There has been a swelling debate around the original intent of microfinance organizations centered around social good, and the recent “commercialization” of the model as evident in private fund raising, and promoters and PE funds making windfall gains in public markets.
The article here by Elisabeth Rhyne seems to advance a great argument for the golden mean. Let social and governmental efforts push the frontier and take risks that private capital will not take today (that is where the market failure exists) and let private capital deal with everything that is inside the frontier. Over time, for a sustainable structure to exist, more and more of the space should get folded within the frontier, and that would be a great development for the sector.
There has also been a perception amongst regulators and some microfinance players on the non-profit side that promoters and investors are making huge gains at the cost of poor people who are being charged exorbitant rates. The argument seems to be flawed on various counts.
First, worldwide data available on credible sources such as MIX market show that privately funded microfinance organizations are operationally more efficient compared to non-profit ones. This efficiency is being created by great management teams that are being attracted to the sector by a combination of social good and personal value creation potential. This efficiency creates value that gets shared between the poor customers (in form of lower interest rates) and the promoters/shareholders (in form of profitability).
Second, influx of private capital actually allows the sector to grow at a much faster pace than is possible otherwise. Hence more poor people get the benefit of such services.
Third, private equity is a very fragmented space, and genuine competition exists amongst PE firms. When some of the PE firms invested in this space years back, the risk perception of the sector was very high, and that risk has played out in the right direction. Because of that, the risk perception now is lowered, and capital is available at a lower cost (read, high valuations.) This capital formation allows newer MFIs to raise capital at much more attractive terms. In other words, it is erroneous to judge today’s returns against the risk perception today – it needs to be judged against the risk perception that existed when the money was invested. As a corollary, going forward, the relative returns on standard MFIs will be lower, because the risks are somewhat mitigated. In Rhyne’s words, the standard MFI play has been folded into the frontier, and the frontier is now pushing for newer markets and newer products.
Its ironical, but the greatest service that regulators can do to the sector, and to poor customers of MFI companies, is to provide regulatory clarity around the sector, so that risk perceptions reduce further, and poor people can realize the gains from availability of even cheaper capital.
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Then you always end up meeting friends of friends and finding out you have other friends in common.
Seeking to control MFI interest rates because it taps priority sector lending channels of Banks is like asking corporate houses to cap their export profit margins because they too draw Export credit that falls under the PSL category…Not awkward enough…?
Buffer built by MFIs also go towards extended supply chain initiatives like servicing the consumer product needs of the poor using the same network that gets established for pureplay money lending…
If the govt still insists on MFI curbs, relatively less harmful option may be a cap on MFI dividends to shareholders since profits plowed back into expansion benefits new borrowers. This will still discriminate against MFIs since even large corporates hardly promote financial inclusion, yet face no dividend cap.
With MFIs in India the issues are also around what qualifies as priority sector lending (so banks can lend MFIs money to meet PSL quotas) and whether MFIs can take deposits (which will negate the need for expensive bank loans for the MFIs)
The argument that the MFIs are making high profits is ridiculous, since the alternative is way too high an interest rate. On the other hand, they tend to fund only income generating sources, but we are going to reach a scale where debt will be needed against collateral (which still goes to the moneylenders for say a marriage or education).
Still, that’s no reason an investor should not exit the business at a profit just when there are other investors willing to pay much higher prices; that they exit at a profit is not about them looting investors, it’s a function of the greater fool theory. Okay, not politically correct, but Reliance Power did that too, as did many government IPOs recently. In fact, if anyone’s really looted the poor man, it has been the recent PSU IPOs like NTPC and NHPC, where they used public sector money from other PSUs to garner subscription. That money could have been lent to poor people at affordable rates too, for arguably a far greater return.
In general I’d ignore the arguments about usury, and focus on the real problems MFIs face – overindebted consumers, debt rollovers to hide NPAs, or crisis management. I remember us discussing angel convertible debt at 30% to startups – the effective interest rate charged by MFIs is far lesser.
Triple Whammy – Regulatory Risk, Credit Risk & Political Risk.
A.> Microfinance (MFIs) in India are built on Government SUBSIDY:
1. Each Bank Lends to MFIs only because it qualifies as Priority Sector Lending i.e. PSL (1 of the some 60 such qualifying areas as per RBI)
2. Each bank also seeks NABARD refinance on the money lent to an MFI, in turn getting a lower CoF from its treasury.
3. By 1. & 2. The Risk-Return equation becomes justified for a bank to lend to an MFI.
4. RBI has set up the VK Sharma committee to assess whether lending to MFI by bank should be PSL
5. In case the PSL qualification were to be removed by RBI., no bank would chase MFIs. MFIs would chase banks.
6. High probability of 5. Happening
7. If 5. Happens, would lead to a serious refinancing crisis for MFIs
1. Additionally, things have changed in the past 2-3 years. Looming Credit Risk and losses:
2. Thinning line of difference between consumer finance and microfinance
3. MFIs have increased the loan sizes by 300-600%. ( From 5K to 25K)
4. MFIs earlier lent for productive purposes, now they don’t care. ( competition is intense)
5. In pockets upto 16 MFIs present leading to rampant multiple borrowing by clients, rampant over leveraging
6. Penguin Effect: All biggies jumping in – Reliance, L&T, Aditya Birla etc.
B.> Political Risk:
1.> Google: Kolar + Microfinance
2.> The end microcredit clients form the precious vote bank.
3.> A large %age of clients belong to a certain religion, where interest is evil.