Micro Finance Institutions of Inida – Saviours or Rent Seekers ?

The Microfinance (MFI) industry in India has grown rapidly over the last 3-4 years and as per latest estimates the total credit outstanding in this industry stands at Rs 12000 Crores and is growing at the rate of over 90% per annum. The repayment rate of MFI’s is an amazing 98%.

Generally MFI’s are praised for being the saviors of the downtrodden and providers of capital to those who do not have access to the formal banking system and were in the hands of unscrupulous moneylenders in rural and semi urban areas. However as it turns out MFI’s seem to be no different from these as they are lending at extremely high rates of interest and getting extremely cheap funding in the form of priority sector funding from the banking industry who are lagging behind in terms of their targets at rates as low as 9% going upto around 11-12%. Such portfolio buyouts in recent times have also happened at rates as low as 8-10%.

Huge amount of Private Equity money has flown into this business with investors smelling a goldmine as such huge return on capital is very difficult to achieve in most other businesses. As such the promoters of these companies today have cheap equity capital in the form of huge amount of private equity money, cheap debt funding from banks and lending rates that vary on an average between 22-24%. As per some sources in the banking industry the lending rates go upto as high as 30-36%.

Given the fact that Indians in general do not like to take loans and in a majority of cases are not willful defaulters the rate of delinquencies continues to be very low. As such with lax regulation on lending rates, low NPA’s and cheap funding the returns in the business are extremely high. Taking a 15% capital adequacy ratio, the leverage available in the business is around 6 times. Assuming a cost of funds of 10% and an average lending rate of 25% this business today is a 100% RONW business. This combined with the high growth rates of the business is taking the valuations of the businesses and the promoters of the companies’ sky high. Private equity investors are estimated to have invested around Rs 2000 Crores in these businesses as on date.

Even in countries like Bangladesh the lending rates of MFI’s are much lower than in India. In countries like Brazil there is a cap on the rate at which money can be lent by such companies. I believe that RBI should come out with some regulations for such Institutions where if they are relying on bank funding for their lending activities then there should be a cap on the spread that they can charge over the money lent to them by the banking system.

The rate of interest of MFI’s in some countries are

Bangladesh —–8 to 22%

Brazil —–12%

India —–25-30%

Infact the huge success of the MFI’s is actually a failure of the banking system where they have not been able to reach out to the poor and lower middle class for satisfying their fund requirements. Today we have cooperative banks and Public Sector Bank branches all across even in small rural hamlets. However these are not interested in maybe small ticket size loans or providing unsecured credit which they will need to monitor closely. Frankly there also is no real incentive for most PSU banks to take such risks which require active monitoring as they are not going to be rewarded if money is made but if NPA’s shoot up then they will always be questioned for that.

Typically the operating costs for MFI’s tends to be low and as such most of the net interest margin becomes the profit. Given the fact that MFI’s are no longer small with the largest MFI nearing USD 1 billion in disbursements there is today a strong need for proper regulation of such entities and also ensuring that they do not become profiteering machines.