Serving The Underserved
There are more than 70 million households in India earning less than $1 a day. To make a living, they need as much as Rs 1 lakh crore in credit. Problem: There's a yawning gap between demand and supply.

SKS Microfinance's Vikram Akula, who has disbursed Rs 484 crore, believes anyone unserved and underserved by banks can become a microfinance customer

The demand for credit from people earning less than $1 a day could be double the estimated Rs 50,000 crore

Five years ago, Chivukula Vijayalaxmi, 49, sensed a market for rexine Bible covers. So, raising a micro loan of Rs 6,000 from Share Microfin, she got hold of a sewing machine and put up a board outside her house in L.B. Nagar in suburban Hyderabad that simply said, 'Vijayalaxmi Rexine Works'. Today, she is busy setting up a shop backed by another loan from Share, but not so micro this time around-it amounts to Rs 50,000-and has a marketing 'team' that comprises two of her sons and vends everything from Bible covers to school bags to raincoats.

Some 1,500 km east from where Vijayalaxmi resides, lives of the poorest people are similarly changing. People like Rupa Bera, 30, of Bagnan, a far-flung area of Howrah. Until three years ago, Bera was living in abject poverty with their only son. Bera's husband had once tried to start some business of his own, but without success. The hardest part for the man was raising working capital. He approached various banks and other sources, but met with no luck. Then, one day, loan officers from Bandhan, a microfinance institution (MFI), came calling. Bera liked the terms at which Bandhan was offering credit, and signed up for a Rs 3,000 loan in Feburary 2003. Bera's husband turned a contractor with this money, and they haven't looked back since. A part of the extra income is now being used to send their son to school and ensure proper medical care for the family.

Vijayalaxmi and Bera are just two of the millions whose lives are getting transformed thanks to microfinance. Last financial year alone, nearly 1.5 crore of India's poor received Rs 6,500 crore in micro loans. Yet, that's just a drop in the ocean. There are about 200 million households, or a staggering 800 million people, who have no access to banks or formal financial services. The demand for credit from people earning less than $1 a day has often been estimated at Rs 50,000 crore, but more recent studies say that the actual number could be double of that. "A back-of-the-envelope calculation would suggest that anywhere between Rs 2,000 crore and Rs 4,000 crore is going into individual lending, but there is a huge potential for this to grow," says Vikram Akula, Founder & CEO, SKS Microfinance. Agrees G. Padmaja Reddy, founding director of Spandana, a Hyderabad-based MFI: "The scope for microfinance is much larger than what we understand today. Whoever is unserved and underserved by banks can really become a microfinance client."

Last financial year alone, nearly 1.5 crore of India's poor received Rs 6,500 crore in micro loans. Vijayalaxmi (R) started with Rs 6,000 and is now setting up her own shop

Currently, there are about 800 MFIs and 22 lakh government-backed self-help groups (SHGs) that are the principal sources of microfinance. The latter is typically an informal association of 10-20 poor women who contribute small amounts into a savings pool. After saving regularly for six months, lending small amounts and maintaining accounts, an SHG becomes eligible to be 'linked' to a bank, which opens a savings bank account for the SHG and offers loans up to four times the group's savings. The SHG can then on-lend the money to its members, helping them to engage in some income generation activities. The MFIs, on the other hand, comprise a mélange of NGOs, NBFCs, Section 25 companies (which are treated as charities that cannot distribute profits to sponsors), and cooperatives (like SEWA in Gujarat). Unlike the SHGs, which tap funds from public sector banks, MFIs draw their capital mostly from private banks, SIDBI, and foreign investors. (Akula's SKS, for instance, has Silicon Valley venture capitalist, Vinod Khosla, as one of its investors.) Currently, the average loan size for an SHG is less than Rs 4,000 and for an MFI, about Rs 5,000.

Good Idea, Poor Milieu

Despite putting credit within the reach of millions of unserved consumers, MFIs are in the middle of a crisis, which can be traced back to a series of events that began unfolding from Andhra Pradesh's Krishna district in March 2006. Early that month, the district collector raided offices of Spandana and Share (two of the largest MFIs in the country) and shuttered 57 of their branches, besides those of some smaller MFIs. What prompted the move? Alleged malpractices in the industry, including usurious rates of interest. Soon, the issue snowballed into a crisis, with the state threatening to put caps on lending rates and the Reserve Bank of India issuing a code of conduct for NBFC-MFIs. Now, the central government is working on a Microfinance Bill, which was approved by the Cabinet on December 7, and is likely to be introduced in the current session of Parliament.

While there's no doubt that some MFIs use questionable tactics to recover loans, the politically-charged issue fails to understand the root cause of the problem-money. According to an industry study by Prabhu Ghate, a former bureaucrat, the cost of funds for MFIs works out to 21-24 per cent, although the SBI prime lending rate is about 9 per cent. Here's why: the cost of credit delivery and collection of payment adds 5 per cent each, while the cost of provisioning for bad debts and capital adequacy requirements add another 1-3 per cent each. Not surprisingly, Spandana's and Share's effective rates before the Krishna district crackdown, writes Ghate, were 31 per cent and 28 per cent, respectively. Interestingly enough, these rates are not very different from what the SHGs, which are considered more empowering and participatory, charge. And compared to the local money lenders, the MFIs charge less than half.

Clearly, there's a problem with the cost structure. And, unfortunately, a large part of the problem can be attributed to the absence of a proper regulatory framework. For instance, MFIs, unless they are mutual- or member-owned outfits, cannot collect savings as deposits, which are one of the cheapest sources of funds. Instead, they must depend on bank borrowings for lending onwards. Says SKS' Akula: "If we are allowed to take deposits, we would be able to slash the interest rates on our loans by about 5-6 per cent."

As a result, Indian MFIs have the highest financial expense ratio (8.5 per cent) in the world. So, how have the MFIs been able to grow at a furious pace? Thanks to private banks, which initially started lending to them to meet their priority sector obligations, but soon realised that microfinance could be a lucrative segment. Says J. S. Tomar, Managing Director of Varanasi-based Cashpor Micro Credit, which operates in eastern Uttar Pradesh and Bihar: "Banks see a huge market in micro-borrowers in rural areas because the urban markets are becoming increasingly competitive." (That also explains why VCs such as Hyderabad-based Bellwether, Mauritius-based Lok Capital and us-based Unitus Equity Fund are investing in MFIs.) ICICI Bank, for example, has funded more than 100 MFIs with an exposure of Rs 2,350 crore.

But since most of the MFIs don't have equity enough to take on debt directly on their books, ICICI Bank pioneered a 'partnership model', where the loans remain on the bank's books and the MFI does, for a fee, everything from loan origination to monitoring to collection. However, the MFI has to guarantee the bank against default (subject to a limit). That, again, becomes a limiting factor, since not all MFIs have the wherewithal to offer guarantees. In 2004, RBI allowed MFIs to act as financial intermediaries, or business correspondents, but added certain riders that made the move a non-starter. For instance, it barred banks from charging more than the PLR (prime lending rate) on loans of less than Rs 2 lakh and any commissions on those less than Rs 25,000. That apart, the MFIs were barred from charging any fee to the customers. Currently, the central bank is finalising the eligibility criteria for NBFCs and has asked banks not to select any business correspondents from among NBFCs.

Need to Get Organised

In a bid to streamline the industry, Sa-Dhan, an apex association of MFIs, has set performance standards under three heads-sustainability, asset quality, and efficiency-and is urging its members to accept them. And according to Mathew Titus, Executive Director, Sa-Dhan, it is also working with the Institute of Chartered Accountants of India (ICAI) on implementing disclosure and reporting standards for the sector. "MFIs need to improve their compliance with disclosure and reporting norms and bring transparency (especially after the Andhra incident)," says Ghate in his report. CRISIL and M-Cril have also started a regular rating programme, funded by SIDBI, for MFIs, and have rated more than 120 of them so far.

On its part, ICICI Bank, led by its Deputy Managing Director, Nachiket Mor, has been pushing MFIs to consider moving to the next level, where they will be able to offer bigger loans to not just the most needy, but also those who are better placed but need money to, say, start an enterprise, buy tractors, or even small houses. Mor even has a name for this new type of MFI: community development finance institutions (CDFIs). "In order to become CDFIs, the MFIs will have to build capabilities in core banking and finance, including risk management, and cash flow analysis for projects and securitisation," says Mor.

Meanwhile, some of the bigger MFIs have realised that they need to innovate in terms of loan products and services. Akula's SKS, for instance, plans to tie up with retailers to help them tap rural consumers. This is how the model could work: the retailers will sell goods to SKS clients but get paid by SKS. The clients, in turn, will make weekly payments to SKS. Other MFIs are talking of dozens of other products, including insurance products, education loans, housing loans and small business loans (for petty traders).

A lot of how the industry evolves will depend on the forthcoming Microfinance Bill. It would be unfortunate if the authorities were to let isolated incidents (like the one in Krishna district) curb the spread of microfinance. There are millions of Indians in desperate need of credit, and their interests are best served by helping the industry become more robust, and not by shutting it down.