Stricter regulatory norms needed for MFIs run as for-profit enterprises
The controversy at SKS Microfinance and the unceremonious sacking of its CEO is probably the best thing to have happened to the micro-finance industry. SKS’s high profile, its ferocious growth (200% last year), and the support of names like Vinod Khosla and NR Narayana Murthy, have invariably silenced critics of its high-cost, high-stakes, high-reward business model. It also allowed SKS to lead the debate on regulating micro-finance institutions (MFIs).
SKS’s actions are now giving voice to those (in India and abroad) who agree with Nobel Prize winner Muhammad Yunus, of Grameen Bank, that micro-lending cannot be done at a breakneck speed through a for-profit model by an organisation that is not owned by the borrowers.
Those alarmed at Vikram Akula’s (the founder of SKS Microfinance) model of poverty alleviation were usually told that it was the only way to transform the lives of over 150 million abjectly poor Indians quickly. Our nationalised banks have failed in poverty alleviation, while Muhammad Yunus’s model—of small organisations where borrowers are the stakeholders—is far too slow. Interestingly, all the for-profit MFIs hope to transform themselves into banks or to float public issues, which will make the early investors stupendously wealthy and yet wear a halo of being in the ‘development sector’. Criticism about high interest rates (often 40% to 70% per annum) is countered with the argument that it is cheaper than traditional moneylenders who charge 100% or more. The low delinquency rates claimed by MFIs are also hard to believe; but it has ensured a rush of private-equity financiers who are apparently egging companies to pump up valuations through furious expansion to ensure profitable exits for themselves.
For the past couple of years, we Indians have been preening about how the Reserve Bank of India’s (RBI) sober policies allowed us to escape the global financial crisis. But a close look at India’s burgeoning MFIs is troubling. The for-profit MFIs are usually headed by ex-Citibankers (or any such) drawing fat pay-cheques and bigger stock options; their access to private-equity finance allows them to run high-cost operations. They also transfer risk by securitising receivables, which have no collateral, at AAA ratings.
All this, coupled with the breakneck growth rate, ought to cause alarm when it is a known fact that even RBI struggles to recruit ‘employable’ people. It is hard to believe that MFIs are able to add thousands of employees and hundreds of branches every month with sound business models. While most MFIs deny that incentives are linked to size of business, employees admit that variable pay or increments are certainly linked to performance. And it is already creating moral hazards. A media report cites a study by the Monitor Group which apparently showed that 90% of SKS borrowers wanted credit for aspirational products like gold coins and televisions, not solar lamps and other such necessities. Interestingly, media reports suggest that several directors of SKS wanted the company to sell gold coins and that Vikram Akula resisted the pressure. But it doesn’t stop them using their channels to create other needs. For instance, SKS was happy to allow a company to give out free samples of hair-dye through the channel. The cost of insurance that is tied to the micro-loans is an issue that even gnaws at the conscience of those within the industry.
Another detailed report on the micro-lending crisis in Karnataka in 2009 says that in Kolar (epicentre of the crisis of 2009) many borrowers had an average of three loans each. It found that an agent charged with recruiting MFI clients had indulged in huge proxy borrowing. All of this created social and economic strain “resulting in tinderbox conditions that only needed a spark to ignite” (which it did). The study pointed out that loans often went beyond what can be considered micro-credit (Rs40,000+) leading to a collapse of the group mechanism that secures micro-loans. Interference by religious leaders and dubious politicians also exposed the inherent risk of a business which has no collateral. Yet, micro-financiers routinely securitise their receivables and also get an AAA rating from agencies such as CRISIL.
Another excellent article, titled “The Hidden Risks behind Microfinance Securitization” by Daniel Rozas and Vinod Kothari in July this year, exposes the dangers of high ratings on securitised assets. They argue that the nature of micro-loans (without collateral) is such that the risk of default can be as high as 100% on an MFI, even if it has been well-performing until then, and result in its collapse.
This sort of crisis is not imaginary. There have been serious issues in Karnataka in 2009 and in Andhra Pradesh. As Rozas and Kothari say, “And yet, we see that in India, where no microfinance credit bureau exists, CRISIL is issuing AAA ratings to microfinance securities where the MFI is rated as low as BBB- (one level above junk). Unfortunately, this would not be the first time that a rating agency assigns an AAA to assets it apparently doesn’t understand. For all the comparisons made between microfinance and subprime, this may be the one that actually fits.”
In the SKS Microfinance case, there are indications that ousted CEO, Suresh Gurumani, was trying to centralise processes and information and halve growth from 200% to 100% in order to put in more robust systems. Since SKS is hiding behind the court case to avoid answering questions, it is time for RBI to step in. It is time to wake up and listen to Muhammad Yunus who defines micro-finance as “lending money to the poorest women for income generating activity, without collateral, so she can help herself out of poverty.” If that boundary is crossed, the business must find itself another name, otherwise “loan sharks can say they are doing micro credit.” He also points out that Grameen Bank is owned by the borrowers, while in India, micro-finance companies are owned by foreign private equity funds seeking high returns and run by foreign bankers on fat salaries and expense accounts. RBI must start by making a distinction between for-profit and not-for-profit MFIs and applying more stringent and intrusive regulatory standards and inspections to the former. — Sucheta Dalal