Indian Microfinance Institutions Have Just Busted A Myth

By definition, microfinance is the business of giving tiny loans to people who do not have access to formal banking services. The Investopedia website defines microfinance as a type of banking service that is provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. “...the goal of microfinance is to give-low income people an opportunity to become self-sufficient by providing a means of saving money, borrowing money and insurance,” it says. In India, microfinance institutions (MFIs) cannot collect deposits, but sell insurance products, besides offering small loans that are typically paid back in weekly or monthly instalments.

Such institutions operate in the hinterland where traditional banks balk at serving. Or, so we believed. The scene has changed. MFIs have shifted their focus from rural pockets to urban India. For the first time in its 25-year history, Indian MFIs have more urban clients than rural ones. The latest data, compiled by industry self-regulatory organization Sa-Dhan, shows 67% of the 37 million MFI customers live in urban India.

The share of rural customers was 69% in fiscal year 2012. That dropped marginally to 67% in 2013. In the following two years, the share of rural customers has declined drastically. In 2014, rural customers constituted 56% of the total. It dropped further to 33% in the following year. This busts the myth that Indian microfinance is predominantly a rural phenomenon, very different from what we see in Latin America and large parts of Africa and Asia.

The industry’s outreach to urban clients was increasing every year and it has now outstripped that of rural customers. Why has this happened? Before we look for an answer, let’s look at the broader picture. The industry had a customer base of 37.1 million in March 2015, up from 33 million a year ago. It included 6.5 million customers of Bandhan Financial Services Ltd, the largest MFI that turned into a bank in August. The percentage of women customers remained unchanged at 97%, while the share of Scheduled Caste and Scheduled Tribe customers rose from 19% to 28%. The loan portfolio was close to Rs.40,000 crore and 80% of it was for income-generating activities. The average loan per borrower in the year ended 31 March rose to Rs.13,162 from Rs.10,079 in at the end of the previous fiscal.

The quality of assets has improved. If we leave a few MFIs that had been affected by the crisis that gripped the industry following the Andhra Pradesh state law five years ago, the industry’s non-performing assets (NPAs) were to the tune of 13 basis points as on 31 March. A basis point is one-hundredth of a percentage point.

Such MFIs were referred to the so-called corporate debt restructuring cell as their equity and reserves were eroded by accumulated bad loans. About 80% of 250-odd MFIs have less than 1% of their loan portfolios at risk. About 12% of MFIs have 1-3% of their loan portfolio at risk, and 8% of MFIs have more than 5% of their loan portfolio at risk. The loans at risk are those that have not been serviced for 30 days.

In contrast, the quality of small loans distributed through the so-called self-help group (SHG) model is inferior. The number of SHGs shrank to 7.71 million in 2015 from 7.43 million in the previous year even though the number of families involved in SHGs increased from 97 million to 101 million. SHGs, typically a group of 20 women, save as well as offer credit to its members from money sourced from commercial banks. SHGs’ total savings stood at Rs.11,307 crore in 2015 and the loan portfolio was Rs.51,727 crore. The average loan outstanding per SHG was Rs.1.15 lakh and NPAs were 7.4%, up from 6.8% in the previous year.

One reason behind the rise in urban customers is the phenomenal growth of a few urban-focused MFIs such as Janalakshmi Financial Services Pvt. Ltd, Ujjivan Financial Services Pvt. Ltd and Satin Credit Card Network Ltd. These three collectively had around 5.7 million customers in March. Their growth last year had been higher than the average industry growth and most of their customers live in urban India. Till it became a bank, Bandhan had an 18% market share of customers, followed by SKS Microfinance Ltd and Shri Kshethra Dharmasthala Rural Development Project. Others among the top 10 are Janalakshmi, Equitus Microfinance Pvt. Ltd, Spandana Spoorthy Financial Ltd, Share Microfin Ltd, Satin and Grameen Koota Financial Services Pvt Ltd. Janalakshmi, Ujjiivan and Equitus have received in-principle approval from the Reserve Bank of India to become small finance banks.

Another reason behind the growth in urban customers is the shift in the business models of many MFIs. They are becoming increasingly urban-centric to cut down operational expenses and maximize operational efficiency. Under the priority sector lending norms, banks in India are required to give 40% of their loans to small borrowers. As they do not have the reach, they give money to the MFIs to be on-lent to such borrowers. While fixing the loan price for small borrowers, the MFIs cannot charge more than 10% over the cost of loans taken from banks. This means their profitability solely depends on operational efficiency as the cost of raising resources is almost the same for all MFIs.

The rise in urban clients of MFIs also tells us that banks in India have a cultural problem—they don’t like small borrowers, be they in rural or urban India. The official reason for not reaching out to small borrowers are many—ranging from higher transaction costs and lack of reach to the absence of a competent rural cadre. These probably explain the banks’ absence in remote villages. But what about urban India? Our drivers and housemaids, vegetable vendors and fishermen in Mumbai and Delhi are being serviced by MFIs as the banks refuse to see business there.

Tamal Bandyopadhyay, consulting editor at Mint, is advisor to Bandhan Bank. He is also the author of Sahara: The Untold Story and A Bank for the Buck.

Email your comments to [email protected]. His Twitter handle is @tamalbandyo

This blog first appeared in www.livemint.com