Unifi Corporate Profile

Monday, June 4, 2012

Policy Fallacy in Indian Microfinance

A snippet on State Intervention and the resultant Mockery

Financial inclusion and access to finance has been one of the large failure stories of the Indian state intervention. India’s policy thrust for financial inclusion has always been well intentioned with the apex bank pushing for easy capital availability through a slew of policy initiatives; however capital delivery has consistently evaded the target segments. While the Regional Rural Banks have failed to grow without sponsorship of large state owned banks, priority sector lending initiatives have largely been conducted as a top down policy-fulfillment objective rather than a need based bottom up approach. This effectively fuelled the rise of informal sources of finance at costs that have had the exactly opposite effect of achieving financial security, low cost of credit and inclusion.
The Indian private sector after a much wait and watch approach and buoyed by the global success of micro credit loans in the rest of the world stepped in to full fill the role of financial inclusion at an institutional level. Today, India has around 200 million bank account holders and far fewer numbers who access other formal financial services like credit and insurance. A study conducted by the Centre for Microfinance in Andhra Pradesh in 2009-2010 revealed that 93% of the surveyed households were indebted. 75 % of these households were indebted to moneylenders and other informal sources of finance in-spite of fairly high penetration of banking among these households. Micro finance Institutions accounted for 11% of the indebtedness. (Source: Access to Finance in AP, Doug Johnson, Sushmita Meka)

The Indian Microfinance industry (MFI) represented the middle ground between formal financial services provided by banks and informal financial services provided by moneylenders. The industry grew rapidly in the period 2004-2009, with an average increase in number of clients year-on-year being 91%, while the size of micro credit outstanding grew by almost 100% Y-o-Y indicating the massive levels of under penetration to a large part of the Indian population (source: ‘Inverting the Pyramid’, Third Edition, Intellecap Publication). The business models of microfinance also evolved in this period to become businesses which seek capital from the formal sources and lend to the poor at a margin as opposed to the non-profit model earlier.

This period of high growth was accompanied by a barrage of private equity investments chasing established as well as start up microfinance operations. One of the pit falls of the break neck speed at which micro credit grew, was an inherent oversight in capping credit to customer who have borrowed credit from multiple sources. This resulted in multiple refinancing to the same customer resulting in repayment stress and leading to a few cases of personal extremities; an apt calling card for political intervention. Accompanying these events was a two pronged media coverage highlighting (a) the new and seemingly limitless investment & profit opportunity keeping in perspective India’s unbanked population and (b) the anti-thesis to such investments – financial strangulation of the poor. While both arguments had its merits, the second parameter was again an opportune moment for a bit of political mediation. Only, it did not remain confined to a bit.
This period of high growth came to a halt in Oct 2010 with the passing of the Andhra Pradesh Microfinance regulation act. Spurred on by allegations of unfair lending practices and exploitative debt recovery, the AP government, without adherence to what may have been sporadic cases of poor lending, clamped down on the entire microfinance industry in the State. Borrowers across the State sensing social and political sympathy sensed an opportune moment to default thus throwing the entire industry in a tizzy – among others, micro credit leaders SKS Microfinance and Spandana saw serious depletion of their networth and ability to continue. This opened the floodgates of regulation – the Microfinance Institutions (Development and Regulation) Bill 2011 - which was provisionally approved by the cabinet. The bill seeks to handle regulation of MFI's to the RBI and address multiple issues like prudential regulation and registration of MFI's . As per the draft, it would be mandatory for micro finance institutions (MFI) to be registered with the Reserve Bank and have a minimum net-owned funds of Rs 5 lakh. In addition, a Micro-Finance Development Council will be set up to advice the government on formulation of policies, schemes and other measures required in the interest of orderly growth and development of the sector with a view to promote financial inclusion. 

The bill is a classic example of "well intentioned" government intervention in a sector where a market failure has not been conclusively demonstrated. While it provides for certain broad controls and regulation, it fails to answer the question that led to the industry in the first place: what is the policy stance on ensuring credit delivery to the rural and urban poor?
Vinod Kothari, a micro credit securitization expert writes: The word “micro credit” itself is not defined. First of all, there is no monetary limit to the definition of micro credit provided in the law – that is, loans of what amount are “micro credit”, and beyond what amount they cease to be micro credit. Neither is there a definition by reference to who the borrower is - that is, whether loans to rural or urban or both borrowers would be micro credit. It is a surprise how the regulator skipped defining a parameter as rudimentary as this. The cause effect of this will now be regulatory stringency in determining who is a Microfinance NBFC and who is not a Microfinance NBFC – creating another set of regulatory confusion without addressing the core question of how do we deliver cheap credit to the poor.
On another note, the applicability of prudential norms to micro finance institutions also gives away the poor understanding law makers have of MFI's as a business. MFI's unlike thrifts or banks do not incur asset liability mismatches which are very large. The institutions they borrow from are already prudentially regulated and by increasing level of prudential regulation of MFI's the government is increasing the cost of MFI business adversely impacting their capacity to raise credit.
The MFI industry has shown a 20% decline since the AP ordinance. The impact on large MFI's is much more as they have not been able to access credit and they have shrunk in size. As a result, the broader policy questions remain to be asked: What has the regulator done to reign in larger unorganized money lending industry targeting the rural and urban?
While the Central Government’s Credit Guarantee Fund Trust for Micro and Small enterprises (they essentially provide collateral free lending for small sums of money – from zero to Rs.10 Lakhs) is a strong initiative in enabling formal credit to small and tiny enterprises, the Government needs to replicate a similar initiative one step below the tiny enterprises to ensure delivery of affordable credit to the unbanked population – a crucial step in ensuring the delivery of the great Indian demographic dividend.

(Funding to the microfinance sector: Review of options Guest Article by : Jayshree Venkatesan, CEO, IFMR Mezzanine and Vineet Sukumar, Head, Treasury and Origination, IFMR Capital)

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