Microfinance Grapples With Success

Wednesday, March 3, 2010

Microfinance is in the news, again for the wrong reasons. Five years ago, it was tension over multiple lending and coercive recovery in Andhra Pradesh. Now it is Muslim community leaders in a couple of districts in Karnataka issuing a fiat to their members to renege on microfinance institution (MFI) loan repayments as they do not approve of such borrowings. What’s worse, the Reserve Bank of India (RBI) has issued a severe warning to MFIs against wrong practices. RBI’s main concern, reports indicate, is benami lending, re-lending to cover up bad loans and poor governance.

But these are not the ultimate concerns. If this was all then the large number of unhealthy and unprofessional MFIs would wither away, ending the sector’s exponential growth. The bigger problem, say insiders, lies not with failures but successes. The original founders of the industry are increasingly exiting in favour of private equity (PE) funds, enabling some founders to encash at $100 million or more and thereby establishing MFI valuations at even half a billion dollars! The PE funds are seeking at least 20 per cent return on equity. If anybody dreamed of microfinance becoming mainstream and getting global funding then this is it.

Some of the best MFIs are hiring top managers, who have seen their prospects dimmed by the global financial crisis, at annual compensations of Rs 8-9 crore. Some of the best professionally-run MFIs are getting ready to come out with public issues, which will allow a partial, highly-profitable exit for the PE funds.

The entry of PE funds into the best and the biggest MFIs brings in resources and professional management practices. This aids growth and a fall in costs, leading to the high rates of return. RBI is upset that the fruits of healthy growth are not being passed on to the borrowers via lower lending rates, which remain in the 26-30 per cent range. If this continues, the central bank threatens, it will stop categorising loans to MFIs as priority-sector lending, thus making it difficult for them to access bank loans at around 12 per cent and onlend.

Source: Business Standard (link opens in a new window)