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The fate of microfinance

Microfinance companies have rebounded strongly after hitting a rough patch in 2011. Their future, however, remains in doubt

The microfinance industry (MFI) is growing at a scorching pace. Microfinance Institutions Network (MFIN) reported an 84 per cent increase in the gross loan portfolio (GLP) of the industry over the previous year, to ₹53,000 crore. This does not include the figures for Bandhan, which converted into a bank over the course of the year. If those were included, the figures would be higher. For an industry that almost died over 2011-13, the comeback has been impressive.

The reported figures of 'portfolio at risk' - outstanding loan book where interest payments are behind schedule - are miniscule, at less than 1 per cent for the industry (figure 1). The industry leader SKS (now renamed as Bharat Financial Inclusion) reported a return on equity (RoE) of close to 25 per cent (March 2016). Investors are willing to pay 9.5 times book value for the stock. This can only be justified if high growth rates (over 30 per cent) can sustain over at least five-eight years, with stable RoE and asset quality of lending. Clearly, there is high belief in the story.

Can the industry continue to grow for a long time?

Estimates of the size of the microfinance market by borrowers vary. India has approximately 24.7 crore households. One estimate could simply be that 40 per cent of these households, i.e. ten crore households, do not have access to the formal banking system. The MFI industry reports approximately 3.5 crore accounts. Assuming no overlap (and this is not likely to be true), this would mean that penetration is only 35 per cent. Assuming a constant portfolio size, the industry could reach 76 per cent penetration in three years if it were to continue with mere 30 per cent growth (significantly lower than the 84 per cent registered last year). Perhaps the estimates of growth potential are overstated.

GLP estimates assume a market size between ₹2,50,000 crore and ₹3,50,000 crore (figure 2). The industry reports an average loan size of about ₹18,000 per borrower. If everyone of the ten crore households with no access to formal banking were to borrow that amount, the GLP could be ₹1,80,000 crore. MFIN reported ₹53,000 crore as the GLP at the end of the previous fiscal. Is the market really so underserved?

The unbanked sector is currently being serviced by a large variety of players - self-help groups (SHGs) and banks, too, have a mandate of financial inclusion. The government's initiative of Mudra Bank is also in the same direction, though it uses banking and the microfinance channel to give out loans. Eliminating duplication across MFIs and Mudra Bank (but not commercial banks), it would appear that the outstanding loan book to this segment is already ₹212 lakh crore - not the ₹53,000 crore.
Gold-loan companies, too, lend money to the same segment, with largely the same end use. If one were to eliminate loans by banks (on basis that these are accounted for in the Mudra Bank refinancing) but add gold loans (only by top eight lenders), GLP would remain at ₹213 lakh crore. This implies that outstanding loans already have penetration indicative of full demand. The loan-growth numbers, however, do not show signs of abating.

Another issue is end-use classification. The MFI industry reports that 80 per cent of loans are income generating. It appears that we have ten crore small entrepreneurs (when taking all sources of loans). If that is indeed the case, it is a cause for huge celebration, but we should not then be worried about deep poverty.

Credit costs - unsustainable

The current default rates for the industry are less than 1 per cent. Putting this in context, all other forms of lending that are 'secured' have been between 2 and 5 per cent default rates. If one were to go by recent numbers of public-sector banks, corporate lending has double-digit defaults, when it is almost always fully secured. However, magically, the 'sub-prime' segment of India suffers from no such delinquency. The amazing part is that SHGs do have a problem (figure 3). So it's just that MFIs seem to get all the best clients across the country.

Over 2011-13, the industry saw almost a million customers defaulting in the state of Andhra Pradesh - perhaps the single largest default in the world at one location. MFIN's survey examining the reason for default was illuminating: over 60 per cent of those who defaulted admitted that without new loans, the willingness to repay did not exist (figure 4).

Industry participants, expectedly, deny this, pointing to a large volume of borrowers who have repaid and not borrowed again. What is pertinent is to focus on those who continue to borrow and with increasing amounts. Importantly, the industry is 'improving' its yield per employee. As per MFIN, the typical loan officer caters to 603 clients and manages a portfolio of ₹0.99 crore. If you keep in mind that clients are to be met perhaps weekly, the numbers will start to look startling. Only if clients are long-term clients with increasing portfolio size can these 'productivity' numbers be achieved.

When money is cheap, risks don't count

Clearly, at an average of six times book value for listed MFIs, the stock prices reflect the market's confidence on extended growth at high yields and robust asset quality. As discussed above, each of these appears to be optimistic. It is not possible to say if and when the music will stop, so it is entirely possible that the stock prices will continue to rise. Experience, however, suggests that when exuberance marks a sector, long-term returns are likely to suffer.

This article first appeared in the August 2016 issue of Wealth Insight.

Anand Tandon is an independent analyst.