125 At the Crossroads

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					          At the Crossroads
                                                                                        ICRA BULLETIN

          Microfinance in India                                                               &
                                                                                             J U L Y . 2 0 1 1


           As of early 2011, the microfinance industry in India, one of the
                                                                                       This paper sketches
largest in the world, is facing a moment of reckoning. The recent developments
                                                                                         the background of
in Andhra Pradesh, the cradle of microfinance in India, have stamped the
future of the sector with a huge question mark. This paper sketches the                    the microfinance
background of the microfinance movement in India as well as its current
geographical distribution and outreach; chief models and major players; and,             movement in India
finally, the economics of interest rates in the sector. It discusses the offerings
made by Microfinance Institutions (MFIs) ranging from simply credit to other           as well as its current
financial services to a plethora of social services packaged with microfinance
and the effect this has on interest rates. It discusses briefly the tension between            geographical
the twin objectives of profitability and development and how this is tackled
differently in profit-oriented MFIs versus non-profits, and outlines the role of
                                                                                            distribution and
government in the microfinance movement in India. The recent events in
                                                                                             outreach; chief
Andhra Pradesh, their rationale, fallout and implications in the larger context,
are discussed.                                                                           models and major
         Introduction                                                                  players; and, finally,
        The microfinance industry in India, one of the largest in the
world, is facing a moment of reckoning today. From roots going as far                     the economics of
back as the 1970s, the sector had come to prominence and
demonstrated spectacular growth in the last decade and a half.                                 interest rates
According to the Finance ministry’s mid-year analysis of the financial
year 2010–11, the combined micro credit outstanding in India is                                in the sector.
estimated at US$6.7 billion with nearly 30 million beneficiaries.
Growth in MFIs’ activities had reached year-on-year rates of 70–80 per

          * The authors would like to thank Kanika Chawla, Ranjan Nayak and
Sesha Sairam for excellent assistance. The responsibility for the errors and
shortcomings rests with the authors alone. The authors, both at the Indian School of
Business, Hyderabad, can be contacted at rajesh_chakrabarti@isb.edu and
shamika_ravi@isb.edu, respectively.                                                                  125
 ICRA BULLETIN             cent—with some 62 per cent growth in unique clients and 88 per cent
                           per annum growth in terms of portfolio—over the past five years. It has
       &                   been widely heralded in academia, government and international
                           development circles alike as the solution with the greatest promise of
         Finance           poverty reduction and financial inclusion. At the same time, it has also
                           emerged as a major profit centre activity with private equity
       J U L Y . 2 0 1 1
                           institutions reportedly investing US$500 million in the last two years.1
                                    And yet the recent developments in Andhra Pradesh, the heart
                           of microfinance in India, have indeed stamped the future of the sector
                           with a huge question mark. The government’s resolution, coming in the
                           wake of close to 30 farmer suicides in various parts of the state
The combined micro
                           allegedly linked to recovery pressures of microcredit providers, has
credit outstanding in      made it extremely difficult for private microfinance players to carry out
                           their daily operations. Recovery rates have slumped from near perfect
India is estimated at      to below 30 per cent in many cases. In a broader context, the move has
                           created policy uncertainty about the sector in general and almost
US$6.7 billion with        overnight transformed the image of MFIs from that of saviours of the
                           poor to unfeeling usurers. The RBI report submitted by Mr. Y.H.
nearly 30 million          Malegam has sought to bring some clarity but the matter remains far
                           from settled.
beneficiaries.                      Only weeks before the Andhra Pradesh ordinance, Hyderabad-
                           based SKS Microfinance had carried out the wildly successful first-ever
Growth in MFIs’            IPO by an MFI in India. The turn of events leading both to the SKS
                           issue and the Andhra Pradesh ordinance have posed several questions
activities had
                           about the microfinance sector in India, many of which are perennial
reached year-on-           issues that the industry has had to grapple with around the world. As
                           microfinance supposedly seeks to “end poverty through profitability”,
year growth rates of       to quote the subtitle of SKS founder Vikram Akula’s recent book, where
                           does the emphasis lie? Do the different models of microfinance—self-
70–80%—with                help groups versus group-lending versus individual lending—differ in
                           their stress? Clearly, private equity funds that have been falling over
some 62% growth            one another to invest in profitable MFIs have high returns on their
                           minds. On the other hand, there is wide recognition of the changes that
in unique clients          the sector has brought in the lives of millions. And yet most anecdotes
                           stress the effect of micro-loans. What other offerings—micro-insurance
and 88% per annum
                           and micro-advisory services, for instance—could be more welfare
growth in terms of         enhancing?
                                    Interest rates in the sector frequently exceed 25 per cent. The
portfolio—over the         justification commonly provided runs in terms of higher information
                           and transaction costs of micro-lending on the one hand, and the much
past five years.           higher rates charged by the only alternative source of finance, money-
                           lenders, on the other. But are the margins commensurate with these
                           explanations? Do small private players play by a different set of rules
                           than the major banks—often the public-sector ones—in this matter?

126                                1   Finance Ministry (2010).
         For sure, like any other industry, the microfinance industry        ICRA BULLETIN

encompasses significant heterogeneity in players and practices;
universal conclusions are hard to come by. Nevertheless, a better
understanding of these issues requires both an appreciation of the                 &
background and evolution of the industry in India—as it involves                    Finance
unique features like the mix of private and government roles in its
                                                                                  J U L Y . 2 0 1 1
spread and growth—as well as the issues affecting MFIs elsewhere in
the world. That, indeed, is an objective of this paper.
         The rest of the paper is structured as follows. The next section
sketches the background of the microfinance movement in India
including its origins and rationale, expansion, evolution, and growth as
                                                                               Microfinance is a
well as its current geographical distribution and outreach; chief models
and major players; and, finally, the economics of interest rates in the             process that
sector. The third section covers the offerings made by MFIs ranging
from simply credit to other financial services to a plethora of social         includes financial
services packaged with microfinance and the effect this has on interest
rates. The fourth section covers the quintessential tension between the      intermediation such
twin objectives of profitability and development and how this is tackled
differently in profit-oriented MFIs versus non-profits—both world-wide       as supplying credit,
as well as in India. The fifth section discusses the role of government in
the microfinance movement in India in both its regulatory role as well              savings and
as a major player. The sixth section narrates the recent events in
Andhra Pradesh, their rationale and implications. The seventh and final
                                                                             insurance products
section concludes with underlining the broad contours of the current
                                                                             with a goal towards
controversy, the resulting uncertainty about the industry’s future and
what it means in the larger context.                                                       social
        Microfinance in India: A Brief Background                            intermediation such
         Microfinance has been described as the provision of financial
services to those excluded from the formal financial system. It is a         as reducing poverty
process that includes financial intermediation such as supplying credit,
savings and insurance products with a goal towards social                          and enabling
intermediation such as reducing poverty and enabling empowerment.
Until the late nineties, it was commonly believed that the poor are              empowerment.
“unbankable”. This was because they lack collateral, which is a pre-
requisite for accessing all forms of formal finance. So, for generations,
poverty reproduced poverty. Microfinance thus emerged as a tool for
breaking this vicious cycle as it does not require any collateral. And
there lies the wider appeal of microfinance as a way of doing business
with the population that was considered “unbankable”.
         Before microfinance entered the low income segment of the
finance market, there were essentially only two sources of credit for the
poor. The first were the informal commercial lenders, including
moneylenders, traders and landlords. The second source of credit
consisted of the state owned banks such as Regional Rural Banks and
specialised schemes such as Integrated Rural Development Programme.
The informal commercial lenders are characterised by easy access but                      127
 ICRA BULLETIN              very high interest rates. The state owned banks, on the other hand,
                            aimed at targeted lending through heavily subsidised schemes that were
        &                   eventually siphoned off by local elites and educated households. This
                            led to high default rates and high arrears and the banks suffered large
          Finance           losses. Microfinance was therefore well positioned to fill this gap
                            between the large loss making subsidised state schemes and expensive
        J U L Y . 2 0 1 1
                            and sometimes exploitative informal lenders.
                                     There is another way to understand why microfinance is a
                            natural way to improve access to finance for low income households.
                            Informal lenders have rich information about these households and
                            therefore effective means of enforcing repayments. But they are limited
Microfinance is seen
                            in their resources. These are typically small jewellery shop owners or
as a way to bridge          traders who operate on a small scale. The formal lenders such as the
                            state owned banks, on the other hand, have very limited information
this gap between            about the clients and therefore ineffective enforcement mechanisms in
                            the absence of collateral. But they have access to large resources and
access to                   can operate on a bigger scale. Microfinance is seen as a way to bridge
                            this gap between access to information and resources. The core idea of
information and             microfinance is to come up with innovative “collateral substitutes”
                            such as a joint liability contract.
resources. The core                  Microfinance in India is still at a nascent stage whether we
                            look at it from a scale or a scope perspective. It is estimated that
idea of microfinance        between 350 and 400 million people live below the poverty line in
                            India, which means that between 70 and 80 million households need
is to come up with
                            microfinance services. Only 8 per cent of all poor rural households
innovative collateral       have access to microfinance products where the average loan
                            outstanding is Rs. 5,500. Close to 56 per cent of the poor still borrow
substitutes such as         exclusively from informal sources. If we consider the scope of
                            microfinance by looking at access to different financial products, 70 per
a joint liability           cent of rural poor do not have access to deposit or saving account and
                            less than 15 per cent have access to any kind of formal insurance.
                                     Expansion, Evolution, Growth and Current Geographical
                                     Distribution and Concentration
                                     The Microfinance Information Exchange (MIX) data shows
                            that there are 233 microfinance institutions currently operational in
                            India with a cumulative outreach of 20 million households. It is
                            important to bear in mind, however, that these are self selected groups
                            or organisations that report data to the MIX. This might exclude a
                            substantial group of smaller MFIs that operate as Non-Government
                            Organisations and which might not have the means or incentive to
                            report this data. It is important to bear in mind that microfinance
                            institutions in India come in different forms. SaDhan, an association of
                            Indian MFIs, claims that in the year 2009, there were more than 2,000
                            NGOs involved in the NABARD SHG-Bank linkage programme. And
                            out of these, approximately 800 have some operations in financial
128                         intermediation. Then there are MFIs that are organised as co-operatives
such as over 500 Mutually Aided Cooperative Thrift and Credit Societies.                               ICRA BULLETIN

Finally, there are the large NBFCs, which are regulated by the RBI.
         Data from CRISIL, an independent rating and research
company, highlights the growth of microfinance sector in India (Chart                                      &
1). CRISIL estimates MFIs’ loans outstanding to have increased to Rs.                                       Finance
114 billion in year 2009 as compared with Rs. 60 billion in the year
                                                                                                          J U L Y . 2 0 1 1
2008. Moreover, there is also a steady increase in microfinance
outreach with the total number of borrowers increasing from 3 million
in the year 2000 to almost 16 million in year 2009. Several large MFIs
have accomplished more than 100 per cent year-on-year growth.
         Chart 2 outlines microfinance operations by regions within
India and the loan portfolio across regions. As has been the trend since
the beginning of the microfinance movement in India, the concentration

                                            CHART 1
                                          Growth Trends

                120                                                                 18

                                                                                         No. million
  Rs. billion

                 80                                                                 12
                 40                                                                 6
                  0                                                                 0
                         2006           2007             2008               2009
                                Loan outstanding                Borrowers

                                                              CHART 2
                                                   State-Wise Performance of MFIs

Source:           Microfinance India, State of the Sector Report 2010.
 ICRA BULLETIN             is largely in the four southern states of Andhra Pradesh, Tamil Nadu,
                           Kerala and Karnataka. Cumulatively, this region has 51.1 per cent of
        &                  India’s microfinance outreach. In contrast, the northern states and
                           north-eastern states of India contribute a mere 4 per cent to the total
         Finance           microfinance outreach in India. When we look at the graph for the loan
                           portfolio, as expected, more than half the loan portfolio is concentrated
       J U L Y . 2 0 1 1
                           within the southern region.
                                     The pre-eminence of the South, and in particular, Andhra
                           Pradesh, can be traced to a collection of factors, including the history
                           of women’s anti-arrack campaigns in the 1980s—an agitation that went
                           a long way in organising women in groups and setting the stage for
While the SHG
                           SHGs in the years to come. More recently, the Chandrababu Naidu
model was the first        administration in Andhra was among the first state governments to
                           officially adopt the SHG movement, which led to a massive rollout that
to start in the            was continued under later governments.

country, its current                Outreach and Models
                                    In India, currently there are several models of microfinance
pre-eminence has           operational and these include the NGOs, the NBFCs and the Self Help
                           Groups. According to the Microfinance India: State of the Sector Report
much more to do            2010, 45 per cent of all MFIs in India are regsitered as NBFCs, which
                           include all the large commercial institutions such as the ones listed in
with government            Table 1. Societies, the next popular form, have a share of nearly 30 per
adoption rather than
                                    If we look at the expansion in operations of the Self Help
first-mover                Group model and contrast it to the MFIs, which include the NBFCs and
                           the NGOs, we note that over the last few years MFIs have contributed
advantage.                 aggressively to the total disbursement. In the year 2008–09 the MFIs
                           accounted for nearly 64 per cent of the total disbursement (Chart 3).
                           This reflects the acceptance of MFIs as commercially viable institutions
                           that can attract capital and resources.
                                    While the SHG model was the first to start in the country, its
                           current pre-eminence has much more to do with government adoption
                           rather than first-mover advantage. As we shall see in a subsequent
                           section, government’s adoption of the model led to an expansion on an
                           unprecedented scale.
                                    As the Malegam report points out, about 75 per cent of the
                           funding for the NBFCs have also come from banks and specialised
                           financial institutions like SIDBI with total direct lending amounting to
                           Rs. 13,800 crore as well as securitised loans amounting to another
                           Rs. 4,200 crore.
                                    Beyond the SHG and MFI classification, we can also divide
                           institutions within the Indian microfinance industry on the basis of
                           other dimensions. There are institutions with a business model built
                           around the philosophy of stripped down credit as against one of “credit
                           plus” (see Table 1). While SKS and Spandana fall under the simple
130                        credit model, BASIX functions along the “credit plus” philosophy. This
                                                                                                   ICRA BULLETIN
                                                        TABLE 1
                                            Product Offerings of Top 50 MFIs
            Top 50 MFI by CRISIL
                      Region    Legal Number
                                                 Outreach                               Services
                                                    Percen- Average Insur- Funds Training/ Volun- Agricul- Second     Full
                                status of Active    tage of   loan    ance Trans- Consul-   tary ture andFinance
                                                                                                             tier    scale
                                        borro-      women balance            fer   ting/    sav- business lend-     finan-
                                         wers       borro-     per          Ser- Capacity    ing  develop U L Y .
                                                                                                         J          2 cial1 1
                                                      wer    borro-         vices building          ment      to     serv-
                                                            wer (Rs.)                             services  MFI       ices

  Aadarsha Welfare Andhra       NGO      18930        100       7279
  Society          Pradesh
  Adhikar             Orissa    NBFC     62652        100       6489       X   X    X
  Arohan Financial West
  Services Ltd (AFSL) Bengal    NBFC    187754       92.9       5209
  Asmitha Microfin    Andhra
  Ltd                 Pradesh   NBFC   1340288        100       10584
  ASOMI               Assam     NGO      40449       97.3       5263
  Bandhan Financial West
  Services Pvt Ltd
  (BFSPL)           Bengal      NBFC   2301433       100.0      6496
  Bhartiya Sam-       Andhra
  ruddhi Finance
  Limited (BSFL)      Pradesh   NBFC   1114468       66.4       9008       X                         X
  BSS Microfinance
  Pvt Ltd (BMPL)      Karnataka NBFC    228514       99.9       6335       X
  BWDA Finance        Tamil
  Limited (BFL)       Nadu      NBFC    220645       97.91      4863
  Cashpor Micro       Uttar
  Credit (CMC)        Pradesh   NGO     417039       100.0      6412                                                  X
  Centre for Rural    Andhra
  Centre for Rural    Pradesh   NBFC     35118       100.0      7080       X
  through Social
  Action (CReSA)

  Community           Tamil     NGO Info not        Info not    Info not
  Development         Nadu          available      available   available
  Centre                             on MIX         on MIX      on MIX
                                     data set       data set    data set
                                     and not        and not     and not
                                       even           even        even
                                      on its         on its      on its
                                     website        website     website

  Equitas Micro       Tamil     NBFC 888600          100         6812      X
  Finance India       Nadu
  P Ltd (Equitas)
  ESAF Microfin-     Kerala     NGO    220011       99.22        7074      X        X                X
  ance & Investments
  Pvt. Ltd (EMFIL)
  Future Financial    Andhra    NBFC 257991          100         9471
  Services Ltd (FFSL) Pradesh
  Gandhi Smaraka      Kerala    NGO     34833       40.02        5317      X        X          X                      X
  Grama Seva
  Gram Utthan         Orissa    NGO     67240        100         6044      X   X    X          X
  Grama Vidiyal       Tamil     NBFC 772050          100         7838      X        X          X     X
  Micro Finance       Nadu
  Pvt Ltd (GVMFL)

(continued on the next page)
        Top L MFI I CRISIL
I C R A B U 50L E T byN                          Outreach                              Services

MFI                Region      Legal Number       Percen- Average Insur- Funds Training/     Volun-   Agricul- Second Full

                               status of Active   tage of   loan    ance Trans- Consul-       tary    ture and   tier scale
                                       borro-     women balance            fer   ting/        sav-    business lend- finan-
                                        wers      borro-     per          Ser- Capacity        ing    develop    ing   cial
          Finance                                   wer    borro-
                                                          wer (Rs.)
                                                                          vices building                ment
        J U L Y 2 0 1 1
Grameen Financial. Karnataka NBFC       352648     99.39       9363      X                        X                        X
Services Pvt Ltd
Hand in Hand       Tamil       NGO       82118      100        4939                X
Tamil Nadu         Nadu
IDF Financial      Karnataka   NGO      129600     99.97       4490                X                                       X
Services Pvt Ltd

Indian Association Tamil       NGO      19603     Info not    Info not
for Savings and    Nadu                          available   available
Credit                                            on MIX      on MIX
                                                  data set    data set
                                                  and not     and not
                                                    even        even
                                                   on its      on its
                                                  website     website

Indur Intideepam   Andhra      Credit   24668      100         8082                               X
MACS               Pradesh     Union
Janalakshmi        Karnataka NBFC       82161      100         8160
Janodaya Public    Karnataka   NGO       9988     99.78        7005
Madura Micro       Tamil       NBFC 250208         100         5956
Finance Ltd        Nadu
Payakaraopeta      Andhra      Credit   36543      100         8624      X         X              X      X
Women’s            Pradesh     Union
Pragathi Mutually Andhra       Credit   36543      100         8624      X         X              X
Aided Cooperative Pradesh      Union
Credit and Market-
ing Federation Ltd
Rashtriya Gramin Assam         NGO      101389    90.71        5527                                      X        X
Vikas Nidhi – CSP
Rashtriya Seva     Andhra      NGO      47265      100        14284
Samithi (RASS)     Pradesh
RORES Micro        Karnataka   NGO      26238      100         5790      X                                                 X
S.M.I.L.E Micro-   Tamil       NBFC 214280         100         6644      X
finance Limited    Nadu
Saadhana Microfin Andhra       NGO      90930      100         7357
Society (Saadhana) Pradesh
Sahara Utsarga     West        NGO      102094     100         5598
Welfare Society    Bengal
Sahara Uttarayan West          NGO      61128      100         6128
Sanghamithra       Karnataka   NGO      118807    99.17        5829                                      X
Rural Financial
Services (SRFS)
Sarvodaya Nano Tamil           NBFC 147122         100         5819
Finance Ltd (SNFL) Nadu

                                                                                                      (continued on the next page)
           Top 50 MFI by CRISIL                  Outreach                             Services       ICRA BULLETIN

 MFI                 Region    Legal Number       Percen- Average Insur- Funds    Training/
                                                                                              Volun- Agricul-Second Full

                               status of Active   tage of   loan    ance Trans-    Consul-     tary ture and tier   scale
                                       borro-     women balance            fer      ting/      sav- business lend- finan-
                                        wers      borro-     per          Ser-    Capacity      ing  develop ing     cial
                                                    wer    borro-
                                                          wer (Rs.)
                                                                          vices    building            ment   Finance
                                                                                                     services MFI

 SEWA MACTS         Andhra     Credit    62775     64.97    1,773   X                            X          J U L Y . 2 0 1 1
 Federation Limited Pradesh    Union
 Share Micro         Andhra    NBFC     2357456     100     7184                     X                  X
 finance Ltd         Pradesh
 Shri Kshetra      Karnataka   NGO      1225570    63.92    5017    X                X                  X
 Shri Kshetra
 Rural Development
 SKS Microfinance Andhra       NBFC     5795028     100     7456
 Sonata Finance      Uttar     NBFC      85897      100     6580
 PVT. Ltd            Pradesh
 Spandana Spoorty Andhra       NBFC     3662846    91.95    9666    X                                                  X
 Financial Ltd    Pradesh
 SWAWS Credit      Andhra      NBFC     122656      100     7265
 Corporation India Pradesh
 Pvt Ltd (SCCI)
 Swayamshree         Orissa    NGO       46105      —       5308                                                       X
 Micro Credit
 Trident             Andhra    NBFC     174873     99.16    7403    X                X
 Microfinance        Pradesh
 Ujjivan Financial   Karnataka NBFC     566929      100     6540    X
 Services Pvt Ltd
 Village Financial   West      NBFC     184020      100     5781    X                X
 Services            Bengal
 Welfare Organi-     Tamil     NGO       36543      100     8624
 sation for Multi-   Nadu
 purpose Mass
 Awareness Net-
 work (WOMAN)

 Notes: 1. Bandhan NGO is reported as part of Bhandan NBFC in the MIX data set.
        2. CRISIL ranking was done for the year 2008; Data on outreach and services is from Microfinance
        Information eXchange, 2009.

is because the BASIX business model incorporates enterprise
development and livelihood training along with credit. The main idea
is that borrowers need training and information along with credit to
successfully run enterprises. The objective of a microfinance institution
that operates on “credit only” philosophy is to make credit available to
those excluded from the formal financial market. The MFIs that operate
on this simple standardised credit model have greater growth than
those that have a credit plus philosophy.
         Another dimension to classify MFIs is based on group lending
versus individual lending. First of all, it is important to note that there
are few organisations in India that have a business model solely based                                              133
 ICRA BULLETIN                                                           CHART 3
                                                                       Number of MFIs
       J U L Y . 2 0 1 1

The objective of a


institution that           Source:              Microfinance India, State of Sector Report 2010.

operates on ‘credit                                                       CHART 4
                                                                    Trend in Disbursements
only’ philosophy is
to make credit

available to those                        250
                            Rs. billion

excluded from the

formal financial                          100

market. The MFIs                           0
                                                   2004-05       2005-06       2006-07        2007-08       2008-09 (E)
that operate on this                                                            Year

                                                         SHG-bank linkage           MFIs            Total
simple standardised
                           Source:              India Top 50 Microfinance Institutions CRISIL Rating, Oct 2009.
credit model have

greater growth than
                           on individual loans. Most are based on group loans, though some have
those that have a          a mix of the two types. If one compares the characteristics of these two
                           types of institutions, one notes that institutions that do individual
credit plus                lending are mostly smaller, serve better-off clients, give out larger loans
                           and have lower operational costs than institutions that do group
philosophy.                lending. This is basically because individual loan contracts are
                           typically made to clients who have “graduated” from group lending.
                           These are clients who have successfully repaid several loans in the past,
                           thereby building a credit history, and demand bigger loans.
                                    If one classifies MFIs along the basic objective, one has the
                           large commercial institutions with strong financial bottom lines and the
134                        relatively smaller institutions with overriding social bottom lines. The
commercial MFIs have typically lower operating costs than the ones          ICRA BULLETIN

with overwhelming social objectives. Another major difference between
them is the source of capital. Large commercial MFIs rely on banks
and other market sources for capital while the MFIs with social                   &
objectives rely heavily on subsidised donor funds.                                 Finance
                                                                                 J U L Y . 2 0 1 1
         Profitability of Indian MFIs
         Analysis of the return on assets of MFIs in India reveals high
profit potential in the sector. Microfinance India: State of the Sector
Report 2010, presents information on 70 MFIs with nearly 62
institutions reporting positive returns. More than half the sample
                                                                            Most MFIs reflect a
(nearly 35 institutions) reports return on assets in excess of 2 per cent
(see Chart 5). In contrast, a typical banking company exhibits a return       healthy return on
on assets figure between 1 and 2 per cent. The best return on assets of a
public and private bank is reported to be 1.6 per cent to 2 per cent.       equity. There are in
         Return on equity is relatively a less reliable indicator across
different forms of institutions or among different companies on account        total seven MFIs

                                                                            reporting return on
                                 CHART 5
                      ROA Range-Wise Distribution of MFIs                   equity of more than

                                                                                 50%, with the
 12                                                                              highest return
  8                                                                              reported to be
                                                                             147%. There are a
          Above 7%        4-7%           2-4%           1-2%    0-1%        significant number

Source:   Microfinance India, State of Sector Report 2010.                      of institutions,

                                 CHART 6                                    however, that have
                      ROE Range-Wise Distribution of MFIs
                                                                              ROE of less than





          Above 50%           25–50%             10–25%        0–10%

Source:   Microfinance India, State of Sector Report 2010.                               135
 ICRA BULLETIN             of the differences in equity and leverage ratios. But an institution’s
                           ability of service equity is a good reflector of its operational health.
       &                   Most MFIs reflect a healthy return on equity. There are in total seven
                           MFIs reporting return on equity of more than 50 per cent (see Chart 6),
         Finance           with the highest return reported to be 147 per cent. There are a
                           significant number of institutions, however, that have ROE of less than
       J U L Y . 2 0 1 1
                           10 per cent. This for a high profit sector could potentially be a cause of
                           concern, particularly, if we consider the fact that loan pricing is fairly
                           homogenous across MFIs.

                                   Offerings Made by MFIs
Micro-savings, its
                                     It is important to note that the term microfinance has replaced
advocates claim, is        microcredit in the last two decades as it truly reflects the all
                           encompassing efforts to bank the poor. This change is due to an
more valuable than         underlying shift in the financial inclusion outlook. There is widespread
                           recognition that the poor require a basket of financial instruments like
credit for poor            savings, insurance and asset transfers just like the non-poor. More
                           recently, this has been well documented as findings from financial
households because         diaries of low income households across Bangladesh, India and South
                           Africa (Collins, Morduch, Rutherford and Ruthven, 2009).
of several reasons.                  Micro-savings, its advocates claim, is more valuable than
                           credit for poor households because of several reasons. Micro-savings
Micro-savings can          can be used to build assets that can be used as collateral. These can
                           also be used to self insure during times of need and can be used to
be used to build
                           smooth consumption if there is a shock to the household income. Most
assets that can be         MFIs in India that operate as Non-Government Organisations require
                           clients to save a certain minimum amount before they become eligible
used as collateral.        for loans. This is in tune with the basic principle the Self Help Group
                           model of microfinance. Early savings are viewed as a disciplining
These can also be          mechanism for clients of microfinance loans. MFIs that are registered
                           as Non-Bank Financial Companies, however, are not allowed to collect
used to self insure        deposits as per regulation in India.
                                     Over the last decade, micro-insurance has gained popularity as
during times of need       an instrument to achieve financial inclusion in India. There are several
                           instruments such as life insurance, health insurance, and property and
and can be used to
                           crop insurance that are being tried out. Among these, life insurance has
smooth                     been the most successful in terms of profitability and outreach. One
                           reason for this being that it is commonly offered as a product tied to the
consumption if there       loan. Health insurance, on the other hand, has been piloted by several
                           MFIs but few schemes have been rolled out extensively. And those too
is a shock to the          provide limited coverage and rely heavily on the public healthcare
                           system. SEWA’s health insurance programme is one of the pioneers in
household income.          this field. BASIX rolled out one of the largest health insurance schemes
                           in Indian microfinance in 2005. A study by Rai and Ravi (2011) found
                           that while the outreach of health insurance expanded, the claims to
                           coverage ratio remained quite low. This was in part due to the lack of
136                        financial literacy where borrowers did not fully comprehend the
benefits of the health insurance product tied to their loan. And as would    ICRA BULLETIN

be expected, the claims to coverage ratio improved over the years as
clients began to understand the product and see the benefits. The study
also found that low claims could be partly explained by the lack of                &
empowerment measured as health seeking behaviour of women                           Finance
beneficiaries of the health insurance scheme. Women as borrowers are
                                                                                  J U L Y . 2 0 1 1
significantly more likely to file claims than women as non-borrowers
who are enrolled in the health insurance scheme as spouses. There is no
such difference among male beneficiaries.
         Property (catastrophic) insurance has been sold by some MFIs
such as SEWA. This was particularly helpful for low income households
                                                                              The new paradigm
in Gujarat during the flash floods and earthquakes. An innovative
insurance scheme called Rainfall Insurance was promoted by BASIX                 in international
with support from the World Bank. The basic idea of this product is to
insure against bad weather directly rather than against crop yield. This     microfinance is the
is a sophisticated weather derivative and the benefits are not limited to
farmers. This product however had few takers primarily due to poor             financial systems
marketing and lack of financial literacy where people perceived it to be
too complicated.                                                                approach, which

        The Commercialisation of Microfinance                                        claims that
          Commercialisation is used to refer to the movement of
microfinance out of heavily donor dependent and subsidised operations
                                                                             exponential growth
into one in which microfinance is managed on a business basis as part
                                                                             can only come from
of a regulated system. The new paradigm in international microfinance
is the financial systems approach, which claims that exponential             commercialisation.
growth can only come from commercialisation. The aim is to attain
wide outreach in a sustainable manner. In India, the main drivers of         The aim is to attain
commercial microfinance are MFIs that started out as NGOs but have
since transformed themselves into licensed NBFCs and large retail             wide outreach in a
banks such as ICICI and SBI.
          Most would agree that without the profit motive, it is difficult   sustainable manner.
to have organisations that would engage in the activity in a sustained
and efficient manner. On the other hand, a total fixation on the bottom
line can easily lead to “mission drift” of a microfinance organisation. It
is therefore the razor’s edge that all microfinance providers have to
walk on. It seems globally the “social development” model accounts for
about 90 per cent of microfinance organisations but the 10 per cent of
profit-oriented providers are very large and account for over half the
industry assets (Morduch et al 2008). The “non-profits” lend more to
the “bottom of the pyramid” while the “for-profits” tend to focus on a
slightly higher tier. Also “non-profits” are more likely to go for group-
lending while “for-profits” go largely for individual-lending. There is
not much difference in loan quality though. So, in conclusion, “for-
profits” and “non-profits” have somewhat different profiles in the
microfinance industry, but both have important roles to play.
          Compared to Latin America where commercial microfinance is                      137
 ICRA BULLETIN             most advanced and where loan portfolios are based on micro-
                           enterprises that grow and generate employment, in India microfinance
        &                  still primarily targets poor marginalised women. The MIX data shows
                           that an overwhelming proportion of profitable MFIs in India are
         Finance           commercial NBFCs.
                                     The main consequence of commercialisation of microfinance in
       J U L Y . 2 0 1 1
                           India is that it has transformed ownership of the MFIs. Most MFIs
                           started as NGOs but realising that commercialisation was inevitable
                           for exponential growth, transformed themselves into regulated
                           commercial entities. This gave them access to diversified funding
                           sources and the entire governance structure of the organisation
The main
                           changed. This brought in broader competencies such as technological
consequence of             advancements, experimenting with new products and processes; it has
                           also pushed organisations away from group loans towards individual
commercialisation          and better clients. The biggest drawback of this process, however, is
                           that it has led to over-indebtedness and rise in strategic defaults, as we
of microfinance in         witnessed in the Andhra Pradesh debacle.

India is that it has               Impact of Microfinance in India
                                     There is widespread acceptance that availability of financial
transformed                services improves the lives of the poor. However, this belief is mostly
                           backed by anecdotes, which unfortunately are not a substitute for
ownership of the           careful statistical evaluation. In 1999, Jonathan Morduch noted that
                           “the ‘win-win’ rhetoric promising poverty alleviation with profits has
MFIs. Most MFIs
                           moved far ahead of the evidence and even the most fundamental claims
started as NGOs but        remain unsubstantiated”. There are very few impact studies and their
                           results are far more subdued. There are studies that have shown that
realising that             while some clients thrive and some will remain unchanged, there are
                           also some that will slip backwards.
commercialisation                    The problem in assessing the impact of microfinance is that we
                           cannot simply compare the outcomes of participants with the non-
was inevitable for         participants due to self selection. Clients of microfinance are either self
                           selected or join the programmes because MFIs target villages and
exponential growth,        clients based on expected outcomes. This makes establishing a causal
                           relationship between access to microfinance and outcomes very
                           difficult. Randomised evaluations, in this case, would provide clear and
themselves into            credible evidence. There have been some randomised controlled trails
                           across the world to explore the impact of a number of microfinance
regulated                  product designs such as group lending, for instance, Gine and Karlan
                           (2006, 2009).
commercial entities.                 In India, there has been one major study to measure the impact
                           of microcredit becoming available in a new market. And the results
                           indicate that in the short run, there are no significant positive outcomes
                           on consumption, health, education or women’s decision making. This
                           was conducted by Banerjee et al in 2009 in 104 slums of Hyderabad
                           over 18 months. The baseline survey showed that there was almost no
138                        borrowing from formal sources such as commercial banks or MFIs
before the experiment. One-third of the households operated at least         ICRA BULLETIN

one small business and the average profit from these was Rs. 3,040 on
a monthly basis. As a part of the experiment design, Spandana opened
branches in 52 slums randomly selected from the 104 slums. The study               &
reveals that as a result of this experiment, households were 50 per cent            Finance
more likely to borrow from MFIs and were 32 per cent more likely to
                                                                                  J U L Y . 2 0 1 1
open a business. There were changes in the consumption pattern across
different groups. Households with an existing business at the start of the
experiment invested in durable goods and their profits increased.
Households with a high propensity to become entrepreneurs saw a
decrease in non-durable consumption like that on food and transportation.
                                                                              In India, there has
Households with low propensity to become entrepreneurs saw an
increase in non-durable consumption. The scope of the results is limited         been one major
due to the short time frame of the study. Certain outcomes take longer
to manifest, particularly social outcomes such as health, education and        study to measure
decision making powers of women.
                                                                                   the impact of
        Government and Microfinance in India
          While the microfinance sector in India, as in most places in the           microcredit
world, originated out of private initiatives of typically not-for-profits,
and thrived, for a long while, without direct government supervision,        becoming available
the role of government in its scale-up can hardly be overemphasised. As
Ramesh (2007) points out, the SHG movement in the country had
                                                                                in a new market.
largely been led by the RBI and NABARD in recent years after these
                                                                                 And the results
agencies adopted the model in 1992. At the turn of the century, almost
two-thirds of the SHGs were promoted by NGOs. Six years later, that           indicate that in the
share had fallen to a third, with the government (mostly state
governments) promoting about half the total number of SHGs in the            short run, there are
country, and the remainder being promoted by banks including the
nationalised banks.                                                                no significant
          Government certainly enjoys a significant scale advantage over
the private players in scaling up. As Ramesh (2007) notes, it took            positive outcomes
SEWA 35 years to mobilise 8 lakh women. Dhan Foundation took 17
years to mobilise 2.6 lakh women. The Andhra Pradesh government, on            on consumption,
the other hand, mobilised 80 lakh women in just 15 years.
                                                                             health, education or
Notwithstanding the different time periods over which these expansions
happened, the difference is striking.                                         women’s decision
          Among state governments, Andhra Pradesh was among the first
to adopt the SHG model as a major strategy for poverty alleviation,                      making.
cementing the state’s status as the unquestioned leader in the sector.
Other Southern states have also been on the forefront in the area. The
single biggest boost to the SHG movement came in 1999 with the
adoption of the Swarna Jayanti Gram Swarojgar Yojana (SGSY) by the
central government. SGSY was launched as an integrated programme
for self-employment of the rural poor on 1 April 1999 with the
objective of bringing the assisted poor families above the poverty line
by organising them into Self Help Groups (SHGs) through the process                       139
 ICRA BULLETIN             of social mobilisation, and providing training, capacity building and
                           income generating assets through a mix of bank credit and government
        &                  subsidy. The scheme focuses on certain key activities based on the
                           aptitude and skill of the people, availability of resources and market
          Finance          potential, and involves NGOs/CBOs/Individuals/Banks and Self Help
                           Promoting Institutions. The subsidy allowed under the SGSY is 30 per
       J U L Y . 2 0 1 1
                           cent of the total project cost, subject to a ceiling of Rs. 7,500 (for SC/
                           STs and disabled persons, the subsidy limit is 50 per cent of the project
                           cost, subject to a ceiling of Rs. 10,000). For SHGs, the subsidy would
                           be 50 per cent of the project cost, subject to a ceiling of Rs. 1.25 lakh
                           or a per capita subsidy of Rs. 10,000, whichever is less. There is a
Among government
                           special focus on the vulnerable groups such as SC/STs, women and
agencies, NABARD           persons with physical disability, who account for around 50 per cent,
                           40 per cent and 3 per cent of the Swarozgaries, respectively. The SGSY
and SIDBI have             seeks to promote multiple credits rather than a one-time credit
                           injection. Over the years, funds mobilised under the SGSY scheme—
played a particularly      both savings and loans outstanding—have come to account for over a
                           quarter of the total bank lending to SHGs (see Table 2).
important role in                   Among government agencies, NABARD and SIDBI have
                           played a particularly important role in microfinance in India.
microfinance in            NABARD was an early adopter of the SHG–Bank Linkage
                           programme—linking SHGs to bank credit, often with the aid of NGOs
India. NABARD was          acting as Self Help Promoting Institutions—having adopted it way back
                           in 1992; over time the programme has become one of the biggest
an early adopter of
                           conduits of microfinance flows in the country. The institution of the
the SHG–Bank               Microfinance Development Fund (MFDF) in 2001 and its conversion to
                           the Microfinance Development and Equity Fund (MFDEF) in 2005–06
Linkage                    have made about Rs. 200 crore available to NABARD for extending
                           microfinance and taking the SHG structure beyond finance.
programme—                          Among banks too, nationalised banks have played a major role
                           in the SHG movement. While ICICI Bank’s initiatives in the area of
linking SHGs to            microfinance had been among the earliest ones, today SBI is by far the
                           largest microfinance lender. Table 3 presents the sectoral break-down of
bank credit, often         microfinance lending by different agencies in the country during the
                           period 2006–07 to 2008–09.
with the aid of NGOs
                                    While there can be no denying of the developmental role of the
acting as Self Help        central and state governments, gaps have existed on the regulatory
                           side. Much like the Indian software industry, microfinance in India has
Promoting                  grown without a specific regulatory structure in place. Many MFIs
                           function with a Non-Banking Financial Company (NBFC) licence from
Institutions.              the RBI and hence are governed by the rules of that larger sector.
                           Others that operate as Section 25 companies follow the Companies Act,
                           1956. However, given the distinctive nature of the industry, the special
                           profile of its beneficiaries and the blend of organisational forms of its
                           players, there is a clear need for a sector-specific regulator sensitive to
                           the needs and responsibilities of the sector. But the regulatory structure
140                        for the microfinance industry is still in an emergent phase. In the wake
of the recent trouble in Andhra Pradesh and the report of the Malegam                                 ICRA BULLETIN

committee, jurisdictional issues are still not clear and whether state-
specific laws or RBI regulations would have the final say is an issue
that is yet to be sorted out.                                                                                   &
          Recent Developments in Andhra Pradesh
                                                                                                              J U L Y . 2 0 1 1
         The state of Andhra Pradesh accounts for nearly 40 per cent of
all microfinance activity in India. Hyderabad, the home of by far the
largest number of microfinance giants, is virtually the capital of
microfinance in India. Till a few months ago, the state wore this
distinction as a badge of honour. The sector also owed a lot to
government support in Andhra Pradesh for its lead in this sector (see
Ramesh (2007)). In recent years, Andhra has also been the home of a
few of the fastest-growing for-profit MFIs, including the top two: SKS
and Spandana.
         SKS, which had made waves in the past by initiating the
practice of private equity participation in the microfinance sector, had

                                                        TABLE 2
                                                  SGSY and Bank-Linkage
                                                                                                         (Amounts in Rs. crore)

 Particulars                          2007–08            2008–09            % Growth           2009–10            % Growth
                                                                            (2008–09)                             (2008–09)
                                 No. of    Amount    No. of    Amount     No. of   Amount   No. of    Amount     No. of Amount
                                 SHGs                SHGs                 SHGs              SHGs                 SHGs

 A. SHG-Bank Linkage Model
 Saving of      Total SHGs      5009794    3785.39 6121147     5545.62     22.2     46.5    6953250    6198.71    13.6    11.8
 SHGs with
 Banks as on    Out of which
 31 March       SGSY            1203070     809.51 1505581     1563.38     25.1     93.1    1693910    1292.62    12.5   –17.3
 Bank Loans      Total SHGs     1227770    8849.26 1609586 12253.51        31.1     38.5    1586822 14453.3       –1.4    17.9
 disbursed to
 SHGs during     Out of which
 the year        SGSY            246649    1857.74   264653    2015.22      7.3      8.5    267403     2198        1       9.1
 Bank Loans      Total SHGs     3625941 16999.91 4224338 22679.84          16.5     33.4    4851356 28038.28      14.8    23.6
 with SHGs as    Out of which
 on 31March      SGSY            916978    4816.87   976887    5861.72      6.5     21.7    1245394    6251.08    27.5     6.6

 B. MFI-Bank Linkage Model
 Bank Loans
 disbursed to
 SHGs during
 the year        518             1970.15    581      3732.33       12.2    89.4    691      8062.74      18.9    116.0
 Bank Loans
 with SHGs as
 on 31 March                      1109     2748.84    1915     5009.09     72.7     82.2     1513     10147.54 -21.0     102.6

 Note:   Actual number of MFIs provided with bank loans would be less as several MFIs have availed loans from more than one
 Source: NABARD (2010).


       J U L Y . 2 0 1 1

                                                       TABLE 3a
                         Microfinance Activities of Scheduled Commercial Banks–Public Sector
                                                                                           (Amounts in Rs. lakh)

As on March 31, 2010                Details of SHGs Saving          Out of total SHGs—           Out of total SHGs—
                                      linked with Banks             under SGSY Scheme          Exclusively women SHGs
Sl. Name of Bank                 No. of    No. of     Saving     No. of    No. of   Saving    No. of    No. of    Saving
No.                              SHGS     Members     Amount     SHGS     Members   Amount    SHGS     Members    Amount

Public Sector Banks—All India Position
 1 Allahabad Bank                 78861    859115      5257.95    63900   689350    4441.77    50584    551274    3312.5
 2 Andhra Bank                   269645   3235949    24268.05      3813     42515    266.86   269645   3235949   24268.05
 3 Bank of Baroda                114285   1312641    11531.87     49893    564260   4658.16    80862    978035    6018.18
 4 Bank of India                 180173   2123950    21592.43     74557    857391   4703.86   145153   1700531    9970.41
 5 Bank of Maharashtra            75015    750154       380.13    21650    216502    108.27    38948    389482     194.77
 6 Canara bank                   245283   3585054    17486.97     77374   1258197   3291.83   227690   3300795   15053.44
 7 Corporation Bank              129703   1332753      8621.45    85652    795092   5978.07    99619    977203    6250.54
 8 Central Bank of India          27256    328609      2527.93     1641     22183    158.33    25419    303165    2339.4
 9 Dena Bank                      37992        NA      3370.71     9555      5578    648.01    29809         9    1485.59
10 IDBI Bank                      54839    642223      5750.06      NA        NA     NA        34507    392836    3592.63
11 Indian Bank                   217384   3309105    32110.59     18515    182828    971.41   207762   2958001   30728.37
12 Indian Overseas Bank          257891   3093507    36502       160091   1887682 15327       247574   2920008   31242
13 Oriental Bank of Commerce       7351      53824      990.02     2622     24187    417.32     5282     38172     776.28
14 Punjab & Sind Bank            178166   1995265    21580.55     87842    933079   6545.02   114029   1259920   15160.38
15 Punjab National Bank            2777      28395      420.76     1849     18804    334.92     1510     15865     189.72
16 State Bank of India            42240    556824       549.12    10242    133146   122.9      36846    464730     479.03
17 State bank of Bikaner
   & Jaipur                      144977   1739790    11427          NA        NA     NA       130675   1570713   10443
18 State Bank of Hyderabad      1216891 15453057     84650       213370   2619029 14522       973527 12333989    70778
19 State Bank of Indore           18159    217665       858.77     5520     60825    166.95     5495     60425     208.85
20 State Bnk of Mysore            42843    728246       842.17     2429     43606    207.69    39103    702476     890.23
21 State Bank of Patiala           3354      35674      257.13     1049     11402     81.83     1907     19835     154.43
22 State Bank of Travancore      110692        NA    15613.61     44278       NA    4797.43   101836       NA    14364.51
23 Syndicate Bank                121601   1547841    17638.83     13799    187350   2728.19   106783   1401122   15031.13
24 Union Bank of India            67654    762408      8201.49    39306    431175   4944.55    52453    597229    4974.39
25 United Bank of India          125461   1028951    13459.65     36926    273450   3859.85   104448    868650   10533.74
26 UCO Bank                      103721   1248643      5644.12    37586    449051   1922.47    91157   1092772    4434.48
27 Vijaya Bank                    45466    585471      1806.87     5235     61808    364.36    40587    527224    1534.54

    Total—Public Sector CBs     3919680 46555114 353340.23 1068694 11768490 81569.05 3263210 38660410 284408.59

                                                                                                ICRA BULLETIN

                                                                                                        J U L Y . 2 0 1 1

                                                      TABLE 3b
                        Microfinance Activities of Scheduled Commercial Banks–Private Sector
                                                (As on March 31, 2010)
                                                                                           (Amounts in Rs. lakh)

Sl. Name of Bank                  No. of    No. of   Saving     No. of    No. of    Saving     No. of No. of    Saving
No.                               SHGs     Members   Amount     SHGs     Members    Amount     SHGs Members     Amount

Private Sector Banks—
All India Position                    47      705        6.4        19        285      4.67        47     705      6.4
 1 AXIS Bank                        1436    16681      284.12     1049      11656   235.58       1174   12961    203.69
 2 Bank of Rajasthan                7773       NA      299.01     1621        NA      65          NA       NA     NA
 3 City Union Bank                 19370   336755     2992.7      4123      65968   182.44       6771 106947    1911.22
 4 Dhanalakshmi Bank                2400       NA      227.17      188        NA      17.55      1112      NA     83.08
 5 Federal Bank                    45407   635698      525.34      378       5292      4.59     34285 573146     520.39
 6 HDFC Bank                       19307   289605     1066.63      NA         NA     NA         19307 289605    1066.63
 7 ICICI Bank                      12426   122596     6897.15     6698      64711   654.89       5523   63268    488.2
 8 ING -Vysya Bank                  1127       NA       85.21      527        NA      50.21       527      NA     50.21
 9 Jammu & Kashmir Bank             7351   108585      663.59      911      14234   146.67       6125   91317    589.76
10 Karnataka Bank                    680     6850       44.06      495       4950     29.77        16     160      0.12
11 Nainital Bank                     721     8003      229.3       143       1504      5.94       413    4552    167.4
12 Ratnakar Bank                    5245    75229      385.58     2440      41353   135.71       4585   67661    296.85
13 South Indian Bank                9945   145490      342.75      874      14197     45.5       6959 101743     265.1
    Sector CBs                   133235     2E+06    14049.01    19466    224150    1578.52     86844   1E+06   5649.05
    TOTAL—All Public
    Sector CBs-(from table 3a)
    Grand Total—
    Commercial Banks             3919680    5E+07 353340.23 1068694      11768490 81569.05    3263210   4E+07 284408.59
    Grand Total—
    Commercial Banks             4052915    5E+07 367389.24 1088160      11992640 83147.57    3350054   4E+07 290057.64

Source: NABARD (2011).

 ICRA BULLETIN             its headline-grabbing and hugely successful IPO (oversubscribed almost
                           14 times) in August 2010. To many it was the signal of the Indian
        &                  microfinance industry coming of age and several other capital issues
                           were being planned even though many engaged in social sector
           Finance         activism, including Muhammad Yunus himself, were less than
                           impressed by what they perceived to be a shift of focus from social
       J U L Y . 2 0 1 1
                           impact to investor returns. The celebrations were short-lived however,
                           and not just because of the top-level personnel changes happening at
                           SKS soon after the IPO. Within weeks of the IPO, Andhra Pradesh was
                           engulfed by a spate of close to 30 farmer suicides, allegedly linked to
                           coercive collection methods of MFIs. More than half these unfortunate
Given the distinctive
                           farmers were allegedly borrowers of SKS and/or Spandana.
nature of the                        The resulting crash in the stock of microfinance in Andhra
                           Pradesh has few parallels in recent times. The political establishment
industry, the special      swung into action following the suicides and the MFIs were demonised
                           in the vernacular media. Vandalism of MFI offices by political goons
profile of its             was followed by police interrogation. Overnight Andhra Pradesh’s blue-
                           eyed boy had become a pariah, and private MFIs persona non grata.
beneficiaries and the      The yesterday crusaders against mass poverty became persecuted as
                           pitiless usurers exploiting the hapless poor. It is Andhra’s pre-eminence
blend of                   in microfinance that has made the recent turn of events particularly
                           notable and ominous for the industry.
organisational forms                 For sure this was not the first time that microfinance had been
                           at the centre of negative media glare, not even in Andhra Pradesh.
of it players, there is
                           Only four years ago, a spate of suicides in the state’s Krishna district
a clear need for a         had been linked to “barbaric” practices of MFIs. That impasse had
                           ended with the state setting up village and Mandal-level vigilance
sector-specific            committees to oversee the functioning of MFIs, the industry lobby
                           proposing a code of conduct for MFIs and the latter voluntarily
regulator sensitive        reducing interest rates.
                                     This time the crisis was further precipitated by the
to the needs and           promulgation of the Andhra Pradesh Microfinance Institutions
                           (Regulation of Money Lending) Ordinance, 2010, on October 15, later
responsibilities of        ratified by the Andhra Pradesh Assembly with some changes on
                           December 15.
the sector. But the
                                     In both episodes, the problem has been identified as a debt trap
regulatory structure       and over-borrowing by the poor from multiple, competing MFIs
                           resulting in a near-default or default situation worsened by aggressive
for the microfinance       collection practices resulting in disastrous calamities like suicides. In
                           both occurrences, the exact linkage between the suicides and the MFI
industry is still in an    involvement has been tenuous.
                                     The main features of the October Ordinance included a
emergent phase.            requirement for MFIs to register themselves with government
                           authorities, prevention of further lending in cases loans were
                           outstanding, and restriction of collection at a frequency no higher than
                           once a month. Coupled with administrative bottlenecks that made
144                        registration difficult and the widespread political campaign maligning
the MFIs as loan sharks that encouraged default, this brought the           ICRA BULLETIN

industry to a practical halt for several weeks in Andhra Pradesh. The
reduction in collection frequency arguably affected saving discipline as
well. In any case, the major players saw their recovery rates drop from           &
above 90 per cent to below 30 per cent post-Ordinance. Clearly, the                 Finance
activity became untenable for most players in Andhra Pradesh and
                                                                                  J U L Y . 2 0 1 1
threatens the very survival of the sector on its home turf. The biggest
victims are the poor who would now be denied credit flow.
         It is important to understand that the purported problem in the
case of the suicides lay not so much with multiple borrowing itself as
with over-indebtedness caused by a lack of proper credit infrastructure
                                                                               It is important to
and the resulting inability of MFIs to judge the suitability and
creditworthiness of the borrowers. Of course, the eagerness of some         understand that the
lenders to push credit cannot be entirely ignored either. With only
about a quarter of the microfinance loans in the state going to              purported problem
productive purposes, the use of loan remains another major concern. At
worst, the NBFCs may be guilty of mis-selling loans and of loan-               lay not so much
pushing. The social implications of indebtedness and bankruptcy are as
much responsible for the drastic and unfortunate steps the victims had             with multiple
taken (assuming in the first place that the deaths were indeed related to
microfinance). Given its quasi-public good nature, the credit                borrowing itself as
infrastructure in most well-functioning credit markets is provided by
institutions—private or public—that are separate from lenders. It is
                                                                                      with over-
partly this gap that has, for decades, helped the village moneylenders
maintain their grip over the market. The industry-supportive solution to
the problem would have involved an attempt to fill this lacuna. But the     caused by a lack of
actual development was differently focused.
         While the state government’s concern at the farmer suicides is,           proper credit
of course, understandable, the Ordinance is a clear example of
regulatory overreach that threatens to do no less than stifle the entire      infrastructure and
industry. Also as noted before, the Andhra Pradesh government itself is
a major player in the microfinance sector and the government-led SHG               the resulting
programme, often in competition with the NBFCs in the microfinance
space, has alleged that the latter poach on SHG members to extend            inability of MFIs to
loans. Clearly, there is a significant conflict of interest between the
                                                                            judge the suitability
industry player and regulatory roles of the government, which may
have contributed to the harshness of the Ordinance.                                           and
         The situation resulting from the Andhra Pradesh Ordinance
compelled the RBI into looking at developing a policy for MFIs to end       creditworthiness of
the impasse and avert such situations elsewhere. The Malegam
committee constituted towards this end submitted its recommendations             the borrowers.
in January 2011. The recommendations are quite far-reaching in nature
and include creating a new class of NBFCs, NBFC–MFIs, for regulatory
purposes. These NBFC–MFIs, the Committee has proposed, should have
a net worth of at least Rs. 15 crore with a minimum of 90 per cent of
their assets being “qualifying assets”. These “qualifying assets” or
micro-loans are non-collateralised loans to households with annual                        145
 ICRA BULLETIN             income below Rs. 50,000, with loan size and/or total indebtedness not
                           exceeding Rs. 25,000. Finally repayment should be monthly or less
          &                frequent. At least 75 per cent of the credit should be for income
                           generating purposes. The NBFC–MFIs would be exempt from
          Finance          Moneylenders Acts and loans to these MFIs by banks would continue to
                           enjoy priority lending status. There needs to be a margin cap over cost
       J U L Y . 2 0 1 1
                           of funds—12 per cent for MFIs with total loan portfolio size below Rs.
                           100 crore and 10 per cent for others—as well as an overall interest cap
                           of 24 per cent on individual loans. Several provisions discourage over-
                           borrowing, multiple-lending and ghost-borrowing including the one
                           making it the responsibility of the MFIs to ensure that a borrower is not
While the intent of
                           part of more than one Joint Liability Group (JLG) till the time a Credit
the Malegam                Information Bureau takes up the task. There are provisions for
                           borrower protection including those regulating recovery methods and
committee                  the suggestion to formulate a client protection code by the designated
                           sector regulator.
recommendations is                   While the intent of the Malegam committee recommendations
                           is easy to understand, their practical implications are less obvious.
easy to understand,        Insisting that an MFI ensure that 75 per cent of its loans go to
                           productive uses—thrice the current levels admitted by the committee
their practical            itself—is imposing more than a little burden on the lender. The
                           regulatory compliance will add significantly to the operating costs of
implications are less      all MFIs while at the same time pushing down the interest rate from the
                           current average of about 30 per cent to the new cap of 24 per cent.
obvious. Insisting
                           Using MIX data for 2009, Subramanian (2011) points out that while
that an MFI ensure         there is no significant difference between loan size and revenue per
                           rupee of lending between the smallest and the largest MFIs, the
that 75% of its loans      operating costs of the former are almost twice those of the latter. The
                           effects of this squeeze would therefore be disproportionately more for
go to productive           the smaller players, leading to consolidation in the industry. This may
                           well be an intended effect, making it easier to regulate the sector and
uses—thrice the            possibly tilting the field in favour of the government sponsored SHG
                           schemes, but it is also likely to dry up credit flow to the poor. Given
current levels             that the central issue here is that of consumer (borrower) protection, the
                           wisdom of regulating prices remains questionable.
admitted by the
                                     The Malegam committee argues that if its provisions come into
committee itself—is        effect, there would be no need for a separate Andhra Pradesh Micro
                           Finance Institutions (Regulation of Money Lending) Act. But the Andhra
imposing more than         Pradesh government has not dropped the Bill yet. The committee’s
                           recommendations also have to be reconciled with an older ongoing
a little burden on the     legislative process—the drafting of the Microfinance (Development and
                           Regulation) Bill 2010 by the Central Government, that among other things,
lender.                    seeks to make NABARD the apex regulator in the microfinance area.

                                   The Road Ahead
                                   The Indian microfinance journey over the last two decades has
146                        been a historical one but its eventfulness in the last three years has
perhaps been unmatched before. On the one hand, international private                  ICRA BULLETIN

equity jostled to enter the field—three PE deals bringing in US$52
million in 2008 followed by 11 the following year fetching US$178
million2—followed by a spectacular IPO making global headlines. On                           &
the other hand, charges of unethical and extortionist practices by MFIs                       Finance
led to arguably a draconian measure in its home turf—Andhra
                                                                                            J U L Y . 2 0 1 1
Pradesh—halting the industry in its tracks.
          There is no doubt that the microfinance movement in India has
been as gigantic as the country itself and yet opportunities abound. The
movement remains unbalanced with the microfinance penetration index
(a state’s share of national microfinance clients divided by its share of
                                                                                       Clearly, crores have
the national population) in the South being over 10 times than that in
the Northern region.3 As for poverty penetration, (the denominator now                 reached the poor in
being the state’s share of the nation’s poor), the worst performing
Central Region, again scores less than the South.                                        many parts of the
          The regional disparity aside, the growth in microfinance has
been beyond doubt. Clearly, crores have reached the poor or the near-                     country. What is
poor in many parts of the country. What is therefore more than a little
surprising is the absence of evidence of a clear improvement in key                   therefore surprising
measures of welfare: consumption, health, education or women’s
decision making. It seems that it is systematic investigation of impact                  is the absence of
assessment that has lagged the microfinance revolution in India.
          Notwithstanding its phenomenal growth, the microfinance
                                                                                        evidence of a clear
industry in India today stands at a juncture marked with uncertainty.
                                                                                      improvement in key
Much depends on the policy stance and a settlement between the Centre
and the states about jurisdictional issues. Whether the visible hand of               measures of welfare.
the state in India would prove to be a nurturing one for the industry or
a crushing one, only future can tell. And it better tell it soon, for there              It seems that it is
is hardly much time to dither.
Bhat Ramesh, Mavalankar Dileep, Maheshwari Sunil Kumar, Saha Somen (2007),                 investigation of
          “Provision of Reproductive Health Services to Urban Poor through Public–
          Private Partnerships, The Case of Andhra Pradesh Urban Health Care
          Project,” IIMA Working Papers WP 2007–01–07, Indian Institute of             impact assessment
          Management Ahmedabad, Research and Publication Department.
Abhijit Banerjee, Esther Duflo, Rachel Glennerster and Cynthia Kinnan (2010),          that has lagged the
          “The Miracle of Microfinance? Evidence from a Randomized Evaluation”,
          Working Paper, MIT.
Ashok Rai and Shamika Ravi (2009), “Do Spouses Make Claims? Empowerment
          and Microfinance in India”, World Development, forthcoming.
Collins, D., Morduch, J., Rutherford, S. and Ruthven, Orlanda (2009), Portfolios of    revolution in India.
          the Poor: How the World’s Poor Live on $2 a Day, Princeton University
Dean Karlan, Xavier Gine, Jonathan Morduch and Pamela Jakiela (2006),
          “Microfinance Games,” Working Papers 936, Economic Growth Center,
          Yale University.

             Srinivasan (2010).
             Srinivasan (2010).                                                                     147
ICRA BULLETIN          EDA Rural Systems and APMAD (2006), Self-Help groups in India: A Study of
                                 Lights and Shades, a report prepared for Catholic Relief Service, CARE,
Money                            USAID and GTZ/NABARD.

      &                Finance Ministry (2010), Mid-Year Analysis 2010–2011, Department of Economic
                                 Affairs, Ministry of Finance, Economic Division, Government of India.
      Finance          Karlan, Dean and Xavier Gine (2009), “Group versus Individual Liability Long
                                 Term Evidence from Philippine Microcredit Lending Groups”, Working
   J U L Y . 2 0 1 1             Paper 61, Yale University, Department of Economics.
                       NABARD (2011), “Status of Microfinance in India: 2009–10”, www.nabard.org.
                       Ramesh, Jairam (2007), “Self-help Groups Revolution: What Next?”, Economic and
                                 Political Weekly, Sept 8.
                       Srinivasan, N. (2010), Microfinance India: State of the Sector Reports, Sage
                                 Publications, New Delhi.
                       Subramanian, Krishnamurthy (2011), “Malegam Report to Hurt Microfinance”,
                                 Economic Times, February 8.

                                  In its Monetary Policy for 2011–12, the RBI has largely accepted the
                       Malegam Committee’s recommendations with a few changes like raising the interest
                       rate ceiling from the proposed 24% to 26%, and the household income eligibility
                       ceiling for MFI loans to Rs. 60,000 for rural areas and Rs. 1,20,000 for urban areas
                       from the proposed Rs. 50,000.


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