CONNECTING THE DOTS…
By Sirish Dhurjety
(The author of this article, Sirish Dhurjety, is currently pursuing his Doctoral Programme focusing on impact investments in India. He is also the cofounder of a boutique investment bank – Capital Logic , based out of India. The views expressed in the below article are personal. Feedback can be sent to email@example.com )
India’s once- booming Microfinance industry has fallen into the crosshairs of the country’s murky politics. Will the industry survive and what could be the industry’s possible contours going forward?
Microfinance has been very much in the news lately. The financial markets led by savvy Private Equity funds, started taking notice of and investing in the industry’s rapid growth a few years back, culminating in the highly successful first ever IPO of an Indian MFI in August of this year. Unfortunately, the industry’s fortunes have steadily plunged downhill thereafter. This paper connects the dots of the MFI industry scenario with other key economic and political factors playing out in the country. The views discussed in this paper are strictly non-political, but are an effort to link various situations leading up to a holistic case for the future.
On the one side, most of the post crisis headline news on Microfinance (i.e. from September 2010) has been negative. ‘Getting it right on Microfinance’, ‘Microfinance in India is like subprime lending’, ‘Anatomy of a crisis’, ‘Are MFIs showing Shylockian streak?’, ‘What’s wrong with Microfinance Institutions in India?’ to name a few, paint a picture of an industry struggling to survive. On the other side, there is increasing coverage and focus on Inclusive Growth in India – meaning mainly financial inclusion, which could be a starting step for some interesting developments in the midst of the growing political controversy.
To begin with, MFI industry fortunes can only be understood with an appreciation for the effect this rapid industry growth has had, where it has increasingly impinged directly on the agenda of state and federal level politics in India.
Background of the situation
One of the key mandates of our current government is Inclusive Growth – mainly Financial Inclusion. Unfortunately, our national leaders have been spending more of their time in handling/ responding to the several multi- billion rupees scams and digesting poor electoral performance in a few key states in the country. The recent controversies in
Andhra Pradesh politics – dispute within the state, Chief Minister quitting, former Chief Minister’s son rebellious act and the MFI saga – has led to some opposition parties playing the political card by urging borrowers not to repay their loans to MFIs. Andhra Pradesh accounts for around 30% of the MFI loans in the country and has witnessed an alarming number of suicides by some debtors, purportedly due to harassment from MFI agents over repayment.
The Indian MFI industry which has close to Rs 30,000-crore in outstanding loans to 30 million borrowers is going through a rough tide and has been challenged ever since the SKS Microfinance IPO. Major Indian Public and Private Banks – State Bank of India, Bank of India, Indian Overseas Bank, Punjab National Bank, Andhra Bank, SIDBI, Axis Bank and ICICI have amongst the maximum credit exposure to MFI firms, estimated to be close to 70% of the total credit outstanding to the industry.
Some of the figures lent to MFIs by banks, according to data from a rating company, are as follows-
|SIDBI||~ Rs. 4000 crore|
|ICICI||Rs. 2000 crore|
|SBI||> Rs.1000 crore|
|Corporation Bank||~ Rs. 600 crore|
|Andhra Bank||Rs 320 crore|
Source: CARE rating
In addition to their direct lending to MFI’s, most of the public and private banks have purchased loan pools for millions of dollars from MFIs. These loan pools are also expected to be under pressure, as the securitization mechanism exposes the investors to the ultimate borrowers and a drop in repayment rates will subsequently affect them.
Public Sector —————————- Private Sector
|Bank of Baroda||Rs.1.3 crores|
|Yes Bank||Rs. 4.5 crores|
|Bank of India||Rs. 2.8 crores|
|Axis Bank||Rs. 13 crores|
|Corporation Bank||Rs. 6 crores|
|IndusInd Bank||Rs. 3.6 crores,|
|PNB||Rs. 9 crores|
|HDFC Bank||Rs. 9 crores|
|Union Bank||Rs. 2 crores|
|Kotak Mahindra Bank||Rs. 1.3 crores|
|Canara Bank||Rs. 3 crores.|
Source: Morgan Stanley Asia Pacific Report through Moneylife
Stocks of banking companies, mainly the private sector have been under pressure lately after having outperforming the market over the last few months. Banks with the highest MFI exposure have witnessed the sharpest fall in their share price in the last week. Shares of Yes Bank fell by around 10% in the three trading sessions last week, while those of Axis Bank and Oriental Bank of Commerce fell by 9% each. But even though the impact on ICICI Bank and HDFC Bank is somewhat similar to that on Axis Bank and Oriental Bank of Commerce, their shares fell at a lower rate of 6% and 3.4%, respectively.
One of main concerns of the investors is the asset quality of microfinance institutions (MFIs), which is under pressure after measures taken by the Andhra Pradesh (AP) government to tighten regulations governing the industry which challenges the existing business model – banning of the weekly collections from the borrowers. This has resulted in a sharp decline in the repayment of loans across AP and the trend is spreading across the country mainly in areas such as West Bengal, Madhya Pradesh, Orissa and Karnataka.
Source Microfinance exposure takes toll on banking stocks through Livemint
Latest Developments – the dots…
In spite of the current crisis, many MFIs have approached banks for emergency funds amounting to Rs 10,000 Cr, admitting to suffering a severe liquidity crisis. As some banks in some states have stopped lending to MFIs, many are worried that the crisis could deepen and threaten a collapse. As per Vijay Mahajan, one of the pioneers of the Indian microfinance industry in India and the President of Microfinance Institutions Network
(MFIN), the MFI industry will collapse and will be finished as early as first quarter of the coming year in case the banks decline to support and lend to the microfinance institutions because of the current environment in the MFI market.
Amid all the chaos, some of interesting developments in the economic and political environment are:
- The Union Finance Minister clearly indicating not to “strangulate” the industry and to finalize the regulatory architecture for microfinance institutions and the
‘Microfinance Bill’ by early next year
- MFI bill introduced in Andhra Pradesh assembly and Karnataka government planning to establish a state funded microfinance institution like Andhra Pradesh’s SHG-based SERP programme
- MFI regulation panel proposed by Orissa state government
- Nation’s largest lender – State Bank of India announced its 750-million euro (about Rs. 4,650 crore) five-year bond issue and also awaiting government’s nod to come out with a Rs. 20,000-crore rights issue improve its capital base sometime in late December or early next year
- Union Bank’s direct entry in the MFI business
- Axis bank’s top management’s apprehension in relation to huge exposure to the
- Major PSU Banks – Bank of Baroda and Indian Bank sign contracts with MFIs to rein interest rates, ensuring MFIs do not charge interest rates beyond a certain ceiling from their borrowers
- Corporation bank management’s mooted thought of converting the debt from
MFIs to equity, for safeguarding risks in case of default
- Indian Banks’ Association proposal for roping in “Bollywood” film stars for spreading the message of financial inclusion – to educate rural masses about the benefits of bank accounts and other financial services
- One of the leading NBFC’s from the South, Muthoot Pappachan Group has tied up with Accion of US to boost lending in microfinance sector and also in the final stages of acquiring a leading MFI player in the North
The way forward – …Connecting the dots
The microfinance industry which was considered to be an instrument in realizing the goal of financial inclusion, as they serve a segment of the population without access to banks, will certainly face regulatory headwinds. The issue is primarily whether the proposed regulations will be supportive of an industry that has emerged as a global frontrunner in combining social and economic goals – or whether they will land up throttling the industry with unviable requirements.
Snapshot of the Microfinance Industry
|Time Line – PESTEL||Past (Before crisis)||Present||Future|
|Economic (Interest)||Very High||Low||Low*|
|Social (Objective)||High||Medium||Medium / High|
|Environment (to venture into this business)||High||Low||Medium*|
* Depending on nature of regulation that emerges
Going forward, the MFI promoters as well as for the Investors might not have the best news – at least not to the extent they would have imagined couple of months back. In case the same trend continues- borrowers defaulting, very limited access to capital, regulatory risks, ratings with negative implications and political resistance, MFI’s would be faced with both solvency and liquidity challenges. An IPO exit would remain a distant dream for the players, as well as their private equity investors.
Analyzing and evaluating the sequence of events strategically, along with some crystal ball gazing, the following might be the way forward for this industry
Potential Convergence between Banks and MFIs: Although current regulations maintain a clear demarcation between scheduled commercial banks and MFIs (the large MFIs are mostly regulated as NBFCs), the mutual advantages to each other are fairly obvious. MFIs can significantly lower their cost of funds, and also remove potential hazards of dependence on institutional liquidity through conversion to a banking model; banks can get into the financial inclusion game through best practices from MFIs.
The convergence needs to be initiated through regulatory changes from the RBI, and the resulting activity could either be organic or inorganic. Though the business model is different between Banks and MFIs, there could be some interest from the Banks to acquire MFIs given their exposure to the industry and also which could give them access to new and rural parts of the country. SBI raising funds (may be part of it is to acquire MFIs), Union bank entry into this business and Corporation’s bank intention to acquire stake in MFIs might be early signs from Banks intending for consolidation in financial services space.
It might be premature to discuss the modalities of partnership at this point in time, but this idea should certainly be explored by Y.H. Malegam and team, a sub-committee appointed by RBI to study the industry and recommend ways to better its practices. This could be a win-win situation for banks, regulatory bodies and mainly the customers – provided the banks give a decent valuation for the MFIs. From the government’s perspective, this could be a one of the best strategies to fulfill the Financial Inclusion objective as well as to get the situation politically correct.
Partnership with Regional Rural Banks (RRB): As per the data till last financial year, there were 82 RRBs (with a network of 15475 branches spread over 619 districts in 26
States and 1 Union Territory), of which only 3 RRBs out of 82 RRBs were incurring losses. In addition, the RRB’s were given a target by the Finance Ministry to open 2000 branches by March 2011 with the right banking technology platform as part of their financial inclusion strategy. Partnership with MFIs could be one of the routes which could be explored by RRB’s to have better access to similar client base and to fulfill their mandate of financial inclusion
Consolidation within the MFI industry: Consolidation amongst existing MFI players could come about, in the situation that present stressed conditions continue for a further quarter or two. Larger MFIs with good balance sheet, with appetite for risk till the regulatory framework is worked out and also having the capacity digest an acquisition in this environment might look to buyout other small/medium MFIs for their customers and loan books, at distressed valuations. However, the challenges in this case as mentioned earlier remain – borrowers defaulting, very limited access to capital, regulatory risks, ratings with negative implications and political resistance.
Investments by Microfinance Investment Vehicles (MIV’s) / Impact Investors in the Indian MFI space
Investments done by Financial Investors in Indian Microfinance companies
The above tables give a brief overview of the VC/ PE investments in the Indian MFI landscape. Indian MFIs have raised more than $450 million across 66 deals from private equity investors since 2006, according to VCCEdge. Investors in the sector include international DFIs like IFC, Silicon Valley Bank to venture capital firms Sequoia Capital and Canaan Partners, social VC firms like Aavishkaar and Elevar to hedge funds like Sandstone Capital and Tree Line Asia.
Most of the marquee domestic and international investors had done multiple deals / investments in the Indian MFI. Being a capital intensive business, MFIs demand for capital is no-doubt very high. The investors were very optimistic about the growth trends and the MFIs needed more money to scale-up which resulted in multiple borrowings – both through debt and equity till September this year.
In the current environment, consolidation amongst the existing MFIs might not be a bad idea for MFIs wanting to operate on a standalone and the investee companies of same fund can explore the possibility of partnering together.
For instance, Matrix Partners – a financial investor which has invested in an NBFC (Muthoot Finance) and an MFI (Bhartiya Samruddhi Finance Limited) might look at closing an internal deal amongst its portfolio companies for their exit (Muthoot buying stake in the MFI).
The other possibilities could be Muthoot Finance acquiring Swadhaar FinServe or Saija Finance in which Accion has invested in the past. Muthoot has recently tied up with Accion to boost lending in microfinance sector, in case we were to go by the latest developments and the given situation in the market. Muthoot Finance is planning to raise at least Rs 800 crore ($178 million) from an initial public offering (IPO) soon.
Emergence of Cross – border (inbound) acquisitions / strategic partnerships: Global microfinance had around $12bn in cross-border investment by the end of 2009, up from
$4bn three years ago according to CGAP (The Consultative Group to Assist the Poor, a World Bank linked group). The first table above lists specialized microfinance investment vehicles (MIVs) like IFC, Oikocredit, Hovos, Micro Ventures and Incofin to name a few, which have investments in multiple MFIs across the globe, which may very well turn out to be the drivers for cross-border consolidation and strategic partnership so that best practices across the globe are shared and MFIs move towards higher bargaining
power in countries like India where they are currently at the mercy of politicians and bureaucrats. In addition, major international MFIs like Compartamos – a listed Mexican player may be open to exploring strategic options in India. Globally, there have been few interesting cases of cross-border acquisitions and given the current environment, Inbound M&A deals could emerge as a new trend in the Indian MFI space.
Development of non-institutional funding base: MFIs have in some cases moved beyond institutional sources of funding (primarily banks and MFs) to securitization of loans. As the current crisis demonstrates, dependence on institutional sources of funding can be a significant risk in times of stress. Going forward, larger MFIs may need to raise the bar through innovation in developing a retail bond/deposit market for raising their funding.
New Bank / Larger NBFCs and the MFI model – More than a decade after the Reserve Bank of India issued the last of the two banking licenses to private sector entities; the government has again started the process of allowing non-banking finance companies (NBFCs) to graduate to full-fledged banks. The ordinance for issuing new banking license will be considered on the thrust given to financial inclusion. The business model could be required to clearly articulate the strategy and the targets for achieving significant outreach to clientele in Tier 3 to 6 centers (i.e. in populations less than 50000) especially in the under banked regions of the country either through branches or branchless models
– which indeed could be good fit for them to invest/ partner with existing MFI’s – though the model is different from banking, the partnership could create a base by providing better understanding of the market and have live business from the starting point. Reliance Capital, Mahindra, Religare enterprises, Cholamandalam and Tata Finance have already expressed their interest in acquiring a banking license, of which Reliance Capital has already invested in MFI space in India.
Pure Political Card aka Prepare for More Regulation! – This could be the best part and the might be the best weapon for the existing government to win hearts and gain votes. The cynical view is that the ground situation in AP could very well move towards
waiver of MFI loans as a means of creating a vote bank for parties – and that the politician / bureaucrat nexus in the state would not mind killing the MFI industry for its own benefit. Last year, the government announced farm loan waiver of Rs. 72,000 crore during the budget and this year it might be to waive off the MFI loans which will certainly form a solid platform for the general elections in 2013. In this case we are discussing about close to Rs 30,000-crore in outstanding loans for 30 million votes. In addition, the objective of Financial Inclusion is fulfilled – sounds like a good deal to me. Borrowers or Aam Aadmi (which means “Common Man” in Hindi) is safe and situation is politically correct. Thus proving the philosophy that most of the politicians who run this country follow “As long as the general public is given what they want, we (politicians) get what we want”
Thankfully sanity might prevail at the federal/national level,and through recommendations from the Malegam committee. What cannot be escaped is that the industry will be regulated more tightly – maybe in the form of interest rate caps, stronger criteria and diligence for disbursement, less aggressive collections methods. At the end of the day, what is required is a set of regulations that reasonably protect the borrower/consumer, and at the same time ensure continued growth and innovation in an industry that has emerged as a global leader in combining societal and community impact objectives with commercial and entrepreneurial drive sourced from the corporate world.
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