Sunday, November 29, 2009

The biggest debate of Indian Microfinance Sector: Microfinance in India - In Stable Orbit

Original article published in Microfinance Insights
When the Wall Street Journal (WSJ) starts publishing poorly researched, sensationalized articles about Indian microfinance institutions (MFIs) and senior analysts from major investment banks begin to call Indian microfinance assets “sub-prime,” it is time to put things in perspective. In Hindi, there is a proverb, “Doodh ka jala chhach bhi phook phook kar peeta hai.” (“A person who has burnt his mouth drinking hot milk, tends to blow even at buttermilk,” or simply, “Once bitten, twice shy.”) Granted, the WSJ and investment banks have just emerged from an unprecedented financial meltdown. They are entitled to be cautious, even dark in their forecasts. In this case, however, they're jumping on the wrong bandwagon.
An August 13, 2009 WSJ article claimed that the growth rate of MFIs is abnormally high. However, when compared with other sectors in the Indian economy, microfinance is one of many industries that are growing at a searing pace. In a decade, the number of mobile phones has grown from zero to 400 million. The Indian mobile phone market continues to add more than 10 million new connections a month. The insurance sector has grown at 37% annually since doors were opened to private insurance companies. The microfinance sector's high rate of growth represents supply catching up with decades of unmet demand.
All big MFIs—the ones that are driving these strong growth rates—have mastered their methodology. Their systems in the areas of hiring and training staff, customer acquisition, portfolio tracking and fund mobilization are now managed by professionals with experience in the financial sector. Product diversification is becoming the norm, although most MFIs are still offering variants of the basic Grameen Bank weekly-repayment loan model. Most MFIs have started offering life insurance linked to loans while some also offer stand-alone life and health insurance products. These products protect borrowers, and in turn, MFIs.
Additionally, most big MFIs have now transformed into non-banking finance companies (NBFCs), registered with the Reserve Bank of India (RBI). They are subject to norms that include capital adequacy (10% at present, slated to go up to 12% in April 2010 and 15% in April 2011). As MFIs have had to raise capital from diverse sources, they now have boards quite involved with operational oversight— yet another check on MFIs and the sector at large.
Although some regions have seen mass default by a class of borrowers, such as the Kolar district in Karnataka, overall portfolio quality has remained strong, with only about 1% to 2% of loans overdue beyond 90 days. This number is now much more reliable, because almost all major MFIs have a computerized portfolio tracking system audited by reputed firms. The MFIs are also watched closely by banks since some of the MFIs’ portfolios are assigned to these banks.
What is partly true is that poor households are borrowing beyond their means because loans are easily available. This has been a cause for concern, mainly because most Indian MFIs (with some exceptions) use the Grameen Bank weekly repayment model. However, MFIs are learning quickly and, apart from changing internal policies and incentive structures for field staff, they’re also getting together to establish credit-information sharing forums.
Having said this, there are several actions stakeholders within the microfinance ecosystem need to take to move forward. It will take efforts by MFIs, investors, bankers, regulators and apex bodies, nationally and internationally to steer the sector in the right direction.
At the household level, there should be a push to build greater financial literacy, so customers know the consequences of overborrowing and the benefits of savings and insurance in adversity.
MFIs also need to review their staff incentive systems and attempt to prevent irresponsible lending.
The onus does not fall only on the MFIs. Lending banks also need to exercise discipline by insisting that MFIs incentivize staff to do responsible lending and follow consumer protection norms. Banks also need to strengthen their monitoring mechanisms.
As investors become more familiar with the sector, they are becoming more realistic in their return-on-investment(ROI) expectations. Investors on the boards of MFIs must play an institution-building role for their own long-term benefit.
On the regulatory front, the RBI has enhanced its supervision of larger microfinance NBFCs by seeking monthly returns from the “systemically important” ones and by conducting on-site inspections. The RBI needs to simultaneously enhance the protection of regulated microfinance NBFCs from arbitrary action by district and state government authorities.
Attention must also be focused on MFIs that have not yet transformed into NBFCs. The Micro Finance Bill drafted in 2007 covers only NGOs and needs to be redrafted. Loan waivers and interest subsidies tend to cause credit indiscipline and distort the market. Instead, the Indian government could offer support to MFIs working in the 300 districts with low financial inclusion.
To close where we began, CGAP and other organizations should educate the likes of the WSJ and the investment banks to stop sensationalizing small incidents and get on board with the one part of the financial sector that is working – microfinance in India.


Arthi said...

Interesting blog post Praveen. RangDe( is a non profit peer to peer lending portal that micro loans to entrepreneurs in rural communities. Please visit us to learn how we work.

Would like to invite you to post your thoughts on peer to peer lending in India.

Arthi said...

You can write to me at and let me know if you would like to write a blog post for our official blog.