High interest and repayment rates make micro-finance institutions profitable

Private equity (PE) investments in microfinance institutions (MFIs), which fell by 12 per cent last year (2009), have recovered this year. Between January and June this year, MFIs have attracted PE investment totalling $84 million (about Rs 386.4 crore) — an increase of a little over 15 per cent over the first half of 2009.

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This has led to an increase in the investment flow into Indian MFIs, despite the financial crisis.

PE firms have shown particular interest in investing in MFIs that are registered as non-banking finance companies. The firms typically invest in closely held companies in which they see possibilities of good returns that can be obtained through an exit strategy involving an initial public offer (IPO) or a takeover by large companies.

For instance, SKS Microfinance, which has attracted the maximum PE investments , will soon become the first microfinance company to be listed on the Bombay Stock Exchange. The company is planning to raise around $250 million through an initial public offering (IPO).
 

SKS was the first MFI in India to obtain PE funding. Venture investors in SKS include Sequoia Capital India, Silicon Valley Bank and Bajaj Allianz Life Insurance. Another pre-IPO investor was Catamaran Management Services, a fund run by N R Narayana Murthy, a co-founder of outsourcing giant Infosys.

While the increase in MFI lending has been appreciated, their profits have been criticised. Social activists argue that the high interest rates they charge are exploitative and could trap borrowers into poverty. Another concern is that pressure to boost profits could prompt micro-lenders to ignore the poor.
 

The fact that repayment rates are close to 100 per cent also suggests that the activities for which the loans are used generate sufficient profit to ensure repayment. This indicates that access to loans may be far more critical to the poor than the interest rate.

Finally, while pioneer Grameen Bank in Bangladesh took 30 years to expand its client base to six million, companies such as SKS have achieved this in six years. This suggests a more commercial orientation will enable an MFI to help a greater number of the poor and expand its reach far more quickly.

SKS’s chief mentor, Alok Mittal, argued in a recent newspaper column that interest rates for customers would have to remain quite high, given the operational challenges and risks that lenders faced.

SKS’s IPO is likely to revive the debate over whether MFIs should be run as non-profit or for-profit institutions, a debate that has divided the MFI community.

“It would be a mistake to conclude that this business is universally a cash cow. SKS is clearly a positive outlier, which has performed exceedingly well on most counts — and hence the stellar returns that investors are getting.

“Having said that, what you get by financing this sector in a for-profit mode is sustainability and scale. Presumably, PE also brings more efficiency to the business, as the superior operating efficiency of many of the for-profit MFIs indicates,” he wrote.

PE investments in Indian MFIs can, therefore, be expected to continue increasing.

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