Over the years, Microfinance Institutions (MFIs) have been providing small scale loans and financial services to individuals primarily in rural & semi-urban areas that have traditionally been excluded from the formal financial system due to multiple constraints including geographical presence, unavailability of formal financial history etc. Given the strong drive towards financial inclusion by Government of India and RBI over the past decade or so, MFIs have assumed a key role in ensuring the reach of financial services to the target segments enabling them to undertake income generation activities, drive self-employment and overcome the economic barriers in a sustainable manner.
In order to provide easy access to finance, MFIs have traditionally used group based lending model leveraging the social structure in rural areas supplemented by differentiated products, innovative payment structures and doorstep collection models. With the emerging digital ecosystem enabled by Aadhaar in India, MFIs have also started to experiment with digitally enabled operating models improve efficiencies and control costs.
The Indian Microfinance Sector has witnessed a phenomenal growth over the past few years. MFIs currently operate in 29 States, 4 Union Territories and 588 districts in India. 223 microfinance entities (including MFI-NBFCs, NGOs, and societies) have reached out to an all-time high of 45 million clients with a loan outstanding of over Rs 1 lakh crore across the private JLG (Joint Liability Group) and the public SHG (Self Help Group) program, 94% of which were used for income generation purposes. Women borrowers constitute about 90% of the total clientele of MFIs, SC/ST borrowers constitute 30% and minorities 27%. MFIs with portfolio size of more than 500 crore contribute significantly to the total outreach (85%) and loan outstanding (88%) of the sector. The sector employs more than 1 lakh personnel, out of which 15% are women.
Geographically, Southern region has the highest share both in terms outreach and loans outstanding, followed by East. However growth rates are higher in the Northeastern and Central regions. Top 10 states i.e. West Bengal, Tamil Nadu, Karnataka, Maharashtra, Bihar, Uttar Pradesh, Madhya Pradesh, Assam, Orissa and Kerala account for almost 86% of the total industry portfolio. 4 of these states are from Eastern India underlying the importance of the region to the industry.
The key reason for the growth of the sector has been adaptability to change, resilience in the face of challenges and an ability to maintain high repayment rates of almost 99.5%. The business relies on a very high level of customer connect before, during and after the credit approval with all clients being met face to face in a weekly, fortnightly or a monthly meeting for about 30-45 minutes in a group setting. The operations are highly cash intensive - both on disbursements and repayments.
The cash intensive nature of the microfinance business proved to be the Achilles heel for the industry when government decided to demonetize 85% of the currency in circulation in Nov 2016. The lack of currency notes, especially in rural areas showed a negative impact on livelihood generation and cash flows for microfinance customers as their businesses slowed down. The RBI dispensation on asset recognition provided to NBFC MFIs was mistakenly interpreted by some borrowers as dispensation on their loan repayments. In some states repayment ratios dipped to under 50%, primarily due to local activism, misunderstanding of regulations and rumors of a loan waiver from the state or central government. While the collections have improved in the later months, many players are still grappling to reach the pre-demonetization collection levels. This has in-turn impacted cash flows, led to portfolio quality issues, increased provisioning requirements and hence led to huge dips in profitability levels.
in the last couple of years, 8 of the largest MFIs have converted to Small Finance Banks. This comes close on the heels of conversion of Bandhan to a scheduled commercial bank. While conversion to bank provides these institutions access to low cost funds through customer deposits, it comes with its own challenges in terms of regulatory and compliance obligations, processes, systems etc. which have led to cost pressures in the short and medium term. Further, banks have also taken a keen interest in MFIs as an avenue for inorganic growth with multiple acquisitions and deals happening in this space e.g. Bharat Microfinance (Indus Ind), BSS Microfinance (Kotak), GramaVidiyal (IDFC), ASA International (IDFC), Annapurna Microfinance (DCB).
The government’s push on digitizing the financial transactions received a major impetus due to demonetization. A significant chunk of PMJDY accounts got activated and the usage of new methods of payments including AEPS, Bharat QR, UPI gathered momentum including in rural India which is the primary market of MFIs. Thus it presents an opportunity for the MFI ecosystem to digitize operations and optimize the cost to serve customers. Further, the initiative to link all major data sources to Aadhaar number is expected to reduce the asymmetry and ambiguities on customer data and contactability and hence improve transparency in MFI operations.
Post-demonetization, the portfolio quality got severely affected and it continues to plague the industry portfolio. At an aggregated industry level, PAR > 30 is at11% and PAR > 90 is at 5% of active balances. Large states like UP, Maharashtra, MP and Karnataka have high share of books at risk of default and hence revitalization of lending processes & risk management capabilities is of utmost importance for MFIs going forward.
Given the recent disruptions in the environment and regulatory reforms, it is necessary to bring micro-lenders, bankers, policy-makers, allied financial service providers and researchers together with a common forum. To this end, the Associate of Micro Finance Institutions – West Bengal, along with its member MFIs and knowledge partner KPMG – is hosting its 3rd Eastern India Microfinance Summit 2018 titled, "Microfinance: The crucial link in inclusiveness" on November 18th at the Lalit Great Eastern, Kolkata. The objective and purpose of the summit is to actively engage key stakeholders in discussions relevant to current and future aspects of financial inclusion.
MFI sector is expected to continue to grow at a rate of 30% and above. However, the growth is expected to be primarily driven by SFBs and Bank led MFIs. Standalone microfinance institutions will have to identify uniquely differentiating propositions to ensure sustainable growth.
MFIs will need to integrate the available digital enablers to improve transparency and reduce cost of operations. Further, there is a need to slowly but surely shift towards non-cash modes of business.
MFIs need to look towards unconventional streams of revenues from targeted propositions for the Bottom of Pyramid customers. This may include financial products like micro-insurance, mutual funds etc. and non-financial products like solar lamps, mobile phones, water, FMCG, etc. MFIs need to actively look for alliance and partnership opportunities to deliver such propositions.
Given the changing landscape, it is imperative for microfinance companies to significantly enhance their current risk management framework. Leveraging technology at various stages of the customer lifecycle and ensuring that risks are managed pro-actively would help MFIs mitigate internal and external risks much better.