July 30, 2014 by Alex Counts
As a result of a complex combination of unwarranted attacks and self-inflicted wounds, the microfinance sector in India experienced a crisis starting in late 2010 after many years of strong growth and recognition for its contribution to poverty alleviation and financial inclusion. When I was asked to give a keynote address at a microfinance conference in India in 2012, I said that it was important to leverage the sector’s strengths and accomplishments, while also addressing its failures and shortcomings.
I visited India in May and July and found that these things were finally happening and leading to on-the-ground progress as well as tangible support from both the outgoing and the newly elected Indian governments. And as this blog went to press, there was another promising development: the government published draft guidelines on creating a pathway for NBFC-MFIs to become specialized or “differentiated” banks, which would enable them to take deposits directly for the first time legally. (Though not all NBFC-MFIs would likely be eligible unless the “stringent norms” proposed are made more flexible.)
My May visit to Mumbai was centered around Grameen Foundation’s workshop “Designing for Adoption and Scale” (click here for highlights and here for my closing address).
One of the highlights of the second trip was speaking with Alok Prasad, the CEO of the Microfinance Institutions Network (MFIN), a respected microfinance industry association. He spoke eloquently about the progress the industry has made recently and the reasons behind it. Below are excerpts from our conversation.
Alex Counts (AC): I sense a new optimism related to Indian microfinance after some difficult years. Would you agree? How would you characterize the last 12 months in terms of how the Indian microfinance sector has developed? What were some of the key contributions of MFIN?
Alok Prasad (AP): Clearly the mood is buoyant, but not in an irrational way! Looking at the last fiscal year (April 1, 2013 to March 31, 2014), much has gone well for the industry. Growth, both in terms of gross loan portfolio and clients, has been strong. Portfolio performance stays at levels which commercial banks can only dream of (for unsecured lending). Branch networks have expanded, and new geographies have been covered. Funding (both debt and equity) has improved markedly. The regulatory environment remains broadly positive, notwithstanding the Microfinance Bill falling by the wayside.
In specific terms, the aggregate gross loan portfolio of MFIN’s member institutions (Non Banking Financial Company-Microfinance Institutions or NBFC-MFIs) stood at Rs. 279.31 billion (US$4.63 billion), an increase of 35%, over the prior fiscal year. Clients covered stood at 28 million, representing growth of 20% over the previous year. Debt funding grew by 46%, along with a definite revival of investor interest.
MFIN, I believe, has played a key role in bringing stability to the sector. Deep and sustained dialogue with the government and the Reserve Bank of India (RBI) has resulted in regulatory changes that are conducive to growth; a much greater appreciation of our industry’s role in promoting financial inclusion; and, the recognition that the industry is an essential component of the national financial architecture. From a systemic standpoint, the development of the credit bureau ecosystem had been a big win. As of this date, more than 150 million client records are present on the databases of two national bureaus. These records are updated on a weekly cycle; and, all lending is only after a bureau check. This has given remarkable results in controlling multiple lending and over-borrowing by clients. Our recognition by the RBI as the self-regulatory organization (SRO) for NBFC-MFIs is a sign of both a certain maturing of the industry and the regulator’s acceptance of that reality. A nice ‘new normal’ for an industry which just 18 months ago appeared deep in the throes of a crisis!
AC: MFIs outside of Andhra Pradesh have begun growing again. Can you give us a sense of this growth and how it compared to other parts of the financial sector? What are the main reasons? Are there risks?
AP: Before the Andhra Pradesh crisis, much of the microfinance portfolio was concentrated in the south. While recognized by many of the players and funders as a risk, historical factors and a certain inertia led to organizational responses being muted. The crisis led to a serious re-think. Operational strategies got re-worked and business focus shifted to markets which hitherto had been largely ignored. The mantra became mitigate political risks by geographical diversification. Lending in states in the north and west such as Bihar, Uttar Pradesh, Rajasthan, Uttrakhand and Gujarat grew significantly. As of March 31, 2014, the regional split of gross loan portfolio was 31% in the South, 28% in the East, 23% in the West, and 18% in the North.
We at MFIN now closely monitor concentration levels by states and districts. Risks are highlighted and information shared with the regulators.
AC: How important a development was the granting of a banking license to Bandhan, in terms of microfinance’s role in Indian society in the eyes of government, the media and civil society?
AP: The RBI gave its in-principle approval for a banking license to Bandhan after an intensive process of evaluation and consultation with a wide range of experts and stakeholders. The granting of this approval is undoubtedly a strong vote of confidence not only for Bandhan but the entire microfinance industry and the financial inclusion focused business model that it has successfully developed. A form of collateral benefit is accruing to the entire industry. Equity investors and other funders are seeing this development as strongly indicative of the potential value of the NBFC- MFI model resulting in enhanced fund flows to the sector.
AC: Grameen Foundation worked with Cashpor as a Section 25 company (now reclassified as a Section 8 company) to show what was possible in terms of building a successful MFI-bank alliance that is able to provide multiple financial services to the poor using the business correspondent model. Very recently, the government has opened up the business correspondent (BC) model to NBFCs. How significant is this development? What is the potential?
AP: MFIs until now were primarily purveyors of microcredit. This was, in large measure, an outcome, of the RBI’s regulatory framework for the industry. The recent change in regulations which enables NBFCs to become business correspondents (BCs) of banks is a welcome development. The industry had been seeking this regulatory change in the belief that a BC role will allow for the building of a robust partnership model with the banks; generation of a new stream of revenues; and, deepening of the connection with clients. This also has implications in terms of reducing political risks.
AC: What do you see as the position of the new Indian government towards microfinance?
AP: The recent policy pronouncements by the new government on financial inclusion strongly suggest that financial inclusion will remain a critical plank of public policy. A “Complete Financial Inclusion” program (with two bank accounts per household) is expected to be formally announced next month. Draft policy guidelines on ‘payment banks’ and ‘small banks’ were released by the RBI on July 17, 2014. Microfinance as a subset of the financial inclusion agenda clearly remains a focus area for the Government and the RBI.
AC: As you just mentioned, MFIN has recently been awarded Self-Regulatory Organization (SRO) status for the microfinance sector. First of all, congratulations! How important is this and how will it change your role? What does this action by the government suggest about its view of microfinance?
AP: Thanks and, yes, this formal recognition by the RBI has large implications both for MFIN and the microfinance industry. I may add that this recognition is unprecedented in the history of the financial sector in India and is a veritable leap of faith on the part of the RBI.
The role given to us is large and challenging. Surveillance over the industry, investigations into areas of concern, client grievance redressal, dispute resolution, data collection and research are the key responsibilities cast upon us. While MFIN was acting as the de facto SRO for the industry over the last three years, the formalization of that role will require us to step up, both structurally and functionally. Failure, even partial, is not a choice we have!
AC: I understand you have been collaborating closely with the Smart Campaign around client protection. How far has the industry in India come, what remains to be done, and what do you see MFIN’s role to be in embedding client protection into the industry’s DNA?
AP: We have a good, constructive partnership with the Smart Campaign. Numerous initiatives taken by them in strengthening client protection have resulted in the acceptance of many good international best practices. At an industry level, a range of initiatives have been taken by MFIN to ensure that many points of criticism, such as multiple lending, pricing of microfinance loans and collection methodology are appropriately addressed. The industry Code of Conduct and development of the Credit Bureau ecosystem have been instrumental in ensuring that all lending by the NBFC-MFIs is done in a responsible manner. MFIN’s monitoring tool called the Responsible Business Index (RBIndex) helps individual MFIs to systematically measure, manage and integrate responsible business practices by doing gap analysis, benchmarking, and tracking progress.
AC: What do you see the role of technology, particularly information technology and the mobile phone, in taking Indian microfinance to the next level?
AP: The only good way to sustainably reduce the cost of services to the "base of the pyramid" client is to leverage technology. The mobile handset, in times to come, will become the universal gadget for availing financial services. The industry is currently seeing a slew of innovations. Today microfinance institutions are experimenting with the use of cell phones for payments, transfers, and other services. The recent guidelines on ‘payment banks’ by the RBI is a forward-looking pointer of things to come.
AC: Anything else you would like to say to people overseas following the journey of microfinance in India?
AP: The key lesson that emerges from the Indian microfinance growth story is the importance of understanding the political economy and constructively connecting with all stakeholders. It is also important to recognize that a successful model of financial inclusion ought not to be based on subsidies, and should be commercially viable.