The microfinance industry has seen tremendous growth over the past five years, growing at a 45% CAGR. It has witnessed rapid evolution with regulatory reforms post the AP crisis in 2010 to regulate product, pricing and protection of customer interest, growth of regulated NBFC MFIs – a special class of RBI regulated entities carrying out microfinance, the formation of the first ever Self-Regulatory Organizations (SROs) of the RBI, Aadhar based lending by NBFC MFIs and transformation of some of the entities into universal and small finance banks. Today, with over 45 million end clients with a loan outstanding of over INR 1 lac crores across the private JLG (Joint Liability Group) and the public SHG (Self Help Group) programmes, employing over 120,000 people across 10000 branches in 28 states of India, it is a key force for financial inclusion in the country. However, this level of outstanding is still lower than 25% of the demand across India and indicates the future potential for growth.
The key reason for the growth of the sector has been adaptability to change, resilience in the face of challenges and ability to maintain high repayment rates of almost 99.5%.
The Nobel prize winning Grameen model of social collateral combined with a high touch model and rigorous credit bureau discipline has helped to maintain such high levels of repayment for this small ticket sized unsecured loans. The USPs of the sector have been microloans, door step delivery and frequent repayments. The business thrives 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. Unfortunately, the business is still highly cash oriented – both on disbursements and repayments.
With demonetization, this proved to be an Achilles heel for the sector. Lack of availability of new notes hit the informal cash intensive economy of the low-income groups served by microfinance in the weeks following the old INR 500 and 1000 rupee notes being declared illegal tender. Microfinance institutions which went door to door collecting these very notes to fulfill repayment of loans by customers were forced to ask customers to get new notes or other denominations. The rural areas were far more affected than urban areas initially. However, demonetization bought with it not only the impact on liquidity for this segment of the population, but over the period of 4-12 weeks also showed a negative impact on livelihood generation and cash flows for microfinance customers as their businesses slowed down. This had a further impact on collection efficiencies. 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. Some poll bound states were especially affected by these rumors.
Clearly, a business which has to manage its costs within 10% with staff, occupancy costs itself taking up almost 60-70% of that cannot be viable at less than 99% collection efficiencies if it has to be a sustainable model.
While given the underlying strength of the business model, collection efficiencies have been estimated to move from 78% in November 2016 to 85% in March 2017, there is still ground to be covered, and specific states and local areas are more deeply affected than others.
Today the imperative for microfinance institutions is to get back to their pre-demonetization collection levels. The industry has cumulatively served millions of customers, almost all of whom are women. Microfinance is a viable source of finance for them to grow their businesses and support their livelihoods. In order for this form of finance to reach more people and further the cause of financial inclusion in the country, it is important for various stakeholders to come together to restore credit discipline amongst borrowers in order to facilitate the growth of the sector.
The sector has attracted significant debt and equity capital over the past few years. In order to grow and reach out to more clients and bridge the financial inclusion gap, the sector has to continue to be able to tap into more debt and equity capital as this is a capital intensive business. The key to this will be moving to the next level of evolution for the industry.
This is a sector where the inclusion and cashless agenda of the government should be pursued and has the potential to create significant empowerment and impact. With the opening up of more Business Correspondents from banks, new age Small Finance Banks and Payment banks, payment platforms such as Aadhaar Pay etc., it is indeed possible to enable a majority of the 45 million end clients to receive loan disbursals and eventually make repayments through bank accounts – this could mean over 100 million e – transactions every month!
Focus on financial literacy drives, increased enablement of cash-in, cash-out points in remote areas using biometric authentication, growth in digital transaction infrastructure with new age banks and UPI will all be key drivers of change. Microfinance institutions will have to experiment with a few models and fine tune ways to enable their customers on a digital transaction platform leveraging the penetration of mobile phones. This will also entail a focus on the technology backbone of the microfinance institutions themselves to facilitate and monitor the increasing volume of transactions.
Microfinance is at a critical juncture today. It has proved its viability as a business model, as well as, its ability to reach out to a significant section of the population which needs mainstreaming. It will continue to remain a relevant and important conduit for providing financial services to a vast segment of the population, acting in complementarity to banks. However, given the inherent vulnerability of the customer base, it is important to plan for current and future risks that can impact repayments and slow down the access to regulated credit lines for the underserved. While there maybe external shocks such as natural calamities, initiatives such as loan waivers also do not bode well for credit discipline. Instead, in a country where 1 in 2 people still do not have a bank account and only 15% have access to formal credit lines, it is key to seriously think of the right to financial inclusion as a fundamental right.
The key focus areas and building blocks for stable and prudent growth of this business to play its role in furthering the financial inclusion objective of the country would be: strengthening/ restoring the credit discipline and culture of repayment, operating cost optimisation through IT enablement, a stronger self-regulatory commitment from all players in the sector including banks and NBFCs, safeguarding of the business model of natural calamities and external activism and mainstreaming of the business within the larger financial services sector in the country. If these factors are taken care of, it can become possible to reach the last Indian in need of financial services, thereby taking a significant step towards greater development and economic parity in the country.
About the Author:
Mr. Manoj Kumar Nambiar serves as Managing Director of Arohan Financial Services Private Limited. Manoj served as Chief Executive Officer and Managing Director of Intellecash Microfinance Network Co. Pvt. Ltd. He served as Deputy Chief Executive Officer of Retail & Private Banking at Ahli Bank. He has more than 25 years of experience across Marketing, Consumer Finance, Retail Banking and Microfinance in India and the Middle East.