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Reserve Bank of India Asks MFIs to Improve Governance Standards
February 16, 2010

New Delhi, February 16, 2010 (The Economic Times) - India’s booming microfinance segment is under the scanner, with the Reserve Bank of India (RBI) issuing a veiled warning that it could
RBI
be taken off the priority sector lending list of banks if the industry fails to improve its governance standards.

This was spelt out at a meeting in late January between senior RBI officials, representatives of Sa-Dhan—the association of Indian microfinance institutions (MFIs)—and some senior MFI managers from Karnataka, West Bengal and Andhra Pradesh.

The RBI officials reportedly told MFI executives that the central bank was aware of the extent of benami loans being given by MFIs, the practice of writing off bad loans and sloppy corporate governance in some of the entities, all of which could have their impact years down the line.

Total outstanding loans issued by the Indian microfinance segment stood at Rs 11,700 crore in 2009, a 13-fold increase from the Rs 897 crore it was worth in 2005.

Many MFIs have generated big returns, often as much as 20-30%, to the promoters and private equity players, who have stepped in as financial investors, looking for an exit in about four years. For instance, Spandana, a Hyderabad-based MFI with current outstandings of Rs 3,061 crore and growing at 100%, is close to wrapping up a deal with Temasek Holdings, where the former will pick up close to a 10% stake for Rs 200 crore.

Currently, all loans to MFIs are categorised as priority sector lending that banks have to fulfil as part of their social obligation and regulatory requirement. Losing priority sector status could snap credit lines that MFIs have with banks.

The industry had come under scrutiny in 2005 when it was reported that some microfinance borrowers in Andhra Pradesh, pressured to repay loans, had committed suicide.

To meet the high growth targets, MFIs are increasing credit limits, opening more branches and adding new customers — SKS Microfinance adds as many as 1.5 lakh borrowers every month. At the same time, to ensure they can access bank funds cheaply, MFIs have to show rock-solid repayment patterns. This can result in a combination of indiscriminate lending and pressure on borrowers to pay on time — an explosive mix that blows up from time to time.

In February ‘09, the Anjuman Committee — a group that opposed MFI operations in Kolar district of Karnataka — told existing borrowers nether to borrow from nor repay MFIs. By end July ‘09, Rs 600 crore was reportedly in default. A similar situation is brewing in Mysore.

Nonetheless, there is growing acceptance that private equity has to come in to shore up capital that’s necessary for growth. And these investors will not come in unless growth and returns are delivered.

But, what’s perhaps worrying the regulator and some of the stakeholders is that MFIs are still being run like small, family-owned firms. Microfinance industry executives told ET on condition of anonymity about dubious practices like board minutes being fudged, senior management trying to enrich themselves, local level staff advancing fresh loans to hide bad debt and staffers running small rackets on the side.

Under the circumstances, RBI’s warning is a powerful one. The cost of funds for the industry could rise by as much as 200-250 basis points, said Padmaja Reddy, managing director of Spandana Sphoorty Financial.
And this would change the equations within the rural credit landscape. At one level, the MFIs will become proportionately (in relation to a hike
RBI
in interest rates) unattractive sources of credit in a marketplace where loans are also available through the SHG-Bank linkage, traditional sources of credit, richer farmers, government schemes, etc.

It’s also pertinent to mention that, last week, the RBI allowed banks to charge ‘commercially viable rates’ (higher than the PLR) for Priority Sector loans below Rs 2 lakh to improve their lending to rural borrowers. In all, says Vijay Mahajan, founder, Basix India, MFIs would face a credit squeeze.

Such a move would also change equations within the microfinance landscape. Among the MFIs, this might tilt the playing field in favour of larger players which operate on scale, focus mainly on credit delivery, and consequently have lower operating costs.

Indeed, as Reddy says, Spandana, which has an operating cost around 5-6% (unlike other large MFIs’ of 10-11%), will not need to hike its interest rates for borrowers. Smaller MFIs, or those offering livelihood support services, however, will be harder hit.

When contacted, industry executives were cautious. Representatives from Sa-Dhan agreed that these meetings had taken place, and that there were concerns that the sector had benefited the investors more than borrowers. But, they declined to comment on the RBI’s statement about revoking the priority sector lending list.

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