakeholders involved.

I hope this alternative perspective is considered for what it is worth and what it is not…


      Have a nice day!


  1. Hi Ramesh,

    I think you have some great insights on microfinance in India. I've stumbled across your blog from indiamicrofinance.com as I'm currently looking into the microfinance situation in India. I would love to talk more with you via email regarding this issue.



  2. Dear Mr Ray

    Thanks for your kind words...My e mail is r_arunachalam@hotmail.com

    Look forward

    Warm Regards


  3. yr insight and researched views on MFIs r commendable. I WISH TO JOIN U IN YR CEASELESS EFFORT TO REBUILD THE INSTITUTION TO SERVE THE POOR.

  4. Dear Sir

    Thanks for your kind words and my e mail is r_arunachalam@hotmail.com and please send an e mail and we could work together

    Warm Regards