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The Turmoil in the Indian Microfinance Sector –Part 1

As I write this piece, SKS Microfinance the bellwether company of the Indian microfinance sector is seeing some turbulent times far from its halcyon IPO time on July 28 2010 which formalized the cross-over of the sector (traditionally funded mainly by grants, foreign aid, PE funds and through the priority sector avenue of banking) into main stream finance. The company had a successful IPO which was oversubscribed over 13 times. It set the initial price of Rs 985 per share at the time of the IPO. However the current situation is farfrom the hey days. (Closing Price on Jan 3 2012 Rs 99.10. See appended link for share price movementhttp://www.moneycontrol.com/india/stockpricequote/finance-general/sks-microfinance/SM11). The USA educated founder, Dr Vikram Akula has stepped down from his position as the executive director of the company and in a unique arrangement has also taken forty employees of his ex-company for launching his new mobile banking venture. About a third of the company’s workforce has quit. The employee strength has shrunk to 18,436 as on November 20 from 27,054 in September 30, 2010. The employee strength as on September 30, 2011, stood at 19,315[1]The very public sacking of the former CEO of SKS Microfinance, Suresh Gurumani soon after its successful IPO, brought the spotlight on the management dissonance within the company. Around the same time the reports of usurious and coercive recovery practices of the MFIs in Andhra Pradesh (re)surfaced   and were cited as the cause of suicides in the state[2] . This was not the first time that such reports had come to fore. In March 2006 the district officials of the Krishna district of Andhra Pradesh had closed down fifty branches of some MFI’s operating in the district due to similar charges being leveled against them[3]. The re-emergence of similar complaints, prompted the Government of Andhra Pradesh to issue an Ordinance on October 15, 2010 which effectively brought all microfinance activity in the state to a grinding halt[4]. Local politicians also used the confusion to make populist announcements to appease the vote bank. The RBI swung into action (finally!) and appointed a sub committee headed by Mr. Y Malegam to study the problems affecting the sector and suggest recommendations. While the quick succession of the events took many by surprise, for followers of the sector the boiling point had been reached after nearly four years and three major episodes that had rocked the sector starting with the problems in Krishna District in 2006 where the district collector had shut down fifty offices of leading MFIs including Asmitha, Spandana and Share microfinance[5]. This crisis had caused ICICI to discontinue with its ”partnership model” in which the MFIs acted as distribution agents for the bank while the loans remained on the banks balance sheet obviating the need for a larger capital base by the MFIs. At the end of 2005, ICICI had initiated about 100 partnerships and its portfolio was USD 227 million lent to about 1.2 million clients. This shutdown in a way prompted the MFIs to look for alternate sources of capital which would allow them to leverage the term loan debt available to them due to the priority sector status accorded to the lending to MFIs by the RBI.

Obviously all this could not have transpired over a short time period and could not have assumed the mammoth proportions overnight. So the question is why this did happen and what were the banks and more importantly the RBI doing while the industry was growing from a NGO driven, grassroots worker led model to its present commercialized avatar assuming huge financial implications for lender banks and the other stakeholders. Think about it this way-what about the common man who invested in SKS Microfinance? Betting upon a company that had promised hope to the financially downtrodden. And if the argument is that a common man should not have punted on a sector that was lets say ‘lesser known’ and which had ‘less data’ to make an informed decision, my question is then what were the pundits sitting in various banks doing while they were dishing out generous amounts of cash to such ‘lesser known/documented’ sectors?. Forget prudent banking practices, the amounts lent by banks to MFI’s defy common sense. Almost a third of the Rs 18000 crore lent to the MFI sector was put up under the CDR ambit. If these trained and qualified people didn’t see it coming then how could the common man do so? And the irony is that an IPO was allowed in the first place is itself a no brainer. Let’s analyze this: A company that lends to the poor is allowed to get funds from banks and is also allowed to go and raise money from the public. So whose money is sitting in the banks? –for the most part the answer is -the public. And who is investing in the IPO-again the public. Now what happens when a poor borrower defaults? Obviously not much can be seized /confiscated and there is not much that this poor defaulter has that is worth suing. So what can be done when a default takes place? The answer is: not much! Now let’s imagine a whole bunch of such poor beneficiary’s defaulting on their loans. To make the perfect storm complete, in the Andhra microfinance debacle there were a lot of instances of multiple lending. Clients were borrowing from one MFI only to repay the other and so on. Also in what defied basic common sense three fourth of the total MFI portfolio across companies was concentrated in Andhra Pradesh and banks still lent to the MFI’s! Was no-one thinking of a default or the demerits of concentration risk?

MFI Clients and loans state wise: 

State wise share of loans and NPAs in 2008 (Source: NABARD)

Region/State MFI Clients (No) Loan Outstanding (Rs Lakhs)
Northern Region



North East Region



Eastern Region



Central Region



Western Region



Southern Region
Andhra Pradesh


Concentration of risks (Andhra Pradesh+ Karnataka+Tamil Nadu’s portfolio)

  • Credit
  • Liquidity
  • Operations
  • Portfolio








Tamil Nadu & Pondicherry






Grand Total



Some of the factors that contributed to the crisis are:

  • Transformation Loans: The ability of the MFIs to ‘grow bigger’ was aided by the access to products such as refinance from NABARD and SIDBI’s ‘Transformation Loans”[6]. In the banking sector ICICI Bank’s ’Transformation Loans’ helped MFIs get access to funds through the securitization of their portfolio. MFIs had to undertake collection of the loans. ICICI Bank partnered with MFIs where the lending was done by the bank with the MFIs acting as the front end and customer service points. This money was recycled back by the MFIs and supported their desire for growth. This ‘mixing’ of different sources of funds made the problem a systemic one rather than a sectoral one. It is banks who were lending to the MFIs and therefore non payment by the end users ultimately was bound to have an impact on the lending banks NPA position, capital adequacy ratio and the final stock price. The state of flux currently prevailing in the industry has meant that banks could see their repayments from MFIs slowing down considerably since the collections in Andhra Pradesh have slowed down. The paradox is that despite having a spurt of growth activity in the MFI space, micro lending numbers from the RBI show that in Andhra Pradesh over 53% of the loans are sourced from money lenders. In Tamil Nadu this percentage is nearly 40% followed by Bihar, Manipur, Punjab and Rajasthan where the figure stands at nearly 30%.
  • Lack of a single point of control: While the RBI controlled the NBFCs, lending to the MFIs by banks came under the regulatory ambit of NABARD. This duality of control has been considered as a contributory factor to the current state of the sector. Post the crisis, the Malegam Committee was set-up by the RBI to study the sector and provide recommendations to streamline it.
  • Concentration Risk: Already described earlier. The problem assumed mega proportions because the stalemate caused in Andhra Pradesh affected the entire sector and the banks.
  • Lack of Transparency & Knowledge about the Sector: The constitution, management and operations of microfinance companies (particularly in Andhra Pradesh) has been a cause of concern. The over generous remuneration paid to the top management in some cases was also seen as a direct contrast to the very raison d’etre of setting up MFI’s.Eg: Vikram Akula was the ninth highest individual tax payer in India in 2009-10. He paid advance tax of Rs 14.2 crore (Rs 142 million) in 2009-10 as compared to Rs 3.1 crore (Rs 31 million) in the previous year
  • Absence of ICT: The profile of the clients makes access to formal data difficult. Compounding this problem is the fact that in most cases records with MFI companies are manually maintained. An independently managed centralized database containing the data on the borrowers especially defaulters is required.

The potential for microfinance if executed in its true spirit is huge in a country like India where only about 40% of the people have bank accounts. However as illustrated above the downfall can also be equally steep especially since the poor particularly the illiterate are prone to being exploited be it at the hands of local money lenders or the more sophisticated thugs-commonly referred to as recovery agents in the banking context.

(Part 2 will be a continuation of this topic and deal with some possible solutions)

[1] Source: Economic Times Dec 6 2011.

[2] http://www.business-standard.com/india/news/mfi-ordinance-to-protectpoor-ap/415542/

[3] Shylendra HS Economic and Political Weekly May 20 2006

[4] On December 14 2010, the Andhra Pradesh Assembly passed the “Andhra Pradesh Microfinance Institutions (Regulation of Money lending) Act, 2010”.  The Act came on close heels of the ordinance that was passed by the state on   October 15, 2010 to curb the usurious practices that were being followed by some of the microfinance institutions operating in the state. The act aims at regulating the sector in general by with focus on the on the lending and recoveries of the MFIs in the state.  For eg: The ordinance prohibits MFIs from lending to the self help groups (SHGs) that are already covered by the formal banking system without seeking prior approval of the banks. Similarly, the MFIs are also mandated to change their recovery practices from weekly basis to monthly basis. The MFIs have also been instructed to conduct their meetings with the borrowers in a prominent government facility like village panchayat office.

[5] MicroSave India Focus Note No 55 http://www.microsave.org

[6] ‘Small Customers Big Market: Commercial Banks in Microfinance’ by Malcolm Harper & Sukhwinder Singh Arora


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