Credit Worthy
Rohit Chawdhry
05-Nov-07
Microfinance is enabling the provision of financial services to poor and low income groups. A recovery percentage of more than 99% is making micro credit highly attractive to venture capitalists. Rohit Chawdhry examines the Indian experience where 26% of the world’s active microfinance clients can be found and considers whether it makes good business sense.
With more than 60% of India’s population residing in rural areas and a similar amount employed in agragarian activities, any activity focused on providing adequate finance for their upliftment is bound to have a major impact on overall economic growth of the country. Microfinance is one such area and its progress in rural India is fast developing into a mega-trend.
Microfinance or micro-credit is the provision of quality financial services to poor and low- income people who do not have access to traditional formal financial institutions or require smaller loans than what conventional banks will entertain. Briefl y, there are around 450 micro-finance institutions globally, with Latin America leading with 33%. The Indian microfinance outreach represents 26% of the total number of active microfinance clients the world over.
Micro-credit is just not any dole to help the poor, there is a commercial angle involved here as well. Contrary to conventional wisdom, the capacity to repay back loans by this lower income group is quite high. According to SIDBI, a key institution involved in this sector, the recovery percentage under the scheme is more than 99 per cent. Further, the portfolio of assets is almost doubling every year. Precisely the reason for venture capitalists to be attracted.
Recently, in the largest ever deal in microfinance in India, a leading Indian microfinance institution, Share Microfin Ltd, has received $27 million investment from Dubai’s Legatum Capital (which invested $25 million) and Aavishkaar Goodwell ($2 million). Subequently, Legatum now owns a 51 per cent stake in the Hyderabad-based microfinance institution. Share is one of the largest micro finance institutions (MFIs) in India with over one million clients and $95 million in outstanding loans. Share operates in five Indian states, across 8,000 villages with 2,300-plus staff .
In an earlier deal, Sequoia Capital (which had earlier invested in Google and You Tube) has also stepped into Indian microfinance scene. They also want to help the poor – and in the process, make some money too. The Silicon Valley-based venture capital fund has invested $11.5 million in India’s leading microfinance institution SKS Microfinance, “the first pure for-profit private equity play” ever seen in the microlending business. SKS’s microlending is not as risky as it has a 99 per cent on-time repayment rate from its 600,000 borrowers. It provides an ROE of 23 percent. Sequoia will be the largest investor in SKS, the others being Unitus Equity, SIDBI and individual investors like Vinod Khosla. Also, Bell Weather has made three equity commitments for start up, and its committee has decided to increase the size of the fund from US$10 million, to US$25 million. Clearly, VCs are finding the playground good enough to run.
The history of microfinance dates back to 1970s when subsidised agricultural credit was given to the farmers. In the modern day version of microfinance, diverse demands and clients have changed focus to inclusive finance. By inclusive finance, it implies poor and low-income earners need access to appropriate financial services, and microfinance should be integrated into the formal financial sector globally.
Micro-credit, has been growing fast in many countries, most notably in Bangladesh since the 1970s when it was initiated by organisations such as the Grameen Bank and BRAC. In India the movement appeared only in the 1990s due to the advent of financial sector reforms that encouraged policy makers to devise and encourage new solutions with a focus on repayment and sustainability. The movement started with the idea to connect a group of villagers, usually a group of 15-20 women, to commercial banks, which became widely known as the self housing group (SHG) -Bank linkage model. In recent years, a new model of microfinance has emerged, closer to world famous Grameen model—financial intermediation by so-called “Micro Finance Institutions” (MFI), specialized institutions created specifically to distribute credit to the un-banked population. More importantly, micro-finance in India is a much more stable model than that in Bangladesh. View a bar chart comparing the success of microfinance in different areas
So what’s the basic structure of microfinance in India ?
The microfinance sector in India, largely unfettered by tedious regulation and interference, is young and dynamic. While there are very few reliable aggregate data available for the Indian microfinance market, a lower bound on supply of credit from the formal sector can be estimated at Rs.37 billion (US$822 million) in 2004-05.
Currently, roughly 75% of the credit supply is via the Self Help Group-Bank linkage route largely financed by the National Bank for Agriculture and Rural Development (NABARD) and the rest comes from MFIs, increasingly backed by commercial banks. However, the difference in market share is decreasing, as the increase in credit flow to SHGs over the previous year is 61% while growth of loans originated by MFIS is well beyond 100%. It is noteworthy to mention here that NABARD intends to start a micro-finance institution which will invest upto Rs 500 crores (US$125 million) over the next 3 years.
And what’s the potential of this market?
According to an April 2006 McKinsey India survey, rural India has the potential to become a US$500 billion market by the year 2020 (current size being US$170 billion). It remains to be seen whether today’s MFIs, banks, lenders and investors have the tenacity, dexterity and wit to retain and build on their first mover advantage.
Considering the mega size, not surprisingly, leading commercial banks such as ICICI are focusing on this segment in a major way. For example, ICICI’s microfinance portfolio has been increasing at an impressive speed. From 10,000 microfinance clients in 2001, ICICI Bank is now lending to 1.2 million clients through its partner microfinance institutions, and its outstanding portfolio has increased from Rs. 0.20 billion (US$4.5 million) to Rs. 9.98 billion (US$227 million). A few years ago, these clients had never been served by a formal lending institution. ICICI Bank is also encouraging venture capitalists to start entering the sector. The bank has entered into agreements with quite a few venture capitalists under which it will provide take-out financing to the MFI to buy out the venture after a period of three to five years, provided the MFI attains an operational sustainability rating from Micro-Credit Ratings International Ltd (M-CRIL) and Credit Rating Information Services of India Limited (CRISIL).
Beyond Microcredit
Microfinance does not only mean microcredit, and ICICI does not limit itself to lending. ICICI’s Social Initiative Group, along with the World Bank and ICICI Lombard, the insurance company set up by ICICI and Canada Lombard, have developed India’s first index-based insurance product. This insurance policy compensates the insured against the likelihood of diminished agricultural output/ yield resulting from a shortfall in the anticipated normal rainfall within the district, subject to a maximum of the sum insured. The insurance policy is linked to a rainfall index.
Further, the bank is also helping MFIs by way of securitizing the receivables. A recent deal in this regard was signed with Bhartya Samruddhi Finance Limited (BSFL), in which ICICI Bank securitised the receivables of a selected portfolio of microfinance loans by BSFL amounting to Rs 42.1 million (US$ 957,000). Both under the partnership model and under the securitisation deal, the bank provides organizations with financial support at a mezzanine level, which enables them to offer credit protection in the microfinance portfolios to a reasonable extent.
Interest Rate Ceilings – Biggest challenge to Microfinance
While the market size is growing rapidly, there is concern over burdening the clients with multiple debts. Further, there is also concern raised over high interest rates charged by various institutions. While several organisation have asked for a ceiling on interest rate charged, the government has not been of the opinion to do so. They suggest that any cap on interest rates would discourage big players such as private and foreign banks to lend to microfinance institutions. We are certain that with more competition, the interest rate would come down, presently in excess of 18%. While these working details are in the process of being tweaked, the future of micro-finance in India certainly looks bright. Who says size doesn’t matter? It does.
