India’s Microfinance Sector

Buzz around India’s microfinance sector quietens Over the past few years microfinance in India has morphed rapidly from a charitable endeavor to a profitable business and then to flavour of the month for private equity investors and venture capitalists. It was a startling transformation for a sector that until recently was considered a non-profit business. High repayment rates of about 98 per cent and a vast pool of “unbanked” Indian customers who need small loans woke banks and investors to the serious business potential of the sector. The buzz around microfinance grew in 2007 when Sequoia, the venture capital firm that backed Google and Apple, invested $11m (£7.6m, €8m) in SKS, one of India’s largest microfinance institutions (MFI). Other deals followed, including a $27m investment in Share Microfin, from Dubai’s Legatum Capital and Indo-Dutch Aavishkaar Goodwell; and a $12.5m investment in Spandana, another leading MFI, by Indiabased JM Financial Fund and Lok Capital. But since the global financial crisis deepened last year, the buzz around microfinance has quieted. What is in store for microfinance in India? In spite of uncertain conditions worldwide, the long-term outlook for microfinance is largely positive though the sector’s stratospheric growth will surely slow. In India, the sector grew 79 per cent in 2007 in terms of value of loans outstanding. “The

financial

crisis

brings

to

light

the

inherent

strength

of

microfinance. Microfinance is the only asset class that has had zero

i

delinquencies in the last five years,” says Moumita Sen Sarma, head of microfinance at ABN-Amro in India, referring to the bank’s portfolio. “We are trying to grapple with other issues but our commitment to microfinance is still strong.” Although Indian banks have been hit by delinquencies on consumer loans, repayment rates for micro-loans remains high at the majority of microfinance institutions. Their core business – distributing small loans to help poor borrowers start income-generating work – is still in demand. ”Investors are still viewing microfinance as an alternative asset class,” says Robert Annibale, head of global microfinance for Citi. However, MFIs are hurting as overall liquidity from banks dries up. Commercial banks supply money to MFIs, which then use their grassroots networks to distribute small loans to customers mainly in rural India. India’s largest MFIs are better able to weather the storm. Big banks prioritise lending to those established players, which still attract some interest from investors. Even in the midst of the global financial crisis, SKS Microfinance – India’s largest MFI – last November sealed a $75m deal. Sandstone, a US hedge fund, Kismet Capital and SVB India Capital, an affiliate of Silicon Valley Bank, together took an undisclosed stake in SKS in what was the largest-ever deal in Indian microfinance.

ii

Previously the largest deal was a $37m investment in SKS in late 2007 by a group that included Sequoia, Silicon Valley Bank and Vinod Khosla, founder of Sun Microsystems. Microfinance has also been favoured by “social investors” who are interested in social as well as monetary returns, such as Legatum and Omidyar Network, set up by eBay founder Pierre Omidyar. Last year they each invested $10m in Unitus Equity Fund, a US fund that invests in microfinance in India and Latin America. Although the largest MFIs are more insulated from the impact of the financial crisis, dozens of smaller MFIs have been dealt a stinging blow. Banks tend to fund the big players while ignoring fledgling MFIs, resulting in slower growth rates. “When banks are flush with funds, microfinance is fashionable to invest in and is a priority. However, when liquidity dries up, it’s no longer a priority. Fund flow to the microfinance sector has been severely reduced,” said Vipin Sharma, chief executive of Access, a leading microfinance advisory company in India. Banks are “a lot more cautious about lending”, agreed P N Vasudevan, managing director of Equitas, a new MFI that launched in Chennai in December 2007. “There’s definitely a slowdown, there’s no question about that.” Mr Vasudevan says his customers continue to repay loans at high rates but because of less liquidity from banks, Equitas’ growth projections have tapered. It had targeted reaching 450,000 total customers by the end of this month but the figure will remain closer to 350,000.

iii

A global survey of MFIs and investors released this month by Microfinance Insights, a Mumbai-based magazine, found that more than 25 per cent of non-deposit taking MFIs decreased their lending in the last 12 months while 20 per cent cut staff. Thirty-seven per cent revised growth projections downward.

Nevertheless, more than four

out of five investors have not reduced their portfolio allocation towards MFIs. In India, MFIs face better prospects for improved liquidity. Indian law mandates that government banks must allocate 40 per cent of financing to “priority sector lending”, which includes microfinance as well as agriculture, small businesses and other neglected sectors. There may also be silver lining in slower growth. Many experts had feared that microfinance in India was overheating as MFIs sought overambitious growth targets. Some accused the sector of drifting away from its original mission of helping the poor in order to increase profits and attract investors. “I hope we do have a slowdown. The industry was in a race to grow with little depth. That creates serious credit risk,” says Nancy Barry, the former president of Women’s World Banking, at a conference in Delhi last November. “The concern is that we are becoming loan dispensers instead of financial intermediaries.” Others agree that a slowdown is an opportunity for MFIs to take stock of themselves, bolster governance and improve services such as financial literacy for customers. “The slowdown is a perfect time to focus back on quality and ensure the foundation is stronger before the next phase of growth,” says Ms Sarma of ABN-Amro.

iv