The Microfinance Crisis: Is There a Way Out?

Monday, August 1, 2011

For the better part of nine months, the microfinance industry has been in paralysis because of restrictions put in place by the government of Andhra Pradesh, the state that was the center of micro-lending in India. Almost immediately, banks turned off the credit tap that allows microfinance lenders to operate, and borrowers abandoned the high repayment rates of the past and stopped paying.

Recently, the full impact of the crisis has been revealed. SKS Microfinance, the stock market-listed microlender, reported a net loss for the three months ended June 30 because of a sharp jump in provisions against bad loans and loan write-offs.

And Vijay Mahajan, the chairman of BASIX, a company that specializes in micro-lending and other services targeted at the poor, warned that his microfinance operation is on the brink of folding.

All this is depressing news for those who view microloans as a means of empowerment for those ignored by mainstream banks. It’s getting to the point where India has to think about whether it really wants a future without microlenders, because that appears to be where things are headed.

Mr. Mahajan, however, is testing a new business model that may, if it catches on, provide something of a lifeline for the industry though it won’t solve all its problems.

The key move he has made is to establish a business within the BASIX Group that acts as a partner to banks rather than a borrower from banks. This is a tweak that doesn’t necessarily change much on the ground but changes tons in perception and viability. Under this model, the company stops being the originator of small loans to the poor, the definition of microfinance, and instead turns BASIX into a bank agent. Borrowers (BASIX lends to individuals and doesn’t use the group model favored by other lenders) won’t see much difference. They still will interact with BASIX representatives, who will be responsible for originating loans and collecting repayments.

But, critically, the BASIX representatives will be dispensing bank loans, rather than BASIX taking credit from banks onto its books and then assuming responsibility for the loans it issues. The bank will be able to set the interest rate and will pay BASIX a fee for handling the loan.

If the politicians of a particular state don’t like what they see, they will have to deal with a politically-connected, well-established bank – most likely government-owned – as well as possibly the Reserve Bank of India, rather than targeting small, politically lightweight microlenders. For microfinance companies, this model has the added advantage that the bank assumes the risk of default on the loan.

Source: The Wall Street Journal (link opens in a new window)