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Microfinance in India – solving the Gordian Knot

19 May

The Reserve Bank of India, the regulator for microfinance broadly accepted the recommendations of the Malegam committee and proposed some guidelines recently. Banks in India have been traditionally mandated to lend a certain percentage of their total lending to priority sectors such as microfinance, small business, agriculture and so on. Previously all loans to microfinance institutions (MFIs) came under priority sector lending and that encouraged banks to lend to MFIs especially since the defaults were extremely low as compared to other priority sector areas.

The new guidelines are more specific on what constitutes priority sector lending under microfinance. The overall objective for the new guidelines seems to be to protect MFI clients (borrowers) while holding banks indirectly accountable for client protection through the priority sector guidelines. The guidelines try to achieve client protection by putting several restrictions (caps) on the way microlending can done and these include:

1) Interest rate caps on loans made by microfinance institutions (MFIs)

2) Margin cap for MFIs

3) Loan size caps based on rural/urban area

4) Loan size caps based on loan cycle

5) Minimum prescribed loan tenors (duration) based on loan size

6) Portfolio mix caps ( what percentage of a loan portfolio of a MFI should be income generating )

The guidelines are however silent on specific client protection practices the MFIs should have in place. In many ways the approach seems convoluted and noted industry commentators N Srinivasan and M S Sriram seem to indicate that the microfinance sector will continue to pay a heavy price for the lack of appropriate regulation. To my knowledge, bank lending is yet to resume in India even after these new guidelines have been released. Hopefully the reasons are just procedural and banks will start lending soon.

In my opinion the regulations need to be a lot simpler. The RBI should have intervened in just two broad areas without getting unduly involved in specifying how the loan product should be structured. They should:

a) Allow sustainability of MFIs but put restrictions on profiteering: The RBI could have specified reasonable dividend cap and a bonus share issue cap (i.e. no stock splits) for MFIs that want to avail of priority sector lending from banks. Additional related caps would be on compensation to key executives of the MFI. Thus MFIs can operate sustainably without resorting to profiteering and the right kind of investors would get involved with microfinance. See Ramesh Arunachalam’s blog for a more elaborate note on this subject.

b) Hold MFIs directly accountable for client protection: The RBI should have mandated specific and strong client protection guidelines and the responsibility should be directly on MFIs and not indirectly on banks that are far removed from the actual practices on the ground.

The RBI is expected to come up with more detailed guidelines. I hope that they will take the opportunity to solve the Gordian Knot of Indian microfinance. India has more poor people than the whole of Africa put together and this requires the government’s and the regulator’s utmost attention. A crisis should never be wasted.

Meanwhile we have also been introduced to the bank in Sri Lanka. Being the first loan to a microfinance institution in Sri Lanka, the bank is moving cautiously and we will have more updates soon.

Over the last few weeks we have also contacted several microfinance institutions in South and Central America. The response we have got has been a bit overwhelming and nearly a dozen MFIs out of the forty MFIs we contacted are interested in partnering with us. In hind sight we should have approached MFIs in South and Central America much earlier, but we did not take it up because we wanted to build some more organizational capacity before we expanded operations to multiple countries.

While we have one volunteer who knows Spanish and is helping us connect with MFIs in South and Central America, we need the help of a few more volunteers who know Spanish. If anyone is interested in volunteering, please write to me at bhalchander(at)unitedprosperity(dot)org. Thanks again for stopping by.

Update on signing a new partner

21 Apr

In the last post I mentioned that we are working on signing a new partner in South Asia. As a part of the sign up process, the new partner Microfinance institution (MFI) needs to fill an extensive evaluation questionnaire which we then assess. We also take third party reference checks, review their financials and also assess the commitment of the MFIs’ senior management to the mission of ending poverty. We also need to find a bank that is willing to make a loan based on the guarantee. Signing up the bank is one of the toughest aspects of our guarantee model.

We have been making good progress with an organization in Sri Lanka called Berendina Microfinance Institute (GTE) Ltd. One of the most interesting aspects about this organization is that apart from providing microloans they also provide business development services to their clients and they are able to do it sustainably through the usage of coupons.We took a third party reference check about the organization and the feedback we received is that Berendina is a very progressive microfinance institution.I am told that they are very professional, have a good long term vision and have good loan products. Their challenge is access to funding.

Berendina has recently approached a few banks to see if they can lend to Berendina based on a guarantee. Berendina has never borrowed from a bank previously so this loan would be the first of its kind. At present one bank is evaluating their proposal and a decision by the bank’s lending committee is likely in the next two to three weeks. From what I understand from Berendina, if the loan gets approved this could be the first loan to an MFI in Sri Lanka from a bank. We are cautiously optimistic that the approval would come through and I will be posting an update on this over the next few weeks.

Meanwhile in India, the Reserve Bank of India which is the Central Bank and the regulator for the large for-profit MFIs has yet to publish its revised regulations for microfinance. Thus the uncertainty amongst banks and MFIs in India continues. As a result there are virtually no loans being made to MFIs from banks. It is nearly seven months since the crisis emerged in Andhra Pradesh state in India and if clarity on regulations does not emerge quickly it will be an increasingly uphill task of reviving the confidence of banks in lending to MFIs especially the smaller and more socially oriented MFIs. While banks will not be much affected if they do not lend to MFIs as microfinance constitutes only a small percentage of the total loans they make, the biggest losers are going to be millions of low income families and especially those who are poorer and in the more remote regions.

I sincerely hope that the government and the regulators in India show the urgency and determination in laying out appropriate regulations for microfinance in India. This is the absolute need of the hour.