Malegam's Microfinance: The Last Laugh

Image: Vikas Khot

MONEY TALK Microfinance institutions are interesting clients for the banks only when they come with a priority tag

The Reserve Bank of India (RBI) has accepted the spirit of the Malegam Committee recommendations on microfinance. The RBI’s response (and modified acceptance) to the recommendations is one step forward for the three steps backward that the committee had taken. The policy now divides the world of microfinance into two categories — microfinance that can access priority sector funds from commercial banks and microfinance that cannot. In the days to come, the major bone of contention will be this tag. If a microfinance institution (MFI) were to be objective, it would not be seeking a priority sector tag. However, the upsides are there to see:
•    The MFI continues to operate without any fundamental changes to its operating systems. It would still be a non-banking financial company (NBFC) with assets that do not qualify as microfinance.
•    Given that the inelasticity of the market for the customer segment in which MFIs are operating, there is scope for continuing to earn more without margin caps or interest caps.
•    The top MFIs have a comfortable capital adequacy, it does not make sense for them to adhere to the onerous norms for the 85 percent qualifying assets — a chunk of which could be financed by equity (assuming that the capital adequacy is in excess of around 20 percent).

The only possible downside is:
•    The cost of borrowing from the banks would go up possibly by 100 to 300 basis points based on how big and mighty one is.

Therefore, it should be natural for MFIs to rejoice at the new policy and opt out of its ambit, while leading a normal life. The irrelevance of recommendations could be easily proved. Technically, this is possible.

However, the picture is not as simple. The picture gets complicated not because of MFIs but because of commercial banks. Irrespective of how well capitalised the MFI is, it cannot do away with bank finance for its operations and growth. Banks do not look at MFIs as just NBFCs on a pure merit basis. The MFIs have been great sources of achieving priority sector targets for banks through lazy banking. To the extent the MFIs have been running around to solve their last mile problem, it is indeed so. The MF tag is also necessary for the banks for their asset classification. Microfinance loans given to groups are classified as secured loans for the purposes of provisioning and prudential norms. And as Basel II kicks in, this will also determine the capital adequacy of the banks themselves. This might add 100 or 200 basis points to the cost of borrowing. MFIs, therefore, are interesting clients for the banks only when they come with a priority tag. If there is no priority tag, the banks have other ample opportunities to lend — large infrastructure projects, huge corporates and a GDP growing at more than 8 percent. NBFCs doing microfinance without the tag are not interesting customers.

In the light of this, clearly MFIs are not left with much of an option particularly given the policy spotlight that has been put on them. One wonders if the exuberance expressed by the biggies like SKS Microfinance and industry association MFIN is misplaced or because they see the inevitable. They seem to be rejoicing the acceptance of the Malegam Committee for all the wrong reasons. In fact, the first of the responses to the news has been the most intriguing. Most of the microfinance leaders have said that this policy framework gives the industry the much needed legitimacy. One thought that for-profit NBFCs, registered with the RBI, were already legitimate.

Expectedly, the bigger MFIs (like Equitas and SKS), who can survive the short term, were the ones that were indicating that they had no problems with the interest rate caps and the margin caps. SKS has crossed the IPO hump and is a while away from hitting the markets again. However, the other organisations that have to hit the market will have to watch out. Already, the sector is seen as one which has significant episodic (as in Andhra Pradesh) risks and the valuations are adversely affected. Now, with an upper bound on profitability and margins, the rate of investment flow might also slow down. Clearly microfinance is not a sexy business anymore.

Malegam and the AP government have achieved a miracle of sorts. Both have theoretically provided for finance business to operate without restrictions if the business does not want a microfinance tag. However, having pre-acquired the microfinance tag, MFIs find it difficult to shed. And if they shed it, there are few alternatives. Clearly Malegam and the AP government, both are having the last laugh. It is inevitable, so better welcome and enjoy the process.

RBI could have handled this better — by getting convergence in its directionality of policy and its treatment of banks and NBFCs. While on the banking side, RBI has moved to market determined rates for all loans (except agriculture), the freedom given to NBFCs to charge as they wish and still get a priority sector sop is withdrawn. In all other sectors, there have been no controls apart from a prudential framework. Microfinance, for some strange reason, is suddenly on the receiving end. All these emanate from the priority sector lending tag. If only RBI had considered what was purportedly in the “confidential” V.K. Sharma committee report on Priority Sector Notes (of removing microfinance from the priority sector category), there was no need for Malegam Committee recommendations.

Even now, the RBI could just remove the option of priority sector recognition (with all its attendant conditions) and treat this sector as consisting of pure-play commercial entities. They could operate in the market, subject to an appropriate consumer protection framework. Unfortunately, that does not appear on the horizon.

The writer is an independent researcher and former professor, IIM, Ahmedabad