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.