Little big bank

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Cheered by bank licence to Bandhan, the microfinance sector is poised to bounce back

Little big bank
Like many big inventions and discoveries that happened by accident, microfinance be­gan in India by a twist of fate.

Padmaja Reddy was working for an NGO in the Guntur district of Andhra Pradesh in the early 1990s, when she happened to come acr-oss a ragpicker — ‘recycler’ to be politically correct — and enquire about her livelihood. The story of the less fortunate woman’s struggle moved her not to tears but into action. She lent Rs 2,000 to the woman to better-manage her business, only to have 200 other ragpickers at her door the very next day, seeking similar assistance.

What followed was a long journey towards institutionalising a charitable impulse that started off under the brand name Spandana.

Three decades thence, loans for the poor women caught on among non-profits as well, following the radical model innovated by the Grameen Bank of Bangladesh. There, women living in a community form self-help groups (SHGs) to avail of loan collectively.

India’s private sector smelt the business opportunity in microfinance when interest rates surged as high as 24 per cent and women borrowers still kept repaying their loans unfailingly.

Microlending picked up at an unprecedented pace until all hell broke loose in 2010, when all microfinance activities were banned in Andhra Pradesh.

The tension began in 2006 when microfinance institutions (MFIs) found it difficult to get repayments of about Rs 150 crore loans that they had extended in the Krishna district because of government intervention after a spate of suicides.

By 2010, MFI growth had peaked, growing at 80 per cent per annum. The network had reached 27 million people. SHGs (self-help groups) and MFIs emerged as two alternatives to meeting the credit needs of the poor and the two models complemented ea­ch other initially. In certain districts of Andhra Pradesh, however, the two models began to compete and lend to each other’s clients.

“In the run-up to the SKS Microfinance IPO in August 2010, this turned into a reckless rush to build portfolio and multiple lending led to over-indebtedness in a small proportion of the borrowers. Many poor families were overwhelmed by the repayment obligations,” recalls Vijay Mahajan, who set up Basix in 1996 and has since been a crusader for the cause of the microfinance institutions.

As borrowers began delaying repayments, MFI staff, accustomed to 100 per cent and on-time repayment, started building pressure leading to instances of coercive recoveries and more suicides.

The Andhra Pradesh government, led by the then rural development secretary Reddy Subramanyam, enforced the AP Microfinance Act in 2010, halting all private sector lending and repayment activities in the state.

The massive debt pile-up did not deter the state from going ahead with the clampdown. Andhra Pradesh was among the top five states along with West Bengal, Tamil Nadu, Karnataka and Maharashtra that accounted for 62 per cent of the total microfinance portfolio then.

As the crisis galvanised and defaults loomed, banks and investors shied away from the sector. Over 9.2 million loans worth Rs 7,200 crore became overdue and borrowers could not repay — or chose not to repay, in some cases — as they had no fresh loan to take care of their financial needs.

Udaia Kumar, founder of Share Microfinance, who is contesting election from Guntur in Andhra Pradesh, says the crowding of the space and an overflow of money led to the crisis. “I was among the first persons from Andhra Pradesh to visit Bangladesh to know about the Mohammed Yunus model of Grameen Bank. As none of the banks were willing to fund me to replicate the model here, Prof Yunus lent me $34,000 to start the business. It took us 10 years to convince that the poor are also bankable. Slowly, NGOs started turning into NBFC-MFIs as banks started lending. Later, around 2000, equity funding also came in. Investors started looking at it because of good return on investment (RoE). With more and more funding options, it led to the 2010 crisis,” he says.

There was a time when 15-20 women meeting in late afternoons at school playgrounds or other open spaces to explore ways to avail of microfinance was a common sight in remote Andhra villages. Following the crisis, they were back at the doors of moneylenders, banks or state government SHG schemes for their financial needs.

“Issues got politicised because the state government and the MFIs stood against each other and there was conflict of interest. The government would obviously work towards protecting its turf,” said Shamika Ravi, professor of economics at the Indian School of Business and visiting fellow at Brookings India.

The performing portfolio in Andhra has since become negligible. The number of MFI clients in Tamil Nadu and West Bengal exceeded that of Andhra Pradesh for the first time in the last quarter of the last financial year.

“Andhra was once the capital of all microfinance activities. Now the state has turned against all MFIs,” rues Samit Ghosh, managing director of Ujjivan Microfinance and president of Micro Finance Institutions Network (MFIN).

Mathew Titus, executive director of Sa-Dhan, a community development finance industry body, says poor villagers in Andhra have been facing immense difficulty in meeting their cash needs in the absence of MFI loans.

“As NGOs with microlending interests transformed into NBFCs, they had to reform and expand rapidly. In India, microfinance is looked at more as a social tool. In other countries it is not considered extraordinary to charge a premium for such services,” says Ravi of ISB.

For a while, there was a total washout of the business in Andhra Pradesh - the state where the revolution had begun. But the industry kept growing in other corners of the country, evoking confidence.

Signs of a turnaround are visible now. The industry regained its 26.5 million borrowers and there was Rs 24,000 crore outstanding loans as of December 2013. Its rival sibling, the SHG-bank linkage programme had 43.5 million borrowers and over Rs 36,000 crore loans outstanding in March, 2012. The two models of MF in India reach at least 56 million poor households (assuming 20 per cent overlap) on a total of 70 million with over Rs 60,000 crore outstanding loans.

Spandana, one of the biggest players, is looking to get a grip on its huge burden of debt.

“MFI operations have since been normalised in other states. The aggregate portfolio increased significantly, though a major share of the portfolio is still held by a few large MFIs,” says Titus of Sa-Dhan.

In October 2013, Crisil awarded the highest grading ‘mfR1’ (on a scale of 1 to 8) to Bandhan Financial Services, signalling that the worst was over for the industry.

A study on Bandhan by the Indian Institute of Management, Ahmedabad, analysing the impact of microfinance and other socio-economic development initiatives in the lives of the underprivileged found that compared with the control group, the average annual household net income increased by Rs 1,323 (inflation-adjusted at 8 per cent), representing a 13.81 per cent jump.

A marked improvement was also seen in the living standard of the clients, who were buying more consumer durables and had access to water, sanitation, electricity and cooking fuel. Households were spending only 8 per cent of their increased income, indicating huge benefits from the microfinance revolution.

RBI’s in-principle approval early this month to a bank licence to Bandhan has come as a shot in the arm for the industry.

According to Titus, the bank licence to Bandhan shows the high-level of credibility that the MFIs enjoy. “This reflects the role and importance that an MFI can play in providing financial services in a transparent, affordable and ethical manner.”

“The banking licence for Bandhan is a recognition to the sector, and also a testimony to the fact that the MFI sector as a whole is run on a viable model, albeit with aberrations,” says Chandra Shekhar Ghosh, chairman and managing director of the Kolkata-headquartered Bandhan. (See full interview on Page 9)

“The current phase of the microfinance industry has been one of qualitative transformation,” he says.

The bank licence, in a way, signals a comeback for the industry with a cleaner slate.

Industry leaders claim most MFIs, regardless of their structure, are adhering to the RBI rules, which take care of most client protection-related matters, including interest rates, recovery and over-indebtedness. Industry associations have come up with a code of conduct for the members. They conduct field visits to ensure strict adherence to the code and work on issues such as client protection, grievance redress, governance, disclosures, transparency and client education.

MFIs are also reporting to the credit information bureaus (CIB) periodically and generating credit reports before disbursing loans to clients. “They generate one million credit every month and more than 100 million client records are captured in CIB. This is a significant initiative to profile credit history of the low-income borrowers, understand th­eir credit behaviour, repayment patterns and over-indebtedness,” says Titus

According to a longitudinal impact study conducted in 2010-13 by Delphi for Ujjivan Microfinance with sample size of over 3,000 clients, there was marked improvement in the lives of most active clients.

The impact study says 96 per cent clients believed their lives would continue to improve compared with 85 per cent who said so in 2010. The study showed a 51 per cent rise in average monthly income of the clients after adjusting for inflation. Also, 81 per cent of customers were able to save money compared with 63 per cent in 2010.

Mahajan of Basix calls the current phase since 2011 as one of qualitative consolidation with the strengthening of infrastructure, increased clarity on the regulatory framework and better consumer protection.

This is a far cry from the crisis years, when the Kolkata-headquartered Arohan Financial Services sold 60 per cent stake to IntelleCash Microfinance Network Company, an arm of the Intellecap group.

A series of back-to-back transactions in IntelleCash and Arohan amounted to over Rs 52 crore and was facilitated by Aavishkaar Goodwell II, a fund that invests in entrepreneurial microfinance and financial inclusion businesses in India. The MFI entity continues to be called Arohan with its headquarters in Kolkata.

“You can say this is a consolidation move. MFIs stand to gain considerably from such consolidation in terms of equity, money and much more. This transaction not only gave the company a strong equity base much needed for future growth, but also deepened our management capacity. Post-consolidation, we have a strong equity base and portfolio spread across three states — Bihar, West Bengal and Assam. It has been a perfect launchpad for us. We are working towards crossing Rs 1,000 crore mark over the next five years,” says Shubhankar Sengupta, CEO of Arohan.

Indian MFIs’ first phase from 1996 to 2010 was mainly characterised by rapid expansion with micro-credit lending to small borrowers seeing a quantum jump.

The MFIs were initially supported by the state-owned Small Industries Development Bank of India (Sidbi). From 2000, MFIs began to get loans from banks under priority sector lending. By 2006, NBFCs started attracting equity investments from specialised investment vehicles and private equity funds.

Quite a handful of microfinance attracted equity investments in 2007; Spandana raised investment from JM Financial, SKS Microfinance from Sequoia Capital and Share Microfin got it from Legatum, a UAE-based investor.

The industry expects a further round of consolidation once the systems are in place. “We now see that the profile of investors in the sector is changing from growth- and return-oriented to that of long-term, patient investors. This will mean moderate growth for the sector. Capping the number of MFIs per borrower will lead to healthy competition for better alternatives. For expansion of business, MFIs will have to scout for newer geographies and reach out to the underserved and unserved areas rather than concentrating on the same location,” says Titus of Sa-Dhan.

For years, the central bank has been beating the drums of financial inclusion to keep the poor out of the clutches of moneylenders, help them gain financial stability and aid them create their livelihood. With more than 450 million people outside the formal banking system, the scope is immense. Yet, very little has happened on the ground.

The microfinance institutions now look ready to take up the challenge, having set up a well-regulated infrastructure to reach out to the ‘unserved’ and ‘underserved’ segments of society. And RBI seems to believe in them, if the bank licence to Bandhan is any indication.

In the next phase, the industry eyes opportunities in financial inclusion. Multiple players could find scope in various aspects other than the core activity of lending, like pension, insurance, remittance and financial literacy.

The MFI bill, awaiting clearance by Parliament is expected to usher in a big change in the landscape.

“Banks, banking correspondents, technology players, NGO-MFIs, NBFC-MFIs and support institutions all have roles to play. At present, there is a three-tier supervision of MFI operations. First, MFIs are self-regulating and self-restraining from unfair practices. Secondly, the association and banks are doing a rigorous checks on the code of conduct compliance and self-regulation. And finally, the RBI regulation is enforced either directly or through the banks using the priority sector guidelines,” says Titus.

Janalakshmi Financial Services was another bank licence aspirant in this round of bank licensing and the industry hopes it will get a licence too. With scaling up, other MFIs may also aspire for bank licences in the future. The developments establish the credentials of the MFI sector and its nature and intent of providing services to the poor who are otherwise deprived of financial services.

“From the customer’s perspective, it will be doorstep banking for composite financial services available to them at affordable price,” Titus says.

Some of the MFIs have already started expanding services, by offering loans for education, housing, water and sanitation facilities. “With the introduction of savings products, around 60 per cent of the total fund requirements can be met through savings, another 20 per cent could come from equity and the rest 20 per cent from bank credit. Banks would then be more comfortable lending to co­mpanies with rural customers. It will be a win-win situation for all stakeholders,” Udaia Kumar said.

A host of MFIs now want to explore the banking correspondent (BC) model as a viable business option to provide financial services to the poor. Already, industry experts say, there are SHGs and some federations piloting the BC option.

The BC model will bring about the changes that can be borrower-friendly — like reduction in the cost of borrowing, improved cash flow and developing credit history. High-tech options like mobile banking and digital financial services are also being explored.

“Right now, RBI is allowing individuals — postmen or retired school teachers — to act as BCs. But leveraging on their existing networks, MFIs can be successful in terms of scalability and for borrowers as well,” says Padmaja Reddy of Spandana.

MFIN — an industry body of 44 NBFC MFIs — feels RBI’s plan to issue licences for differentiated banking will greatly accelerate the pace of financial inclusion. “Many of the MFIs are well geared to transform themselves into regular banks. A differentiated bank licensing regime will allow NBFC-MFIs to seamlessly move into the formal banking space and further integrate themselves into the mainstream financial architecture,” says Alok Prasad, CEO of MFIN. (See full interview on Page 9)

Udaia Kumar of Share Microfinance says the banking licence to Bandhan is an important step as over 40 per cent of the population does not have banking services yet. “In unbanked areas, daily wagers have to typically forfeit to visit a bank for depositing earnings. With banks at the doorstep, it will only boost the local economies and in turn bring our vibrant resources as well.”

Bandhan, with its banking licence, can eventually bring down the cost of capital, benefiting the borrower.

“It would be a natural growth for NBFCs to turn into full-fledged banks. To make financial inclusion close to reality, one must experiment and there are a lot of aspects worth thinking about like — deposits, mobile banking, making use of existing technology, telecom, Aadhar and so on. It will be a narrow view if we look at financial inclusion only through bank accounts,” says Shamika Ravi of ISB.

All eyes are now on the new government and its political will to push through the microfinance bill.


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