Will this high-potential industry cease to exist?

Thu, 28 Jul Pre-Open

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Microfinance institutions (MFIs) promised upliftment to the poor of this country and wealth to shareholders post the high profile listing of SKS Microfinance. However, the controversial Andhra Pradesh (AP) microfinance law turned the entire industry on its head. After a number of suicides in the state on account of allegedly coercive practices by MFIs, the state decided to clamp down on the industry. It challenged the very fundamentals of MFI operations. And it is now about to claim its first casualty of the crisis.

The oldest MFI in India, Bhartiya Samruddhi Finance (BASIX) is crumbling under the weight of bad loans. Borrowers in AP are refusing to repay their loans. Plus, since there is no collateral for MFI loans, more bad loans can wipe out the company's entire net worth and reserves. When borrowers default, the industry collapses, as was seen during the US subprime crisis. The company's promoter Vijay Mahajan, who is also the president of Microfinance Institutions Network (MFIN) stated that his firm is unlikely to survive beyond 2-3 months without fresh funding.

BASIX's loan book has shrunk from Rs 18 bn to Rs 10 bn and Andhra Pradesh accounts for almost half of its book. Repayment rates there have dropped to 5-10%, from over 90% pre-crisis. When the repayment rates dropped, banks which account for 80% of funding to the company decided to pull the plug. BASIX now needs a US$ 100 m equity infusion and a Rs 10 bn bank loan to survive. Without funding, the company cannot even expand to other states in India in order to offset its losses in AP. What's worse is that the level of bad loans in other states has also risen from 1% earlier to 3% currently.

The government recently proposed a draft Bill on microfinance regulation that gives sole regulatory power to RBI. Thus, state governments will not have a say on regulation of the industry. But, Andhra Pradesh is still a major roadblock as the state may not dilute its stance on the matter.

According to Mahajan, the situation for MFIs will get a lot worse before it gets better. It will take some time for the regulation to be put in place and kinks need to be worked out. By this time, smaller MFIs and even industry pioneers like BASIX may fail. India is a country with a huge poor population without access to banking and financial services. Microfinance institutions was the answer to this neglected segment's needs. But with MFIs facing a funding gap, which is far from being plugged, it seems like the noble mission of financial inclusion will remain unfulfilled.