Microfinance: A Fading Business Model?

An interesting aspect of the recent discussion about the nature of microfinance is the quick change in heart of even the most ardent advocates of microfinance about the limitations of their business model. This is in sharp contrast to the views over the past decade, where microfinance was seen as a panacea for the problems plaguing India’s attempt to fight poverty. Less than two years since the AP government’s forceful intervention on behalf of the borrowers, the proponents of Microfinance business seem to be coming to terms with the flaws in their business model, albeit grudgingly and painfully slowly. In a recent article by Suresh Gurumani, titled Ensuring Microfinance’s future prospects, the former CEO of SKS Microfinance, came rather close to accepting various contentions of the AP government. He accepts that "there has been a mission drift where the pioneers of the sector failed to manage the pressures of private equity providers who pushed MFIs to pursue unbridled growth to build their personal wealth disregarding the consequences of excessive growth". 

Microcredit business (as encouraged by the MFIs, especially in AP) is remarkable for the complete lack of vision displayed by the companies. The logic of a business expanding the supply of credit many times beyond the ability of customers to repay is astoundingly similar to a lack of understanding of the history of bubbles. The photo below of the loan sheets of one family in Chittoor district is the norm rather than the exception. 

(The photos in this posting were collected during the course of a larger study supported by the Society for the Elimination of Rural Poverty, Government of Andhra Pradesh, titled " An In-Depth Study of Issues and Challenges in Microfinance Sector in Andhra Pradesh" in 2011)

Most of the borrowers have assets that are not proprietary rights that are acceptable by the present market system. The security that these companies accepted are often like the houses in the picture below:

The owner of the house borrowed Rs 180,000 from different MFIs in Andhra Pradesh and committed suicide due to the harassment by employees of the companies. 

A consequence of this business model resulted in the present crisis in the microfinance sector. It is doubtful if the MFIs have actually changed their behaviour and strategy in different parts of the country.

Gurmani's article contains mostly old contentions but with a very interesting (new) suggestion. His suggestions include:

Among the suggestions that are a reiteration of the old ideas include:

• Allowing MFI NBFCs to offer thrift and savings products
• Increase presence in money transfer business (using the banks' network across the country) 

A new suggestion, albeit unworkable, includes:

• Banks taking ownership of MFI non-banking financial companies (NBFCs). Each of the major banks that hold major debt in these companies can convert that into equity and become majority owners. Alternatively, banks that have NBFC subsidiaries can launch microfinance operations, hiring trained staff from MFI NBFCs.

A very interesting suggestion enunciated by Gurmani is the need for banks to  "graduate seasoned borrowers with successful enterprises to more substantial products such as loans against property and home loans, etc".   

 

There seems to be no reason why the banks, should yet again subsidise the MFIs. The growth in the MFI business was due to the largess provided by the banks. The banks have paid dearly for this support. There is no reason why the banks should yet again support allow a socialisation of the losses. Moreover, there is little need for the banks to ride to the rescue with growing emphasis on financial inclusion by the Government of India and the Reserve Bank of India. Instead of expending money on attempting to revive a redundant model that has clearly failed, the banks will be better advised to invest money on rural branches, Business correspondents, single person rural branches, and business facilitators. Leveraging government promoted SHGs may provide a better safety net for the banks (when it comes to collecting their dues) rather than depending on the muscle power of MFI NBFCs.

What Happens if Stimulus is withdrawn?

A pertinent question to ask would be: what happens to the markets if the stimulus is withdrawn by the Central Banks? The past few months has clearly indicated that the market move based on perceptions of an increase/decrease in stimulus. Any indications that the stimulus may be withdrawn leads to a fall and vice versa.

Imagining what is likely to happen to the financial and commodity markets is not difficult, thanks to the following chart, which makes it easy to correlate the impact  of the past moves by the US Federal Reserve. to expand supply of money. This will be no different for the other regions. 

The solace that the above chart provides: Don't worry Zero percent interest rates are here to stay for a long time - longer than what policy makers tell us!

Rising oil price should not be a problem beyond a certain point. Oil and commodity markets will go into a tailspin if there is even the slightest indication that the US Fed will withdraw the stimulus. Then the problems start for countries like India and China.

Brace for the Bear

At last the onset of summer seems to have taken the sheen out of the euphoria surrounding the equity markets and the global recovery. ECB's attempt to pump in Euros 1.2 trillion in two rounds of LTOR seems to have helped for about 4 weeks. 2012 is turning out to be remarkably similar to 2011.

Misplaced optimism that the Emerging markets will continue to recover seems to be eroding with the economies of India and China growing less than expected. In these countries investors, at last seem to be  waking up to the reality that trees cannot grow to the sky. 

In the US, Equity bulls continue to believe that their equity markets will continue to do well. The chart below (of the S&P 500) should worry any investor. The huge expanding triangle (red lines) on a larger time frame (2011 onwards) and in a shorter time frame (2012) along with major negative divergence (upper pane - yellow line) indicates that the equity markets are due for a shock sooner rather than later. An expanding triangle tends to dissipate the bullishness and the longer the time frame, the larger the fall. A retest of the 2011 lows  and even 2008-09 lows need not be surprising.

While, optimistic investors may not accept the above chart, they would probably do well to ponder why the bond yields continue to be stubbornly low in most parts of the world.