Microfinance sector seeks support to tackle its several challenges

Microfinance has shown capability and resilience in every crisis: Demonetisation or Covid-19. Attention to the issues it faces can make the sector even more vibrant

Microfinance plays a crucial role in fostering financial inclusion. It is an industry that supports almost 120-140 million households (through self-help group bank linkage and joint liability group, or JLG, model of lending) and caters to almost half the households: From bottom of the pyramid. The JLG model alone supports around 80 million households, with Rs 4 trillion loans outstanding. 

The sector faces several challenges; an important one is the perception that loans are priced at “usurious” rates. It is a fact that microfinance institutions’ (MFIs) loans have a higher cost than bank loans. Since they borrow money from higher lending institutions, it amounts to double intermediation and hence the pricing will be higher. According to the Reserve Bank of India’s (RBI’s) regulatory norms of 2022, MFIs are allowed to have their own lending policies and pricing. But the central bank has also given a structure for calculating the pricing based on cost of funds, operational cost, risk cost and net margin for an institution. 

Since MFI operation is a ‘feet on street’ model with door-step delivery, the operational cost tends to be higher. Also, microfinance being 100 per cent non-collateral loans, the risk cost is high too. 

Another perception is that the MFI operations are not regulated. The fact is more than 99 per cent of the microfinance portfolio is regulated by the RBI. The new regulatory norms stipulate assessing the income and loan liability of a household. Being an informal sector, with no regular or formal income, the assessment of household income is a challenge. Data gap of loans availed of by a household in Credit Information Bureau complicates credit liability assessment. Some of the entities and loans issued are outside the purview of Credit Information Companies Regulation Act (2015). 

The microfinance sector depends mainly on borrowed funds. Unlike in many other countries in South East Asia, Africa or Latin America, our MFIs are not allowed to mobilise savings from its members. In Bangladesh, the Microfinance Regulatory Organisation allows MFIs to mobilise funds up to 80 per cent of its outstanding loans. The availability of funds and its cost is a challenge to small- and medium-sized MFIs. Similar is the case with regard to availability of growth capital. Earlier, most of the equity funds came from impact and private equity investors. It is limited now. 

The funding is also linked with the rating of MFIs. Since most of them are small, they may not qualify for higher rating as the rating and size of the institutions is correlated. The MFI grading developed by SIDBI can be a more practical one, with better assessment, taking into account the character of MFIs. Microfinance institutions are prone to higher risks. MFIs need to maintain 75 per cent of the total assets as ‘qualifying asset’ or microfinance assets. This amounts to higher concentration risk. 

Microfinance is a human intensive industry with nearly 300,000 employees, of whom 60 per cent are field level staff. The recruitment of the staff, training or skilling them and retaining them is a tough task. The know your customer (KYC) process used for sourcing loan applications is not uniform. As part of the KYC verification, non-banking financial companies used to have Aadhaar earlier. But after a Supreme Court decision in August 2015, Aadhar cannot be the primary proof of identity. This has made MFIs to go for other identity documents like voter card, ration card, PAN card and this impacts the quality of credit underwriting. The sensitiveness of the borrowers to actions by external forces in the form of false promises, organised campaigns and local influencers can disrupt the credit culture causing defaults. 

Although these challenges exist, the MFIs are able to move forward without much hassle. It has shown its capability and resilience after every crisis it faced, be it demonetisation or Covid-19. However, the attention of governments and other stakeholders to some of these issues can make this sector more vibrant. 

The writer is ED & CEO, Sa-Dhan. The views expressed are personal