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Microfinance institutes: Gingerly progressing fighting setbacks

Microfinance institutes in India mostly lend to the unorganised sector
  • There are 223 microfinance institutes in India
  • They started out with a lot of promise and flourished between 2005 and 2010
  • Their aggressive expansion strategies, however, soon resulted in stringent regulations clamping down their activities
  • Competition from banks which also started to eye the space along with lower lending rates imposed on them, made them lose ground
  • To survive many applied for small finance bank license while others entered into partnerships

Social causes and business profits need not be mutually exclusive. Bandhan Bank, which is making headlines for its IPO (the biggest initial share sale by an Indian bank), has just proved that. This is because its journey began as a microfinance institute, which lent money to small borrowers whom established banks steered clear off due to a lack of credit history, way back in 2001.

It made impressive strides by lending to the unorganised sector and in 2009 was registered as a non-banking financial company providing select banking services. In 2014, it became one of the only two banks among 25 applicants to win a banking license by RBI, beating established conglomerates of the likes of L&T, Bajaj, and Birlas.

At present, it has a customer base of 11 million with a total loan offered to the tune of Rs.20, 800 crore. And the interesting part – despite transforming into a full-fledged bank, small loans to small entrepreneurs still comprise around 90 percent of its business.

But can Bandhan Bank be considered a bellwether of the microfinance industry in India? What about the other players who have not morphed into banks? How have they fared? What are the challenges in their path? Do they play a pivotal role in the nation’s economy?

To find out the answers, we need to start with the basics.

So what are MFIs and how do they function?

A brainchild of Nobel laureate Mohammad Yunus and given shape by Akula (social entrepreneur and the founder of SKS Microfinance) and Chandra Shekhar Ghosh (founder of Bandhan Bank) in India, MFIs started gaining traction in the 90s when lending business was opened up to the private sector in the nation.

They helped to bring about financial inclusion by serving the vast number of unbanked population in India. They entered a domain which traditional banks balked at and this enabled them do brisk business. So much so, between 2005 and 2010, the sector emerged as one of the largest in the world.

MFIs exhibited potential to stamp out poverty by providing systematic loans to farmers, small entrepreneurs, and women’s self-help groups, thereby rescuing them from the clutches of unscrupulous money lenders.

As far as the functioning is concerned, MFIs get the capital to lend from big banks or investors and bond issuance. They also raise money through equity investments, in which they are required to share profits. They are, however, not permitted to accept deposits.

Currently, there are over 223 microfinance institutions, including cooperative societies and NGO-run organizations. There are also 47 non-bank finance company micro-finance institutions (NBFC-MFIs) which carry out the functions of a bank in rural areas where there are no banks.

How smooth has been the trajectory of the microfinance industry so far?

Stringent regulations and populist politics like farm loan waivers are major headwinds MFIs have had to contend with. After its breakneck expansion before 2010, the sector suffered reverses owing to the Andhra Pradesh government promulgating an ordinance to restrain their activities. The massive roadblock was of their own making, as per the government; their aggressive expansion strategies in a saturated market made many farmers debt ridden leading to suicides.

Among other things, the government mandated MFIs to acquire permission from it, before issuing any fresh loans. Other states soon followed suit soon and this dealt a hammer blow to MFIs nationwide. With their bad loans mounting and banks refusing to lend to them, they almost reached a financial cul-de-sac.

Self-regulatory organisations (SRO) Sa-Dhan and Microfinance Institutions Network (MFIN) eventually came into being to monitor MFIs and ensure the lenders are in compliance with the rules.

Besides, the interest rate at which MFIs are allowed to lend is lower than that of small finance banks. This coupled with the fact that they don’t have access to deposits which bank converts have made crimped their ability to profit to an extent.

Such stifling regulatory and policy issues aside, tough competition from banks which are equally in the microfinance space often makes it difficult for them to gain a foothold, let alone prosper.

Demonetisation provided a major jolt again to the sector since it resulted in a further surge of bad loans to provision which they had to set aside money.

With so many roadblocks, will MFIs lose ground further?

The best survival strategy for MFIs so far has been converting to small finance banks that would enable them to collect deposits that would bring down cost of funds for them considerably. In 2015, RBI awarded eight microfinance companies licenses to operate as small finance banks.

But pure-play MFIs may find it difficult to prosper independently without an anchor investor supplying capital. Many are seen partnering with other MFIs and others are getting gobbled up by bigger institutes.

One reason for cheer: Way past the demonetisation shock, equity investments have increased with many non-banking MFIs substantial capital from domestic and foreign investors. Janalakshmi Financial Services is a shining example – it raised Rs.1, 030 crore from investors of the likes of Morgan Stanley, Treeline and TPG Capital.