Microfinance loans are growing at a scorching pace, but it's a warning signal
The industry numbers released by microfinance institutions network (Mfin), an industry body of micro lenders, for the fiscal year 2015 indicate a very sharp pick up in the number and quantum of loans.
The past is never dead. It's not even past. William Faulkner's famous saying is now of significance in the Indian microfinance industry. The institutions that give tiny loans to the poor somehow seem to be rediscovering their long-lost obsession for rocket-speed loan growth — the same mistake that once shattered the entire industry.
The industry numbers released by microfinance institutions network (Mfin), an industry body of micro lenders, for the fiscal year 2015 indicate a very sharp pick up in the number and quantum of loans disbursed during the year.
The total number of loans given over the year 2014-2015 grew by 37 per cent compared with the previous fiscal year, while the quantum of loans disbursed expanded by 55 per cent. The aggregate gross loan portfolio of MFIs thus grew to Rs 40,138 crore—more than double from what it was 2-3 years back.
Such a rate of growth surely indicates that the Indian MFI industry has managed a smart recovery from the days of a severe industry crisis it confronted in 2010 October, when the erstwhile Andhra Pradesh, the biggest microfinance market then, promulgated a law to control the alleged excesses conducted by certain institutions to recover money from the borrowers.
However, this growth also sends some warning signals.
MFIs are a big source of relief for the poor in the under-banked areas of the country. They have played a critical role in promoting livelihood promotion activities in the country since mid-90s. Some of them are likely to soon morph into small banks under the RBI.
For MFIs, some of which had grown their loan books in a rapid pace within just few years, the Andhra Pradesh law came as a shock since it hit their basic business model – collecting money from houses and offer multiple loans to the same borrower – very hard.
More than the law, a political campaign by TDP and other regional parties asking people not to pay back the loans, pushed the loan repayment rate to less than 10 per cent. Several MFIs closed down their shops and a few big ones, including the oldest one, Basix, had to shrink their business to a few hundred crores. The crisis spread over to other regions.
Until then, many MFIs used to charge very high interest rates to the borrower in the range of 35 per cent to 45 per cent annually , in some cases as high as 80 percent. This practice, however, went largely unnoticed since MFI loans were not really interest rate sensitive. For poor borrowers, mostly vegetable vendors or daily labourers, timely availability of the credit was more important.
But what really broke the back of the poor borrowers was their over-indebtedness. This happened in two ways - by taking multiple loans from same or different institutions or by borrowing large amounts beyond the repayment capacity.
After five years, MFIs are in a much better shape. With regulations laid out by the Reserve Bank of India (RBI) in place, the problems arising out of multiple loans and high interest rates have been contained. But where MFIs needs to be watchful is the amount that is lent per borrower.
The recent RBI guidelines increased the limit of individual loans to Rs 100,000 from Rs 50,000. It also also revised the eligible rural and semi-urban household annual incomes and loan amounts to be disbursed in the first cycle and in subsequent cycles upwards.
By design, MFIs are financial intermediaries that should act as a bridge to help the poor move away from the private money lender to the world of commercial banking.
The character of the borrowers in this stage is such that his repayment capacity is limited. Hence, this is where the MFIs need to be cautious. Over-indebtedness of borrowers can potentially result in asset-quality shocks.
As it stands, the asset quality of MFIs is well within control. But in the pursuit of high growth, if the MFIs forget the painful past and resume injecting loans to households beyond repayment capacity, after a period, even a small trigger — political or economic —could push microlenders back to the days of the crisis.
Rating agency, Icra Ltd, in a recent report, has clearly highlighted this problem.
“It would be important for MFIs to assess the debt repayment capacity of the borrowers so as to limit the risk of overleveraging of the borrowers and the consequent threat to its portfolio credit quality," Icra has said.
“While, the revision in limits for indebtedness could help MFIs improve their operating efficiencies; it could pose greater risk from credit standpoint with the expected increase in average ticket size per client. In ICRAs opinion, MFIs would need to exercise caution while determining the debt repayment capability of a borrower on a larger permitted debt burden and ensure that the assessment process captures this Impact,” the agency said.
The rating agency further warns that given the high competitive intensity some MFIs might lend larger loans to the existing borrowers in order to retain them despite debt servicing constraints which could ultimately lead to a rise in delinquencies.
The poor always pay back. But, they also tend to borrow money with both hands, even forgetting their repayment capacity. So it is the lenders who should exercise caution.
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