Microfinance Horizon

By Bindu Ananth and Nachiket Mor

30 December 2010 [IFMR]

We have maintained a consistent position that despite all the imperfections of the MFI industry, the AP crisis was brought on primarily by the Ordinance that restricted the ability of MFIs to collect on the loans they had made and the misplaced perception of key stakeholders that this is an unregulated industry, despite 80% of the loans being made by RBI regulated NBFCs. It was (and still is) imperative to remain completely focussed on solving the immediate issues of liquidity and prevention of contagion to other states so that the collateral damage to hundreds of genuine initiatives is minimised and that the lifeline of access for customers is not permanently damaged.

However, now that the RBI has made a call to restore liquidity, we hope that the short-term issues will be managed and it is time to turn our attention to some of the deeper messages from the crisis. We are proposing a 5 point action plan for MFIs to ensure that there is a better acknowledgement of the value of their contributions to the life of a low-income household the next time around:

1. MFIs provide a very useful service to clients by allowing them to manage their cash intra-year between periods of excess income and deficit income. This kind of cash management ability makes a big difference to a low-income household by reducing their need to sell household assets or take on expensive informal loans. In addition to this service however, MFIs must increasingly work hard to build a relationship with the communities that they serve. They must track the financial well-being of every household that they serve. They must hold themselves and their loan officers accountable to this metric. This is imperative if the community has to stand by their side in future crises.

2. Voluntarily and unilaterally cut interest rates to not exceed 8% above cost of bank loans. Our research suggests that this is very much within reach of the efficient entities who have crossed a minimum scale. If for some MFIs operating in remote geographies, operating costs do not justify the 8% benchmark, they must provide clients with instruments that will let them benefit from future profitability for the “equity capital” that they have inadvertently provided to the entity in its early stages via higher interest rates. The experience of Shri Renuka Sugars in making farmers shareholders may be instructive here.

3. MFIs must remember that the only collateral they have in the traditional Grameen-style loans is group cohesion. Collection problems inevitably can be traced to problems in the way loans are originated. MFIs must remain committed to process adherence. Reinforce to the group before disbursing a loan the nature of their responsibility and re-confirm that there is sufficient knowledge and willingness to guarantee, given multiple loans that some group members may already have. This might require some modifications to the traditional way in which Group Recognition Tests (GRT) are performed. MFIs must invest in training their field staff to deal with delinquencies in a mature manner. Have board approved processes for delinquency management that are then routinely audited by your Internal Audit Departments.

4. As the current loan portfolio runs off over the next twelve months MFIs must consider booking new loans into smaller, regionally focussed and well capitalised subsidiaries rather than into the national entity. This will be great for leadership development, better community engagement as well as converting non-diversifiable systematic risk into much more addressable idiosyncratic risk. Convert the national entity into a holding company [http://bit.ly/dH6VKY] purely for the purposes of raising equity capital and holding all the process and technology capabilities.

5. Ultimately however, the real power of financial services to the low-income household can be realised only with a far more comprehensive approach. When MFIs think about their evolution over the next decade, they might want to think about transforming the business model and channel architecture to enable provision of a broader suite of financial services to clients in a way that is customised to meet every client’s requirement; some appropriate combination of savings, loans, insurance and pension.