MFI sector will take years to recover: Philip Vassiliou

Interview with MD, Legatum

Legatum, a multi-billion dollar global fund managing proprietary capital, owns majority stake in SHARE Microfin, a Hyderabad-based micro-lender that has been hit by the crisis in the microfinance industry. In an interview with Somasroy Chakraborty, Legatum’s managing director Philip Vassiliou says the industry will take years to recover even if a national microfinance law is introduced. Edited excerpts:

Will a national microfinance law help the industry emerge out of the crisis?
The passage of the MFI Bill {the Micro Finance Institutions (Development & Regulation) Bill, 2012} is critical for the future of financial inclusion. While the Bill has a number of shortcomings, it will at least establish the much-needed regulatory clarity and affirm the role of the Reserve Bank of India (RBI) as the regulator. The confidence in the sector has been so eroded by the impact of the AP Act {the Andhra Pradesh Microfinance Institutions (Regulation of Moneylending) Act} that action is long overdue. Even if the AP Act is ultimately repealed, it will likely take years for the sector to recover: For, there are Rs 6,000 crore of outstanding loans to be collected, over nine million women are deemed to be delinquent in the eyes of the credit bureau, and repayment rates have plummeted from near 100 per cent to as low as five per cent in Andhra Pradesh.

What are the shortcomings in the new guidelines?
While we certainly welcome RBI’s recent decision to grant one-year grace period regarding asset qualification provisions, simply buying time at this stage is not what is needed. We must, instead, focus on the root cause of the crises, which is the inability of microfinance institutions to collect outstanding loans in Andhra Pradesh. Furthermore, there are other troubling elements in the guidelines that may have unforeseen consequences: We believe the proposed cap on interest rates and profit margins will have a stifling effect on competition by making it even harder for new micro-lenders to enter the sector. In the past, such competition has driven innovation and ultimately led to market-driven decline in overall interest rates, meaning lower costs for borrowers.

Will you make fresh investments in SHARE to meet the new capital adequacy norms?
The best way for microfinance institutions to meet capital adequacy requirements is to get back to business, to be able to collect outstanding loans in Andhra Pradesh and to start making fresh disbursements. Until microfinance companies are once again able to legally conduct business and serve the poor, no sensible investor will commit further funds to a sector that is so beset with uncertainty caused by the rogue actions of a single state government.

Will consolidating operations of a few large players help them weather the crisis?
Given the severity of the situation, many microfinance companies have been forced to consider a range of alternatives given the threat of write-offs to their entire Andhra Pradesh loan portfolio and the lack of debt funding that has been made available to the sector since the AP Act.

There will almost certainly be a failure of less well-capitalised microfinance firms. Ultimately, no industry consolidation will take place until there is regulatory certainty and microfinance companies are able to conduct normal business to serve the poor.

It is perceived that SHARE’s top management, like in many other micro-lenders, draw astronomical salaries. Will you cut salaries to improve the company’s financials?
The issue of compensation within the microfinance sector has received a great deal of attention. Unfortunately, like many other assertions of the Andhra Pradesh government, these were not always grounded in fact and proper context. We believe senior management compensation should directly reflect performance against objectives.

For microfinance institutions, these objectives extend beyond financial performance alone, and include measures of how well the micro-lender serves its clients. We would, however, fully support the call for all microfinance companies to demonstrate greater transparency in their operations, as well as the highest standards of governance and unswerving adherence to an industry code of conduct.

After debt restructuring, has there been any improvement in SHARE’s financials?
There has been little improvement in the financial health of any microfinance institution with significant exposure in Andhra Pradesh and were forced to enter the Corporate Debt Restructuring process. This mechanism, primarily designed for companies that have caused their own downfall, was supposed to bring much needed relief for microfinance companies. Unfortunately almost six months after the restructuring was finalised, banks continue to be cautious with respect to providing new funds for loans as a result of the regulatory environment.

Will SHARE diversify into other businesses?
SHARE is keen to be a leader in a broader national strategy that reflects a transition from simply providing micro-credit to thinking about financial inclusion for clients. SHARE will continue to innovate and develop products and services that meet clients’ real needs such as group personal loans, insurance and remittance services. In future, products and services may include savings, gold loans, and other customised loan products. The goal will be how to create a scalable and sustainable business within the new regulatory framework.

Do you plan to shift SHARE’s base outside Andhra Pradesh?
We invested in SHARE based on the strength of the management team and their ability to execute their strategy. SHARE already operates in 18 other states, having expanded to meet the needs of the rural poor. Following the AP Act, the needs of the poor have never been greater in Andhra Pradesh so it will continue to be a focus of the company in the short-term. The company’s long-term goal, however, remains to be a leading provider of financial services to the poor across India.

How long do you plan to stay invested in SHARE?
We take a long-term view with all our investments at Legatum. Right now, our primary focus is to support the passage of the MFI Bill in any way we can so that microfinance institutions can hopefully go back to conducting normal daily operations and serving the poor. Only once that happens can investors start thinking about the future.

After the microfinance crisis, how is India perceived as an investment destination for foreign investors?
Foreign investors will continue to pass up investment opportunities in India unless they can see that their investments will be supported by a clear and stable regulatory environment. Since the AP Act was passed, equity investment in the microfinance sector has plummeted from Rs 2,366 crore in 2010 to just Rs 472 crore in 2011. As a significant foreign investor in the Indian capital markets, events like the AP Act give us great cause for concern. Despite India’s enormous potential and thousands of world-class companies, the threat of regulatory risk to investors here cannot be understated. Above all, investors cannot tolerate the uncertainty, which plagues the microfinance sector, threatens its long-term viability, and ultimately diminishes the attractiveness of India as an investment destination.