Microfinance in India has been rapidly growing over the past few years. Having financial inclusion as a significant policy target, microfinance has grabbed center stage as a promising conduit for providing financial services to underprivileged or unbanked sections of the population. But, there is a fear that the growth of microfinance companies can cause a repeat of the 2010 crisis when microfinance was at its peak, and there were reports of multiple lending that led to overleveraging of clients.
The growth of microfinance in India has brought a new set of challenges. The findings of the Inclusive Finance India Report 2016 outline the challenges the microfinance sector faces and suggest they should be addressed before it is too late.
Here are some of the concerns that have a consensus on:
There is a growing consensus on the recent report that the growth in microfinance has been aggressive. The findings on regulated microfinance institutions (MFIs) indicate that debt growth is concentrated in just a few client segments. It shows that loan portfolios have grown by 84% over the last few years and loan disbursement by 45%. The below numbers offer a better sight in comparison:
- Growth in branches – 22%
- Growth in staff strength – 38%
- Growth in the number of clients – 44%
- Growth in the number of loans – 45%
Based on the numbers mentioned above, one can conclude that the loan portfolio has grown at a higher rate than employed, clients, or branches. It is an indication of more debt with the same client segments. It could lead to overleveraging and potentially end up in a large-scale default.
Consequences of such challenges
Compared to the previous crisis induced by microfinance companies, better customer protection measures are in place now. For instance, there are caps on loan size, loan tenure, repayment frequency, margins, and lending rates. Also, microfinance companies report loans to the Credit Bureau of India and consider credit score/credit reports before disbursing loans.
However, due to aggressive growth targets of microfinance in India, microfinance is pushed in areas with limited credit take-off, little urbanization, no robust banking system, and thin diversification in non-farm activities. These areas have limited debt absorption capacity. Due to the said reasons, there is a concentration of loan portfolios among the modestly expanding branch network and increased loan amounts. The data indicates some pockets of concentration risk for microfinance institutions in India.
Here are the possible scenarios:
- Excessive growth may have stress in a given microfinance institution. If loan defaults are in one microfinance company, the contagion can be managed. Still, if the microfinance company is systematically crucial and its financial products are difficult to differentiate, other MFIs might also see a negative impact.
- There may be stress in isolated geographies. For instance, places such as Kolar, Krishna, and Nizamabad districts could see incidents of defaults and stress as it had occurred in the 2010 crisis.
- The defaults and stress in geographical areas could spread with a domino effect. For instance, states with aggressive growth with upcoming elections can have wider consequences.
A matter of concern, not panic
These challenges are more a matter of concern than panic. For instance, the Bangalore district has the highest loan portfolio. However, it is a part of the large city of Bangalore, meaning that there are more chances to lend for diversified livelihoods. A large loan size will likely be absorbed in metropolitan cities such as Bangalore than in remote or rural areas.
There have been several reports on debt stress from states like Uttar Pradesh, Madhya Pradesh, Chattisgarh, Jharkhand, etc. For example, the incidents coming into the light are suicides or attempted suicides due to indebtedness and coercive recovery practices, mass default, obstruction by ring leaders, or the closure of branches by the government. These anecdotal incidents could snowball into a crisis.
The upside is that it can be averted if microfinance in India investigates such incidents and takes serious prevention measures. The MFIs could be more concerned about reputation risk. For instance, the findings in the report are from the regulated MFIs. But, there are self-help group programs that exist alongside providers which are regulated by the state law. Any negative news about them will likely affect the regulated microfinance institutions. So, regulated MFIs must demonstrate practices that differentiate them from others.
The microfinance sector should be mindful of the said challenges. It is high to slow down, pause, and take stock of the negatives. This way, they stand a chance to address issues that could have a far-reaching effect.