Don’t miss the latest developments in business and finance.

Margin cap on MFI loans worries PE players

B Dasarath Reddy Hyderabad
Last Updated : Jun 06 2013 | 2:10 AM IST
Private equity (PE) flows into the micro finance space in India had come down in 2012 on worries over the margin cap on micro finance institution (MFI) loans, in addition to the existing uncertainties that continue to haunt the micro credit sector.

According to VC Circle data, the value of the PE deals in calendar year 2012 stood at $104.5 million, compared to $113.04 million in the previous year and far lower compared with $146 million in PE flows reported in 2010.

However, the increased flow of debt-funding kept the party going for the MFIs, which was also reflected in 23 per cent growth in gross loan portfolio of 41 member-firms of the Micro Finance Institutions Network (MFIN) in FY13. Some believe the steep rise in debt-funding last year was also a result of the cautious approach by PE funds in taking fresh calls for the sector.

Insiders say the micro credit sector became too predictable, compared to what it used to be in the no-regulatory time when some MFIs were charging up to 40 per cent on loans extended to small borrowers. The recent exit of the PE fund Lok Capital from the SatinCreditcare yielded 2x returns, while the similar exits in the pre regulation period witnessed yields ranging between four and seven times.

Margin cap
In August 2012, the Reserve Bank of India (RBI) had imposed a margin cap of 12 per cent for smaller micro finance institutions (MFIs) and 10 per cent for MFIs with over Rs 100-crore business. This came as a modification to the earlier cap for rate of interest on micro lending.

According to this norm, if a smaller MFI had borrowed money at 12 per cent from a bank, then it can lend to its borrowers at a maximum interest rate of 24 per cent, while a bigger MFI can only charge up to 22 per cent from borrowers. MFIs seek a uniform cap of 12 per cent for all players, irrespective of their size. "Investors are worried because they feel the returns will not exceed 16-17 per cent if the margin cap is at 10 per cent. We are asking for the margin cap of 12 per cent irrespective of the size of the company," says Kishore Puli, promoter and CEO of Trident Microfinance.

Agrees Vishal Mehta, founder and partner of Lok Capital, an India-focused venture capital fund with interests in micro finance, education and healthcare sectors. "There are less number of investments happening in this space because of the margin cap." He adds that most of the funding requirements of MFIs are currently being met by the bank. He also feels that these RBI guidelines will eventually keep the size and the number of MFIs under check so as to keep the sector manageable from the regulator's perspective.

The MFIN, an umbrella organisation of 41 MFIs operating in India, says the increased debt funding is an indication to the growing investor confidence. MFIN members received a total debt funding of Rs 10,200 crore in the last financial year, a 79 per cent jump over the previous year.

According to Mehta, about $200 million in PE investments have come into the sector over the past two years and the World Bank's private investment arm, International Finance Corporation (IFC), alone accounts for over half of these investments. IFC investments also come in part debt and part equity.

Regulatory challenges
Investors' worries, however, do not end with the margin cap. The larger issue is central legislation, which still remains unresolved, says Puli. The main worry is: what if some other state comes up with its own set of regulations in line with that of Andhra Pradesh? According to him, the sector needs a couple of more years to get over the recent setbacks.

MFI activities had come under serious challenge when the state government in Andhra Pradesh issued an ordinance to regulate micro lending in October 2010.

Prior to the Andhra Pradesh regulation, the microfinance industry had topped the chart in terms of attracting PE and venture capital investors in a poll conducted by Venture Intelligence in early 2010. The same year, SKS Microfinance Limited debuted on the BSE.

Falling yields
Last month, Lok Capital exited from Delhi-based Satin Creditcare Network Limited, a microfinance player in North India. Mehta says the yield on investment was in the range of 2x. This is all one can expect from the sector at present, he adds. In contrast, PE firms enjoyed four to seven multiples of yield on investment during the pre-crisis period.

Margin cap has also made the valuations of micro credit business unattractive. Earlier, some of the MFIs were charging up to 40 per cent interest.

Mehta says since the margins have shrunk, the research and innovation on pricing and other aspects of micro credit products have also dried up as the MFIs are focusing only on bringing down the costs.

Although RBI deputy governor K C Chakrabarty had ruled out revoking the cap on margins, the industry still expects a positive response to other issues such as uniform treatment to all MFIs, irrespective of size.

Also Read

First Published: Jun 06 2013 | 12:42 AM IST

Next Story