It is natural for a sector like microfinance, which is growing exponentially, to face problems on the way. But the current crop affecting microfinance institutions (MFIs), which are constituted as non-banking financial companies (NBFCs), is somewhat more serious and require a relook at the roots. Microfinance has been celebrated for bringing institutional credit to the poor who have no security or collateral to offer. The model’s success lies in extremely high loan recovery rates of 98 per cent or more. This is why microfinance is now considered mainstream and is attracting private equity funding from all over the world. Founders of some of the best-run MFIs who started off as philanthropists are exiting at phenomenal profit and giving MFIs hitherto undreamed of valuations like half a billion dollars. The importance of private equity will grow as MFIs go public and with this will come the need for private equity to chart its exit according to pre-determined schedules. Private equity and the global financial crisis have brought in senior managers from the financial world at what is considered exorbitant salaries to the world of microfinance.
Professional management and private equity targets, both financial and temporal, have set agendas for both lending and recovery. The result on the ground is that multiple lending (the same borrower taking loans from several MFIs), which was always there, is now considered rampant by some long-term MFI observers. Servicing multiple loans every week is not easy, particularly when they are disbursed under group guarantee, creating peer pressure not to default. A borrower who has bitten off more than she can chew often has no choice but to go to the moneylender. Significantly, informal credit has grown apace with microfinance in recent years. Thus, there is a danger of microfinance not only being unable to remove poverty (health emergencies and social obligations like marriages make the removal of poverty a more challenging goal) but ending up enhancing indebtedness.
The Reserve Bank of India (RBI), which regulates NBFCs, is worried that over and above the adverse trends noted above, the advent of more professional management and economies of scale bringing costs down are not leading to lower borrowing costs. Not all private equity firms are the same but their basic aims militate against charging borrowers less. RBI has, therefore, indicated that if the benefits of success are not shared with the poor borrower then it will take microfinance out of the ambit of priority sector lending, thus not allowing MFIs to access commercial bank credit at attractive rates for onlending to the poor. There are several solutions. One, better self regulation. Two, creation of credit bureaus to help MFIs avoid the pitfall of multiple lending. In Latin America, for example, this has enabled MFIs to get away from group guarantee which has its evils. Three, issuance of banking licences to the best-run MFIs so that they can access cheap funds via community savings. SEWA and Basix already do so. But it is most important for MFIs to reaffirm their social agenda. They are there to help the poor earn more by providing affordable credit. Typically, the poor are vulnerable to emergencies like flood, drought, illness and marriage. So, to insist on a near-perfect recovery schedule is to invite a crisis.
