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The Indian Microfinance Lending Machine

Published: Oct 28, 2010 06:00:34 AM IST
Updated: Oct 28, 2010 08:05:19 AM IST
The Indian Microfinance Lending Machine
Image: Vikas Khot

Vijay Mahajan’s morning walks are interrupted by neighbours who question him about the recent controversy around MFIs. They want the man regarded as the father of microfinance in India to explain why there are so many suicides related to MFI lending. “I feel like my whole life’s work is turning to ashes. I’ve spent the last two weeks, just running to regulators and government officials, defending microfinance,” says the founder and chairman of BASIX, India’s first microfinance company, and president of the Microfinance Institutions Network (MFin).

He is not often given to words as strong as these. But then the microfinance sector hasn’t seen times like these. From one angle, these are the best of times. Microfinance is as hot as the tech sector was 10 years ago. Valuations are crazy. It’s poster child SKS Microfinance has just listed on the stock exchanges at a handsome premium. Investors want a piece of any half-decent microfinance outfit if ongoing capital-raising is any indication.

These are also the worst of times. Officials and the media in Andhra Pradesh, the largest MFI market in the country, have whipped up themselves into frenzy over a sudden spate of what might be MFI-related suicides amongst poor borrowers. Last week, Chief Minister K. Rosaiah warned MFIs against charging usurious interest rates and passed stringent rules governing their behavior. Add to this, a statement from the union finance ministry that a cap on MFI interest rates is being considered. The Reserve Bank of India has also formed a committee to examine if loans from banks to MFIs ought to remain classified as priority sector. “Forget all three, if even one of these policies comes through, it could be a huge setback for the MFI sector,” says Mahajan.

Alok Prasad, CEO of MFin, a group of 44 profit-oriented microfinance companies put it succinctly when he told Financial Times, “The operations of the microfinance institutions have come to a grinding halt. They cannot lend, and they cannot collect repayment. They are dead in the water.” There is every possibility that this will create chunks of bad loans and can cripple many microfinance companies.

The stock market isn’t taking to these developments kindly. Already SKS has fallen from the high perch that investors gave it at the time of listing. Adding to the external problems is the company’s own troubles, chiefly the mystery surrounding the unceremonious dismissal of its CEO, Suresh Gurumani. As a result, the several IPOs that were expected to follow SKS, including those of Spandana and SHARE Microfinance, have been delayed.

For many, the ouster actually signals the wider problem with the aggressive business model that SKS had chosen.

“We’re not a listed entity but we might go in for an IPO in 3-4 years time and this is a good learning lesson so we don’t have such kind of issues when we get into those spaces,” says Suresh Krishnan, MD, Grameen Koota, a Bangalore-based MFI.

Poster Boy to Problem Child
And to think that SKS, the model MFI until yesterday, would be the source of much of this embarrassment. Founded as a non-profit in 1998, SKS (Swayam Krushi Sangam) is the largest MFI in India and one of the first to show private capital could be used as a means to reach the poor. It reaches over 7.3 million women and has 2,226 branches in 100,000 villages in 19 states across the country. It has a 99 per cent on-time repayment rate, a disbursement record of over Rs. 16,000 crore and a net worth of Rs. 1,016 crore (in June) and is of one of the fastest growing MFIs in the world. Much of the growth came after it changed to a for-profit enterprise.

BusinessWeek named SKS as one of the top five emerging and influential companies in the world in 2009 and last year, rating agency CRISIL ranked SKS as first among the top 50 MFIs in India. Its IPO was over-subscribed 13 times. “The performance of the company is not only solid but spectacular,” says the company’s founder and chairman, Vikram Akula.

Despite all its success, many of its peers feel SKS’ aggressive growth has put them on a back foot. Its for-profit image is making regulators deeply uncomfortable. SKS is intriguingly eroding its own messianic image before the world. The controversial decision by its board to sack its CEO barely two months after the IPO has only added to its woes.

 “Somewhere they have got lost and they need to revisit their soul,” says Ela Bhatt, founder of Self Employed Women’s Association (SEWA). Former employees agree. “It seems as though the dream Vikram started out with is rapidly turning into an illusion,” says Anna Somos Krishnan, a former SKS executive and now executive director of Planet Finance India, an international NGO for the development of microfinance.

Private Capital and Culture Change
During the course of this transformation from a support group to a finance company, once private capital began to course through its veins, SKS saw its culture changing. One long-time employee says the change has only sped up now. “Post the IPO, there is even more need to grow, there is no emphasis on slowing down. It’s a pure commercial model we’re following, the social element is missing.” Another employee says he is keen to quit the company because the board was placing extraordinary pressure to grow faster. “The company is trying out various pilots right now in everything from housing to gold. The board has already started asking to scale these up because they want scorching numbers. If we say in one branch only 1,000 loans are possible to be given, they will say make that 10,000-15,000 loans.”

Employees also claim loan agents face a sweatshop-like working condition. “They work 18 hours a day and are extremely dissatisfied… with their attrition rates averaging more than 28 per cent each year,” says one employee.  The Indian Microfinance Lending Machine

Pushing targets can result in problems of multiple lending and rolling debts in the sector. According to ground reports, some of SKS’ urban loan portfolio may also be under stress due to defaults. “In Kolkata there are fights between SKS staff and borrowers, in some areas they are not repaying anything,” says an industry source.

But tracking these default loans may not be that easy for SKS. The company has over 2,000 branches and operates a mix of old and new management information systems that are only manually reconciled at the end of every month. “In the absence of real time connectivity and data tracking, one would assume only that the disbursed amount actually reached the clients because you wouldn’t know until a month later, or until the internal audit department visits the branch,” says Somos Krishnan. “We raised this issue all the time in the head office, however, little was done to mitigate this mounting risk.”  

SKS admits to some problems. In Delhi and Kolkata, for instance, the company is rolling back lending just like it moved out of certain areas in UP and Jharkhand two years ago. However, it says its processes are fine and these roll-back decisions have mostly to do with political interference or other MFIs who skewed the credit culture in those areas. They are looking to expand beyond simple unsecured loans to diversify financial services to the poor. “Our second phase is looking at a full range of financial products from housing to micro insurance to lending against gold and taking these new products to scale,” says Akula. There is every chance this will mean more career bankers coming on board.

This cultural puree of development workers and bankers has already created trouble for SKS. Suresh Gurumani, the 48-year-old career banker, was from Barclays and his style of functioning didn’t go down well within the company. “Suresh would arrive to work with his Satya Paul bag and his Mercedes parked outside — that’s just not who we are,” says one source.  There were quite a few other things where Gurumani didn’t see eye to eye with old timers. Some of the measures he wanted to introduce — such as a credit scoring mechanism and a new information technology platform — were not aligned to SKS’ unique needs, insiders say.

 These issues will not get sorted soon because Akula believes that the pursuit of profit alone will let SKS help the poor. “The more profitable SKS is, the more capital we can raise, the more poor people we can serve,” says Akula. On the flip side, it is possible that SKS might end up attracting talent that loves the money rather than the cause of poverty alleviation.

Mohammed Yunus challenged Akula on the SKS model. “Vikram has mentioned how quickly he has expanded, Grameen is so slow… If you look at our history, you will see in one year, every day of the year we had opened a new branch, every day of the year.  Next year we did two and a half branches per day, so we could go into five branches per day, because it does not cost any money to us.  I always insist microcredit should be about local money, not international money. The moment you get exposed to the international money, you get all the troubles of the international money, the volatility and everything, you are passing on all the risk on the shoulder of these women that you are lending this little money,” said Yunus.

Market of the Poor
Making money off the poor is one label SKS can do without. How will it get rid of the impression that its top management has become incredibly rich in a very short period of time? On October 4 this year, the SKS board sacked Gurumani who was the CEO. Gurumani had helped guide SKS through a supremely successful IPO which saw the company raise Rs. 1,653 crore at a price of Rs. 985 a share and list at an 11 percent premium. He took great initiative in enhancing risk management facilities for the sector via the creation of MFin as well a credit bureau.

But both founder Akula and Gurumani sold significant stock in the months running up to the IPO. According to a recent study by the Consultative Group for the Poor (CGAP), each exercised about a quarter of the options they had been granted in 2007–2008, netting $11.9 million and $1.6 million, respectively. “I’ve made a tonne of money… more than I ever thought I would make in my lifetime and my kid’s lifetime combined,” says Vikram Akula in a recent interview to Business Standard.

The SKS greenback gravy train extends even further. Unitus is a US-based organisation that funds non-profits. Its stake in SKS might today be worth $60 million, which is fair. But Unitus’ board stunned the non-profit world in July by saying that all of its 40-person staff would be laid off and that Unitus would no longer be involved in microfinance activities, leading many to question motivations behind its proceeds made from the IPO.

In January 2010, SKS sold a 1.5 percent stake to Catamaran Fund, created by Infosys founder Narayana Murthy. This stake was sold at a discount price of Rs. 300 per share, less than half the price of other private equity sales by SKS at that time. According to news reports, in 6 months time, the mark-to-market profit of Catamaran is about Rs. 64.24 crore. “Nobody wants to voice their concerns over quality issues in the company because there’s just too much money at stake to protest over and leave. In any case, if we ever told management we want to leave, all they’d say is ‘Why? You’ll lose your stock options,’” says an employee.

The IPO also raised the profile of SKS before the regulators. According to inside sources at the RBI, making so much money out of the priority sector is making the regulator extremely uncomfortable. SKS was recently advised by the top guns to focus more on its image as a development organisation rather than this image it is fast acquiring as a money-making machine.

Unfortunately, the Andhra deaths in the past few weeks have led to the company being touted as one that has made its money at the expense of the lives of its borrowers. “Just look at what happened with the former CEO Suresh Gurumani,” shriek local politicians. “He came for 20 months, made crores of rupees, and left. Is this microfinance any better than blood money?” While SKS has clarified that none of the 17 women borrowers who died were defaulters, the events have only added to a growing negative perception amongst the public and the media, as well as politicians.

Everybody Hurts This Time
A mutual fund manager says the sheen had yet to come off the sector but SKS’ recent behaviour is worrying. “I don’t care if the CEO goes or stays. But if there is a larger, systemic issue in the company, then I’m worried.”

Other MFIs are upset about SKS’s reckless growth rates that they say are damaging the industry’s perception and credit culture amongst the most important segment: Their customers. “SKS goes into a place aggressively and lends and then they wind up and it gives a bad impression to the customer,” says one industry source. “Then for other MFIs trying to work in that area it gets difficult because the customer says why should we repay you?”

Another big sticking point is the perception that big MFIs like SKS don’t reduce their interest rates to benefit the borrower. “It is largely due to exuberant growth with exorbitant profits and no reduction of interest rates that regulators and society are taking such an adverse view of this sector,” says Vijay Mahajan. But there are some MFIs who have fulfilled their promise. Both Ujjivan and Bandhan have reduced their interest rates across the country by as much as 5 percentage points with a promise to continue reducing rates. SKS too points to the fact that it started out with interest rates as high as 41 percent in some states back in 1998, which they have reduced to 26 percent today. “There is room for MFIs to reduce interest rates, costs notwithstanding,” says Bindu Ananth, president of the IFMR Trust.

Samit Ghosh, MD of Ujjivan, says there has been a global repercussion on the sector. “To the world, it looks like all the bad aspects of corporates have come into microfinance and its very bad news for the industry.” Other industry peers who asked not to be named, point to the questions about corporate governance in the microfinance sector that are being raised. “Things overall, have been very poorly handled by SKS. After 2008 and the financial crisis, how could they not realise things have to be handled more gently? Now we’re all running scared. Our investors are asking us a hundred questions and getting new investors on board will be more difficult now.” In fact, the SKS stock itself has lost nearly a third of its value from the peak in the last few days.

Akula thinks the whole thing is a witch hunt. “The reason there is such hostility to the SKS model is that we are upsetting a lot of vested interests. We are breaking the hold of village loan sharks and we are introducing a private sector model for development that many traditional NGOs hate. We are making it difficult for the media because our model cannot be explained in a nice tidy sound bite. It is neither development as usual nor is it business as usual. SKS blends the best aspects of both.”

He is undeterred. “It doesn’t matter who criticises us. As long as our borrowers are being given desperately needed access to finance in an ethical manner, that’s all that counts, that’s all we care about.”  

(This story appears in the 05 November, 2010 issue of Forbes India. To visit our Archives, click here.)

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  • Rajan Alexander

    Chandra Babu Naidu ex- Chief Minister who toured the Ranga Reddy district, addressed several micro finance victims and advised them to just pay the principal and not the interest thereupon. He also told them not to make any payments until the government agreed to extend Pavala Vaddi scheme to the Micro Finance. Telling them to tie those who came to their houses for collection of micro debts and throw them in a room, the former chief minister said that his party would then take care of them. Join the Campaign and ban MFIs. If they want to profit from the blood of the poor, lets give them a taste of their own medicine. Vikram Akula of SKS Microfinance is our mascot What'€™s wrong with Micro-finance Institutions? Practically everything as the case of SKS illustrates. http://devconsultgroup.blogspot.com/2010/10/whats-wrong-with-micro-finance.html

    on Nov 3, 2010
  • Bulu

    Nowadays i think MFI are creating problem for the poor people: The main problems are...as follows: 1-the interest rate(taking(50 to 80%) 2-coercive method of recovery. 2-other charges like LPF, insurance,other products etc...if you calculated all these expenses then it is nearly about 80%...which is more for poor people. 4-their process of lending is not clear yet. 5-they are cheating poor people. 6-their business should be stopped. Otherwise the suicide issue will be more pathetic for govt as well as for others, 7-they are taking some hidden charges, which are not ethical in nature. 8-make them out of country. -Bulu (Orissa)

    on Oct 29, 2010
    • Zeeshan Zafar Ahmad

      In my point of view, actually its not the MFI sector but WE, who are failing the system, and by WE i mean all of us - from stack holders to the end users. I think: 1. Govt can take conclusive action to rectify the situation especially the MARKUP point which is too high there in India (as highlighted in the para). - However keeping in view the current price hikes/ inflation issues/ expenditures and many more, the interest rate could be revised but through the regulatory body and not by the stack holder;s will. 2. Stack holders should be harnessed at a level of profit only. -- closing the MFI sector would creat a malignant financial problems to those who could not go to other commercial banks, however reforming the sector would be much more effective.

      on Nov 3, 2010
  • Mitu

    I request to the AP govt. about MFIs issue 1-To stop the business of MFI as soon as possible...other wise they will kill the poor people..they need regulation..by this the moneylender will hamper the rural people..the same problem is in ORISSA, BIHAR, CHATTISGARH, BENGAL, MAHARASHTRA...etc..due to no control on mfis. 2-they are taking much more interest beyond the expectation. Nearly 80%. I survey the system followed by BASIX in orissa: if u take loan @15000/- then u have to deposit advance the following: -LPF (loan processing fund)-500/- - security 10% of the principal adbds - product cost 450 which is a fake product So its 500 1500 450=2450 in advance Then come to recovery process: They taking 1800 in the form of interest, 1000 for insurance chager=2800/= after taking the loan. In an aggregate they are taking 2800 2450=5250/- with out any investment. The borrower are taking loan 15000 and taking 10000 to home and have pay the installment for 15000/- They are collecting monthly...still their is no reduction in interest. Thats why i am requesting u to stop MFI instead of making a regulatory body for them. Give chance to bank to reach to the poor instead of these moneylenders. They doing this lending business in a smart way...they are very smart.they are killing poor people,farmers of our country BIJAYA (Orissa, Anugul)

    on Oct 29, 2010
  • hemant chaturvedi

    It will be necessary for all MFI that they provide support and training to develop new small business for their clients beside finance so that actual goal will be fulfilled of invention of MFI.

    on Oct 28, 2010
    • Zeeshan Zafar Ahmad

      I agree to Hemant's point of view keeping in view the problem in MFI sector in India. MFIs are the segment which are reaching to the base level people who could not enter the commercial banks or don't have security bonds/ references etc. What is needed is to re-structure the MFI ordinance in India to cope the situation.

      on Nov 3, 2010
  • Rajan Alexander

    When we started out in development a couple of decades ago, we instinctly targeted to reduce the influence of money lenders, if not eliminate them completely. Why? They were the traditional oppressors and exploiters in society. But today, we find MFIs have filled up the vacuum. MFIs believe that "having access to expensive credit is better than no credit" on one hand and "the observed rate is where demand equals supply". The result is an "Animal Farm" situation where we are now not able to distinguish between "pigs" and "humans" and vice versa. In fact, money-lenders have got a face-over by packaging themselves as MFIs. A good example is Mohd Yunis of Grameen Bank comes from a traditional money-lending caste. And of course, he got the Nobel Prize for Peace while the Nobel Committee to date have yet to confer the prize to Mahatma Gandhi, the apostle of Peace! The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 975 - showing how much the market had confidence on their profitability while "banking with the poor". PMFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn't match! Profitability that permits SKS to pay Rs 1 crore as bonuses to their just fired CEO! And how do they attain profitability? A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the micro finance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Micro finance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300. The state's share of outstanding micro finance loans represents nearly 40% of the sector's total portfolio, according to ratings agency CRISIL, a credit rating agency. Now if MFI is all about access to the poor, we can ask the question, why the clamour to be concentrated in a state which belong to top-five in development in the country? We would have thought they would have gone to the five lying at the bottom rung of the country. But no, they avoid it like plague. It is easy to see they do this on repayment potential of states. The interests MFIs pursue are interests of self sustenance and their own growth. The poor is hardly in the radar except for rhetoric. The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector who gave birth to a Frankenstein.

    on Oct 28, 2010