[Analytics] Formalising microfinance in India

Microfinance in India has traversed a long history since it debuted in the late 1980s as a social banking innovation anchored in informal self-help groups (SHGs). It was mainstreamed as the self-help group-bank linkage program (SBLP) in the mid-1990s with the active involvement of non-government organisations (NGOs), banks and provincial governments. Tara Nair specially for the East Asia Forum.

During the late 1990s and early 2000s, many of the NGOs became microfinance institutions (MFIs) and started lending microloans at market rates to poor households, especially poor women. Increased competition among the MFIs in subsequent years led to over-lending and repayment crises in 2006 and 2010, particularly in the over-served markets like Andhra Pradesh.

As a consequence, the Reserve Bank of India (RBI) created a special category of non-banking finance company for microfinance called NBFC-MFI in 2012 to bring commercial microfinance activities under closer regulatory supervision. It also designated two networks — the Microfinance Institutions Network (MFIN) and Sa-Dhan — as self-regulatory organisations for the sector.

Over the years, the SBLP has spread across India’s states and is currently consolidated within the national livelihood mission. Under structured self-regulation and with better credibility due to the regulator’s oversight, the MFIs have also grown their network of branches across most districts, particularly in rural areas. As of March 2019 the portfolio of NBFC-MFIs stood at around US$9.63 billion, about 38 per cent more than what it was in March 2018.

Within the SBLP, the outstanding loans were reported at US$12.17 billion. If one adds microcredit disbursed through other channels, such as not-for-profit NGOs and Small Finance Banks (SFBs), the total outstanding microcredit reaches about US$25.15 billion. Among all types of MFIs, NBFC-MFIs account for 85 per cent of the portfolio. Compared to the financial year 2017–18, the outstanding portfolio of NBFC-MFIs grew by 38 per cent. The number of loan accounts grew by 22 per cent. The idea of microfinance has also evolved over time from simple credit for generic purposes to specialised credit for targeted activities like housing and small business.

These indeed are impressive achievements. But for a country like India, ‘reaching out to the unreached’ involves enormous investment to address structural and institutional bottlenecks — socially, spatially and culturally. Microfinance arrangements have not been able to significantly resolve such bottlenecks so far.

There is a pervasive presence of usurious private money lenders even in markets where microfinance operates profitably. The credit extended by competing MFIs also need not necessarily be invested in micro-business ventures. Much of it gets absorbed in the already constrained kitty for household expenditure. A recent review of extant research found that microfinance is more likely to be associated with increased household consumption expenditure than increased income via productivity enhancement.

Does a thriving microfinance industry expose poorer households to increased vulnerability to indebtedness? Microcredit is high cost credit for a poor household, the average cost sitting at around 24 per cent per annum. Still, it is valued as a convenient source of borrowing by a large section of the poor.

The emerging microfinance policy in India is tilted decisively towards banks. Microfinance activity has been steadily co-opted by mainstream banking under the accelerated financial inclusion program. The RBI has used bank licensing and regulatory mechanisms to incentivise large microfinance players to turn into full scale banks. It granted a universal bank license to one of the largest NBFC-MFIs, Bandhan Financial Services, in 2014 and small finance bank (SFB) licenses to eight others in 2015.

SFB is a new format in Indian banking, though popular in many other countries. Such banks are bound by certain conditionalities meant to make their functioning more relevant to small sectors and low income households. They have a much larger priority sector lending commitment — 75 per cent of the adjusted net bank credit — compared to the 40 per cent requirement of other commercial banks.

They also need to ensure that 50 per cent of their loan portfolio entails advances below Rs 2.5 million (US$35,000). The RBI has recently released draft norms for ‘on tap’ licensing of SFBs to allow entities to apply for licenses on an ongoing basis. Many of the large MFIs are waiting to obtain such licenses to become full service banks.

The issuance of bank licences to large MFIs is the first visible sign of the central bank’s approval of commercial microfinance activity and its intent to regulate it within the evolving frameworks of banking sector reform. The prospect of these institutions eventually converting to banks may help MFIs to envision a strategic direction for growing their business.

But it is not clear how long SFBs will stay committed to the typical clientele of microfinance — women, informal workers, casual labourers, petty entrepreneurs and small and marginal farmers. Faced with a pressure to perform, these organisations will have to turn to institutional and high net worth clientele to build business volumes on the asset and liability sides. Regulatory and policy measures alone may not be enough to inspire these new institutional players to keep serving the small. A mechanism to remind them of their social contract is critical.

Tara Nair is Professor at the Gujarat Institute of Development Research, Ahmedabad, India.

Tags: India