Where Angels Prey

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

Thursday, December 9, 2010

Equity Investment and Burgeoning Growth in Indian Micro-Finance: Is There a (Causal) Relationship?

Ramesh S Arunachalam

Rural Finance Practitioner

I have been trying to post on equity investments in Indian micro-finance for the last several days but have been severely hampered by lack of reliable and valid data on the same. Several people whom I approached refused to share information citing confidentiality aspects and I was left wondering that when we have had almost Rs 3000 crores (US $ 700 Million) of equity into micro-finance, we still have paucity of authoritative published data. Sometimes, I even get worried that we have no (real) idea of who EXACTLY is investing in a very sensitive sector like Micro-Finance and much of my concern relates to the norms laid down by the financial services task force set up after 9/11. Never mind and I do hope that the regulators and other industry stakeholders share my legitimate concerns…

Anyway, after a lot of struggle, I have been finally able to create a reasonably valid database (I say this because the data I have is published or quasi-published but is getting updated regularly). However, as I am still in the process of (re) validating the same, I would therefore like to caution you to view the following data and numbers accordingly… That said, it is also my belief that any further data updation (because of re-validation) will not significantly alter the trends – at best, some numbers for the respective years may increase or decrease marginally…

Having setting out the caveats, let me now proceed to share what I have found…Read on…

The following tables and graphs provide an overview of equity investments into Indian micro-finance, during the last few years:

As evident from the above, it is clear that equity investments in Indian micro-finance have grown very significantly, from April 2007 onwards. The total equity investment - over the years - into Indian micro-finance is about approximately 680 Million US $ (0.68 Billion US $)

The following table and graph provide an overview of equity investments before April 2007 and from April 2007 onwards until July 2010:

The table and figure are rather self-explanatory…Equity investments from April 2007 onwards until July 2010 (A whopping US $ 646.97 Million) are almost 20 times the size of equity investments prior to April 2007 (which are a miniscule US $ 32.51 Million). In many ways, April 2007 appears to be a watershed…with regard to equity investments

In fact, the burgeoning equity investment in Indian micro-finance has prompted experts like Mr N Srinivasan (Author of The State of The Sector Report) to suggest that perhaps ‘micro-finance was the preferred sub-sector of choice in the financial sector for investment bankers[i]’. This is especially a curious phenomenon, given the fact that equity investments into other sectors had (sort of) been less than encouraging, during the years of the global financial crisis –incidentally, it almost during the same years that Indian micro-finance attracted significant equity investment.

However, it appears that the Central Bank had not taken a serious view about the burgeoning investments into the Indian micro-finance industry, although some reports claimed that RBI was perhaps not (exactly) happy with the trend of more equity into Indian micro-finance:

“RBI concerned about Private Equity funds investing in Microfinance Companies - RBI officials told CNBC-TV18 in an interview that was broadcast yesterday that they are yet to take a view on how to treat private equity investments in Microfinance Institions. For decades microfinance in India was always seen as a not for profit function with a social purpose  but this has changed drastically in the last few years with many foreign based private equity funds pouring money into this sector[ii].”

What basic trends are discernable from data and analysis presented above?

First, with no causality being implied, all I can say is that the period of very rapid growth in Indian micro-finance (April 2007 – March 2009[iii]) is associated with significant equity investments into Indian micro-finance (US $ 256.24 Million).

For example, during the period April 2007 – March 2009, the top 14 Indian MFIs (with 6 AP Headquartered MFIs) added almost 75% of their total portfolio of 2009. In numerical terms, this is approximately US $ 2.799 Billion, which is huge by any standards. During the same period, the Big 6 AP Headquartered MFIs also increased their gross loan portfolio by almost US $ 2.077 Billion during this period {in other words AP headquartered MFIs accounted for almost 74.19% of the total portfolio (US $ 2.799 Billion) increase during April 2007 – March 2009}.

Further, it is in the same period of April 2007 – March 2009, that the top 14 Indian MFIS (with 6 AP Headquartered MFIS) added nearly 14.27 Million active borrowers. And interestingly, the Big 6 AP Headquartered MFIs accounted for almost 9.76 Million of these active borrowers (about 68.34%).

Thus, whether growth of active borrowers or gross loan portfolio is considered as a measure, the period, April 2007 to March 2009, is clearly “The Period” of Burgeoning Growth in Indian micro-finance. What is note worthy is that this period is also associated with significant equity investments of US $ 256.24 Million.

Second, the period, April 2009 – March 2010, which succeeds the fastest growth period (of April 2007 – March 2009) as of now[iv] shows the highest equity investment in Indian micro-finance (US $ 390.72 Million)

What then are some possible explanations for the above trends?

I think there are few possible explanations but more research would surely be required to understand these relationships in a conclusive manner. That said, let me make a few observations…

ð      It appears that some of the MFIs (first movers) perhaps grew rapidly in the period April 2007 – March 2009 probably because the equity investors from previous years (rounds) were requiring them to do so. And while doing so, they perhaps accessed more equity from the investors and this seems a reasonable explanation, given that commercial banks[v] may have been a bit shy of the micro-finance industry, especially in the wake of the Krishna district (in Andhra Pradesh) crisis of 2005/6…

ð      Other MFIs (followers) perhaps saw the impact of equity investment (in terms of liquidity, growth etc) for their peer MFIs (first movers) and they also began (trying) to emulate the first mover MFIs…resulting in perhaps more rapid growth in the industry, which also may have resulted in more equity investment…which then perhaps began to drive further burgeoning growth in the industry…and led to more investment with increasingly higher valuations[vi]. That seems to be a plausible cycle of happenings…

ð      In fact, as this cycle perhaps continued and gathered momentum during April 2009 – March 2010, valuations also sky rocketed and is aptly summarized by the following quote…

In a balanced informative article[vii], Xavier Reille of CGAP asks: Are MFIs in India overvalued? He goes on to argue that the

“Current valuation levels are a cause for concern…First, the earning prospects of  Indian MFIs do not justify such high level of valuations. Current profitability is moderate.  Microfinance NBFCs in India are only generating a median ROE of 14.4% (although the largest five institutions show substantially higher numbers). Moreover, I see few prospects to increase profitability. Interest rates are more likely to go down as a result of competition. MFIs might not be able to sustain such record high level of asset quality over the long time, as we have seen in other fast growing markets. Finally, there isn’t much room for increased equity leverage as NBFCs already have a 7.2x debt-to-equity ratio, more than double the global average for NBFC.

Second, overvaluation might be driven by excess capital flows.  A significant share of equity investment in India comes from investors whose objective is to realize profits by floating or otherwise exiting their investments in a relatively short time frame. In many cases in the past this type of capital has produced overvaluation of equity prices in the short term and disappointment in the long term. After all, India is the only microfinance market that has attracted large private equity funds.

But I might be missing the upside. Perhaps investors are expecting MFIs to boost profits through other ways, for example, they might value MFI extensive distribution platforms for goods and services beyond finance?”

To summarise, from the above, I am closer to accepting the assertion that equity investment perhaps induced faster growth in Indian micro-finance which, in turn, may have led to more and more investment into MFIs and caused further (very) rapid growth[viii] and thereby, attracted more equity investments at very high valuations. This is one possible explanation for the association of rapid growth (of Indian MFIs during April 2007 – March 2009) and burgeoning equity investments (in Indian MFIS during the same period and also during April 2009 – July 2010)

While I have tried to identify some aspects related to equity investments in Indian micro-finance, the above premises need further (objective) analysis and the RBI sub-committee may want to look into the relevant issues and come to an informed conclusion about the happenings around equity investments from Indian micro-finance…I will post separately on the critical issues in the equity investment space that the RBI board sub-committee may want to study…

Have A Great Day at Work!

Please Note: Any help in providing authoratative data on equity investments in Indian micro-finance would be greatly appreciated! Thanks in Advance and I am continuing to (re) validate and update my database and will share that publicly when I am done.

[i] Source: The State of The Sector Report, 2010, Sage Publications.
[iii] I am not able to comment on growth of MFIs for 2009 – 2010 as Mix Market data is not yet available for all institutions – at least when I last checked recently.
[iv] Given that end march 2010 is not yet available for all MFIs as noted above
[v] I am looking at the Role of Commercial Banks with regard to growth of Indian micro-finance separately and will post on that in a few days time as that data has also been hard to get…
[vi]Which, according to many industry experts, are very difficult to justify in the micro-finance context
[viii] This issue is almost similar to the aspect of which came first, the Chicken or the Egg ?


  1. Ramesh -- this is very good work. Thanks for putting this together! One question -- is the source of the data confidential? Would be very interesting from where this is drawn.

  2. Dear Daniel

    Thanks for your kind words. It was very hard and a lot of the data is confidential but I could check back and try and make it public. I literally had to beg people and assure them that I will not put out individual names...unless used in aggregate. Let me check back and try and make it public...I have also used the financial statements, DRHP, CGAP deal book, other documents on international fund flows into India etc

  3. Dear Ramesh,

    Congratulations on your work, which former colleagues at MIX brought to my attention. I have also undertaken a study of MFI shareownership, looking into the changes to 'shareholder value' in a number of MFIs (to date, 61) across the globe as means to developing benchmarks, and I can affirm your problem with sourcing reliable transaction data. I am collecting shareholder data and would be happy to exchange my data & sources for the Indian MFIs my research covers, if you would do the same. I can't claim my database is authoritative, but I hope together our data will help us confirm, deny, or develop leads into better sources. Best, Pete

  4. Dear Peter

    Many Thanks for your kind words. A lot of the data is confidential but I could check back and try and share it with you. Thanks and I agree that we need to work together to get a better sense...let me check back with people who gave me the data and try and share it with you

    With best wishes and Warmest regards


  5. Hello Ramesh Sir...
    I have been reading all ur articles i am finding it very interesting....Thank u so much for making us understand mfi sector easily..I have one thing to ask u...do equity investment(pe/vc)in mfi help in raising debt frm banks....can u trow some light on this topic if possible

    Warm Regard