Banks, Stock Exchange Listing & Microfinance

The dynamics of the microfinance sector have undergone a substantial change due to two important changes. The role of banks in lending to the microfinance sector and the rise of 'for profit' microfinance companies with their ultimate aim of listing on the stock exchange and attracting global equity investors have dramatically altered the landscape of the microfinance sector. It is imperative to note that the AP variant is "micro-credit" rather than micro-finance. 

The lead role played by banks in funding the 'for profit' microfinance enterprises to take advantage of the clause of 'priority sector lending' rule has been a gift for the microfinance institutions (MFIs). Concurrently, the growing trend towards attracting global finance capital has led to the growing need for MFIs to push credit and increase profitability at all costs - even if they have to force people to take their own life. Global Capital too has decided to bet big on the Microfinance sector. SKS Microfinance (the first stock exchange listed MFI) has George Soros amongst its shareholder while Share Microfin Ltd has New Zealand Billionarie Christopher Chandler as its shareholder. Share Microfin and Spandana-Sphoorthi are MFIs that had drawn up plans to complete their Initial Public Offerings (IPOs) before the crisis in AP.

It is pertinent to note that equity investors are obsessed with growth and profitability on a quarterly basis. Since they have to declare their results on a quarterly basis, if there has to be a share price, they not only have to consistently and sequentially keep increasing their profits, but also paint a rosy picture about their growth prospects. This has the larger institutions demanding an increasing pie in the sector. This has meant that lending to the poor has emerged as just another statistic that needs to be packaged for the equity investors. 

Ironically, it is the role of these two categories of financial players (Banks and Equity investors) who may actually emerge as the white knights that may bail out the microfinance sector. Both these sections have immense clout among the policymakers, despite at least one former governor of the Reserve Bank of India,  ( Y.V.Reddy) clearly stating that the MFIs are no better than Moneylenders.

The Indian banking sector could not have come to the rescue of the microfinance sector at a more opportune time. The AP Ordinance has near felled the whole sector by attempting to clean up the microfinance business of its unsavoury business practices that have cropped in the hitherto unregulated sector. This in turn has created unintended consequences in another systemically important sector that is one of the most regulated of the formal business - the banking system. Banks have agreed to throw a lifeline to the microfinance sector just as the sector is trying to grapple with a business model that has been exposed to be shaky. Chanda Kochhar, the CEO of the ICICI Bank is the latest high profile person to defend the microfinance sector. She is quoted as saying that microfinance companies serve the nation's poorest, and as "responsible banks, we can't pull the plug" and that the sector should not be constrained for funding. While she called for a review of standards such as the amount of loans provided to each customer, she is stated to have observed that "the momentary experience of one state is not reflective of how the whole situation is" (Quoted  in the Bloomberg article). Ironically most of the defenders of the existing business model of the microfinance firms have mostly come from different segments of the lending business or those from the management discipline.

It is pertinent to note that banks are some of the largest lenders to the microfinance sector. They have been aided by Reserve Bank of India (RBI) guidelines that state that lending to the MFIs can be accounted as priority sector lending in their books. The ostensible reasoning for priority sector lending benefits arises from the view that bank lending to the MFIs and their onward lending would lead to better credit delivery to the poor thereby expanding the scope of financial lending. In a August 2010 meeting, the RBI is stated to frowned upon banks lending to for-profit MFIs at below market interest rates due to the benefits of these loans being classified as priority sector lending. RBI has over the years directed the banks to follow the NABARD guidelines of 1992 about funding norms to be microfinance institutions. The Andhra Pradesh government on the other hand is clearly unhappy with the MFIs, and is reported to have complained to the RBI that there is prima facie evidence that the banks have violated a number of RBI norms in their business dealings with the microfinance companies and hence demanded necessary action by RBI.

Interestingly, the stock markets seem to be forcing the banks to make haste in their dealings with the MFIs sector and probably to force the MFIs to cooperate in the regulatory and investor interest to clean up the sector. The equity markets have emerged as a powerful pressure point as nearly all the major banks in India are listed on various exchanges as is SKS Microfinance (the only listed microfinance company). By 18th November 2010, the share price of SKS Microfinance had nearly halved after its hugely IPO and subsequent listing. Listing on the stock exchanges has also forced the banks and SKS to provide more information about the material adverse changes afflicting the sector since the AP government ordinance.

It has been pointed out that Andhra Pradesh accounts for nearly 35 percent of the microfinance lending in India. The exposure of the banks to the Microfinance companies is estimated at nearly Rs.10,000 crores, while other estimates place it at nearly two or even three times that amount. The major banks which have an exposure to the sector in India are: Axis Bank (about Rs.1,000 crores), Bank of Baroda (Rs.300 crores), HDFC Bank (Rs.1,200 crores), ICICI Bank (Rs.2,500 crores), Punjab National Bank (Rs.1,000 crores), State Bank of India (Rs.1,000 crores) and YES Bank (Rs.700-900 crores). Andhra Bank is rumoured to have a large exposure, though the bank is yet to officially announce its exposure. The detailed exposure of the banks have not been officially announced. The State Bank of India is an exception and it has stated that it has about Rs.300 crores of exposure to the sector in Andhra Pradesh (Business Standard, Section II, 19 November 2010). It has been pointed out that MFIs raise nearly 75-80 percent of their funding requirements from the banks, about 15 percent from equity investors and another 10 percent from other sources.

It has been pointed out that a 25 percent cut in collection of all Andhra Pradesh loans will reduce the earnings of the larger banks by 2-4 percent, while for the smaller banks it could be 5-8 percent. A complete default would lead to a substantial if not all the amounts of money lent going into default. This would be a unmitigated disaster for the banking sector as almost all the banks are struggling with a rise in their non-performing assets over the last six months due to other problems in the economy. This is one of the reasons why the banks have agreed to a proposal that the banks and the MFI industry establish a Rs.1000 crore fund that would be utilised by the smaller companies to overcome their liquidity crisis. The liquidity crisis has been caused because the collection of loans (which even to this day stands at 99 percent per week in other parts of India) has been impacted substantially in Andhra Pradesh.

The microfinance sector is less than forthcoming with information related to the present crisis in Andhra Pradesh, though they claim that their collections have increased. SKS has pointed out in information provided to the stock exchanges on 18th November, that the company has been impacted by AP forcing the company to switch to a monthly collection model from their weekly collection model. SKS itself claims that it has now been able to hold its meetings in 97% of the areas and it has registered itself with the government in all the districts of AP (Company release to Bombay Stock Exchange on 18th November 2010). Newspaper reports, however, indicate that less than 10 percent of the borrowers have paid their installments.

One newspaper headline (Mint, 19 November 2010) aptly asked: "The death of a sunrise industry?" With the big banks behind the sector, there are bound to be a number of other interesting chapters that will unfold. The banks' large scale loans to the sector is likely to mean that the banks will be forced to lend money to the MFIs in future or the banks run the risk of bankruptcy among the MFIs. This fear is likely to force the banks to not only to continue to lend to the sector (they have lent nearly Rs.292 crores to SKS even after the issue of AP ordinance), but they are also likely to pressure the RBI not to take further action. The likely compromise is that the MFIs would have to promise good behaviour in future. While the MFIs may not be too keen to change their way of carrying out business, investors (Indian and Global) and banks would be very keen on such a change. That could be the cost of survival that the microfinance industry may have to pay - a small price considering their past actions. The banks, too will extract their pound of flesh: they will invariably demand higher interest rates and probably even other forms of collateral as the model is increasingly being exposed as being unhealthy.