Microfinance – Evolving with the Times

In the wake of the recent developments in the Microfinance Industry, a lot of finger pointing has come to pass. We have seen the boom of SKS IPO shortly followed by the sacking of its CEO Suresh Gurumani and the current AP crisis. The entire Microfinancial Institution (MFI) community has been portrayed as the villains likening them to money grabbing moneylenders.


Whether there are vested parties involved, whose interests are not served if the rural population has a self sustaining model of improving their standard of living or whether these were some isolated incidents of some MFI’s going overboard in repayment collections remains to be seen. What cannot be disputed is the aggressive lending practices followed by some MFIs and also the relatively high rate of interest charged to a section of society which has low financial literacy. There is definitely a need to take a hard look at the functioning of the MFIs and bring the hitherto unorganized sector into the purview of a proper regulatory framework.

There was recently, a very informative article in the TOI by Vinod Khosla about profit making vs. non profit making MFIs both having their own role in the current market scenario. One key point made in favor of profit making MFI’s is the inherent advantage of acquiring scalability.It is indisputable that the profit making model is definitely the way to scale up which enables it to extend its reach. But having said that, the reality of high interest rates of 26% and above cannot be brushed aside. The reason, which is often touted for these higher interest rates are the associated costs of the raising the capital and the high operational costs.

Technology can play a key role in reducing these operational costs and the MFI’s have to arrive at the technological maturity to view technology as an enabler instead of viewing it as an extraneous expense. With respect to the cost of the capital, if the Bank-MFI model could evolve to a partnership based model instead of the bank acting purely as a term lender , the cost of lending could significantly come down. A still better model would be if an MFI were to be a part of the bank and acted solely as another Line of Business. In this case, the MFI would have easy access to the much needed low-cost capital. Hence, an MFI acting as an independent SBU of the Bank instead of a separate legal entity would have distinct advantages wherein the interest rates charged to the end customer could be significantly be reduced. Further being a part of the bank, the MFI could also accept deposits which could also enable it to be a more self sustaining unit. The offshoot of this model, would be the higher risks assumed by the bank vis a vis the current term lending model which isolated the repayment risks but could not protect against the risk of a possible MFI collapse.The key would be to retain all the flavors of the MFI model geared towards the bottom of the pyramid borrowers and to bring in the much required scalability and maturity in its operations.

There is a huge potential present in the MFI model which can be extended to services much beyond the plain vanilla financial services. In the near future, we might just witness the MFI’s evolve into something akin to a Microtransactional Service Provider which could enable the entire gamut of services including insurance, retail, healthcare, PDS and what have you.

The MFIs are here to stay, simply because there is a pressing need for socio-economic improvement of the rural sector and its high time, the sector got the focus it deserves.

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5 thoughts on “Microfinance – Evolving with the Times

  1. I had read a paper (http://www.adb.org/Documents/Books/interest-rates-microcredit/Microcredit-Understanding-Dealing.pdf), of which I understood little, as economics is usually Greek to me in spite of my best efforts at understanding it, but I got a glimpse of this issue related to high interest rates of microcredit. But I do agree from the little I understand that MF is here to stay and has a huge potential.

    I find you idea interesting, but would not the separation of the MFI from the bank as a separate SBU lead to more power and profits in the hands of the main bank itself? I mean, what could be the downside of such a model that would dissuade the current MFI from such a partnership?

    1. Interesting paper. The case against imposing ceiling rates is definitely thought provoking. In case of an SBU type functioning, the MFI lending rates would more or less conform to the bank’s urban lending rates where an additional x% margin would be levied due to the higher operational costs. Ideally, it should be in the same range as the urban lending rates. But having said that, since the market is not financially savvy enough to let the rates be governed purely by competition, some amount of regulatory frameworks would become essential.
      One downside of the ‘SBU model’ is definitely that the autonomy currently enjoyed by the MFIs will be jeopardized as it would be tantamount to an acquisition of the MFI by the bank.

  2. PhillyGuy

    Its not just operational costs or capital costs that determine lending rates. The projected loss rate plays a crucial part as well. That is true in all cases not just MF. This is the primary reason why those of us that are classified as super-prime walk away with 0% car loan rates, and others have to pay double digit rates for the same vehicle and the same term! Capital usually chases those that need it the least. Its a matter of factoring in risk.

    MFIs as a unit of banks is a very interesting idea. Laws would need to change, and bankers would need to adopt though.

    Another idea to explore is direct peer to peer lending. In the west its catching on due to technology. Check out:

    http://www.prosper.com/welcome/how_it_works.aspx

    In India the tight knit society could play a role, a social networking system that is MF oriented and that caters to folks at the village level could be useful.

    A multi transactional entity would be really nice. Didn’t the guy who founded Sahara (some chap called Roy) already accept micro deposits way back in the 1980s? True micro banking has to go beyond just lending. You’re exactly right there. It has to be the whole gamut of services. If P&G can sell two buck razors, then the finance guys can make profits at the bottom of the pyramid too. Its a huge opportunity just waiting to be exploited.

    1. The repayment rate in an MFI context is nearly 98% which is way ahead of urban rates. But yes, there have been cases of mass defaults that have happened recently as we saw in the case of Kolar, Karnataka.

      P2P lending is a very good model with a mix of investment as well as social responsibility.
      It is catching up in India as well with couple of names like Rangde.org and Dhanax.But one flip side in the current model the way I see it, is that even though the Principle amount is gauranteed, it seems a risky option for an investor to rely on these relatively smaller players. Having a big corporate / bank as a gaurantor might just make all the difference.

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