Microfinance & Regulation

The Microfinance industry never seems to learn from its mistakes. It has been reported in the press ("MFIs hope for better days", The Economic Times, 1 December 2010, p.5) that they sector is hoping that the political problems in Andhra Pradesh would lead to at least some dilution of the recent provisions of the AP ordinance. Interestingly, Mr.Vatti Vasant Kumar, the minister when the ordinance was promulgated has stated that he was given a different portfolio by the new Chief Minister due to the pressure from the MFIs. This lethargy on the part of the MFIs to think of an alternative business model to their present structurally flawed model is flabbergasting, to say the least. Our posts have consistently pointed out that the culture of lending of the MFIs needs to Change.

A number of observers in the financial sector seem to believe that the regulations enacted by Andhra Pradesh, may actually cure the sector rather than curing it of the ails. On the contrary, we believe that the measures are overdue in order to bring about at least a semblance of order to the money-lending space. It is difficult to justify the argument of the MFIs when they claim that they are helping the poor when they are blatantly violating a number of laws put in place by different regulatory bodies including those enacted by the RBI, IRDA and the State governments. These are violations that have come to light till date. The MFIs probably have not realised that the RBI is about to change the rules when it comes to recovery of loans. So their hopes of diluting the laws could be quite premature. It has been pointed out ("Agents can recovery loans only with smile, says Central bank", The Times of India, Hyderabad Edition, 30 November 2010, p.13) that from January 1, 2011, RBI has stipulated that all recovery agents will have to complete a certificate course and 100 hours of training in behavioural skills from the Indian Institute of Banking and Finance (IIBF). This has become necessary as banks are not following RBI guidelines on training and certification courses. The training requires recovery agents to be in formal attire, with both domain knowledge and behavioural skills. This is not to claim that this will lead to complete compliance. It will not - just like most of the other laws. But these regulations would mean that it would give the local police as well as other law enforcement agencies some teeth.

Calls for self-regulation of the MFI sector is ludicrous at best. Historically, self-regulation has always been a very expensive mistake - more so in a business that finds it commercially profitable if a borrower commits suicide. Self regulation is unlikely to work as there is an inherent built in bias against the consumer and goes against the very tenets of the liberal state, which claims to be a neutral arbitrator in disputes. Kaushik Basu, the Chief Economic Advisor has called for regulating MFIs and has called for Transperancy in contractual terms for loan seekers rather than capping interest rates since microfinance has inherent high costsdue to the small size of the loans ("Kaushik Basu Warns against over-regulation of MFIs", Business Standard, Section II, 30 November 2010, p.5).

The MFIs have not portrayed themselves with any of the agencies or departments of the government. Recent reports ("RBI Panel had warned of MFI issues", Business Standard, Hyderabad Edition, 3 December 2010, p.1) have pointed out that two months before the issue came to the forefront in AP, an RBI panel had warned of possible problems in the sector. The panel headed by an Executive Director of the RBI (V.K.Sharma) is reported to have questioned the business model of the MFIs and highlighted the need for a complete revamp. One of the concerns that it raised is lending unsecured loans for unproductive purposes, which could lead to problems in future. The Microfinance India State of the Sector Report 2010 pointed out that in Andhra Pradesh, each poor household has on an average 9.6 loans, so any claims that MFI have replaced the private moneylenders is untrue.

A fundamental change that the MFI sector needs is to avoid the temptation of seeking global equity capital, especially from the more demanding investors such as Private Equity players and Hedge funds. Indian NBFC MFIs are reported to have raised nearly US$565 million since 2006 (Cited in Bloomberg Article). While George Soros, Sequoia have invested in SKS Microfinance, Temasek invested $50 million in Spandana in August 2009. Christopher Chandler, the New Zealand billion has invested in Share Microfin, which has like Spandana postponed their plans to complete a initial public offering. The pressure to grow exponentially has been an important factor for the MFI sector.

The MFIs need to realise that, despite all their claims, they continue to charge usurious rates. A listed MFI in India, S.E. Investments Limited pointed out in a release to the Bombay Stock Exchange on 26 October 2010, that they charge interest rates that are in the range of 24-26% IRR annualised. On a weekly repayment mode, this would work out to about 40 percent and would be far more taxing since a number of borrowers are those who earn about 2000-3000 rupees a month. The Principal Secretary of Andhra Pradesh has pointed out that the MFI have to change their business model from a weekly payment mode to that of a monthly repayment mode as their borrowers earn less than Rs.30,000 but have been given loans of about Rs.100,000 which they are expected to repay within a year. He has pointed out that on the demands of the state, the MFIs are negotiating with the AP government to change the tenor of the loan from 12 months to 18-24 month period - a long over due measure.

We reiterate that unless the MFIs drastically rework their business model, the pressure from below would require large scale governmental interventions, something that very few industries can withstand. The business culture in India is such that unless the government is friendly to the demands of the industry (by providing innumerable concessions) business' would find it difficult to make profits, leave alone exponential profits that many global investors seem to think it is possible.