29 August 2010

Enhancing microfinance -K. V. RAMANAND

Microfinance institutions need to be permitted to operate as a business or an industry with an objective to make profits and grow.

Currently, over Rs 20,000 crore is channelled by private sector MFIs amongst around 28 million borrowers.

"Give a man a fish, you feed him for a day. Teach him how to fish, you feed him for a lifetime," goes the Chinese saying. Microfinance is hailed by many as the panacea to alter the social fabric of rural India.

The depressing levels of poverty, particularly in rural India, motivated policymakers (such as the RBI and the Registrar of Cooperative Societies) to embark on the Self-Help Group (SHG), bank linkage programme to channelise the much-needed capital to the remotest parts of the country with the hallowed twin objectives of social and economic uplift.

SIDBI and NABARD, leading Indian financial institutions, played a stellar role by lending directly. They also paved the way for extensive private sector participation in this industry by funding private sector players.

The emergence of the concept of microfinance and private sector institutions was primarily to supplement and enhance the outreach of the traditional banking sector through the length and breadth of the country.

The benign objective was to protect the poor from the usury they were subjected to from unorganised moneylenders. Microfinance industry operates on the fundamental concept of small loans disbursed amongst a group of close knit people and subtly leverages on social and peer pressure to ensure full and timely repayment.

This industry has an envious record of loan recovery (almost 97 per cent). More importantly, the sector also seems largely immune to the global financial turmoil as it tends to operate on a regional basis. Therefore, it is highly susceptible however, to the regional issues and trends.

Organised phenomenon

What started as a local initiative by a few dedicated individuals with a social/community objective to mobilise and channel local resources has become a parallel organised banking phenomenon.

The style under which the entities operate ranges from for profit corporate entities such as NBFCs (non-banking finance companies to Section 25 companies and societies and trusts. Even the spectrum of regulators is widespread and ranges from the RBI to the Registrar of Cooperatives.

For long, this sector depended on the traditional sources of borrowed capital. There were many restrictions on free access to capital.

Public deposits were not available based on the nature of the entity and sources were primarily from the community and grants. Priority sector norms enabled microfinance institutions (MFIs) access to bank funds. Currently, over Rs 20,000 crore is channelled by private sector MFIs amongst around 28 million borrowers.

Lately, this sector has attracted funds from global development financial institutions and, more importantly, the global private equity funds. Private equity players have invested approximately $300 million in this sector in about 25 transactions since 2006.

This availability of capital in turn saw many socially-oriented entrepreneurs launching MFIs of their own. In all, over 3000 MFIs operate currently in India. This led many to draw comparisons between the credit-card boom for the middle class and the poor man's credit mechanism, the microfinance industry.

Key concerns

This rapid growth has led to many concerns being raised, primarily around the usage of funds by the borrowers and the rates charged by the lenders. In many cases, the lending rates range from an effective 25 per cent per annum to 32 per cent per annum.

Concerns were raised by activists whether this mechanism was fuelling rural consumerism by encouraging "unnecessary" spending by making credit easily available.

Is the credit being used for "productive" purposes? Is the credit going for measures that alleviate the impoverished status of the borrowers or is it meeting their short term consumption requirements? Other serious considerations are with regard to the systems and processes at the lending institutions to monitor and control disbursements and collections.

The MFIs have a requirement to strengthen their internal process and corporate governance standards. This is mandated by the rapid growth of the industry and also the need to operate from discrete and remote locations.

Considering the widespread presence of operations, many a times in remote areas with minimal access to communication networks, there is serious inherent risk in operations. Technology, therefore, will be a great enabler and can play an important role in the stability and growth of this industry by minimising risks and also significantly reducing costs.

We believe that the microfinance industry is a path breaking tool in achieving the stated twin objectives. The best and the most effective way of reaching there is by a judicious mix of active private sector participation with a calibrated approach of support and regulation by the Government and its agencies.

MFIs need to be permitted to operate as a business or an industry with an objective to make profits and grow. The regulatory set-up should be focused on prevention of any frauds or scams considering the high growth this sector is witnessing. The long-term growth of this industry is ensured if the MFIs practise self-regulation and direct the funds for productive purposes at a healthy margin without just being focused on growing the business by maximising (not optimising) disbursals at the highest possible rates of interest.

Sharing of information about borrowers and their payment track record/defaults will go a long way in preventing sizeable write-offs. This will also prevent multiple borrowings by the same borrower from multiple entities. In some instances, the new borrowings were apparently to service the old ones.

Regulatory supervision

The Government and other regulators should enable the MFIs to operate in an unhindered manner but with a clear and strict oversight. There has been a lot of debate about the need to regulate the interest rates on microfinance loans. The best that the regulators can do is to encourage this sector that enables multiple players to enter and participate aggressively, thereby increasing competition and the enhancing the need for efficiencies to survive and grow.

In a very positive development, leading players in this industry have come forward to set up a Microfinance Institutions Network (Mfin) that will interact on behalf of the industry with the regulators to ensure sustainable growth of the industry. It hopes to enhance information sharing amongst the members about the regulations, operational benchmarks and also borrower profiles and, more importantly, act as a self-regulating initiative.

While corporate diktats suggest a full-blown stress on growth and profits, the nature of the industry and the target segment it caters to position the players uniquely with the need for socioeconomic consciousness. This is a challenge for the captains of the entities that operate in this segment. However, we can be certain of one thing here — like some of the events that transformed the country, like the IT revolution, the concept of microfinance is destined to make a significant difference to the populace.

(The author is Executive Director, Corporate Finance, KPMG)

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