Analysis of Micro-finance Industry in the Indian Context
with M. S. Sriram, Expert on Micro-finance Industry
The micro-finance (MF) industry came into existence in the early 1980's with formation of self-help groups (SHG) to provide access to credit services to their members. The industry in India has witnessed a tremendous progress over the last 5 years and has achieved a CAGR of 96% on the outstanding portfolio in the same period. In the last 3 decades of evolution of microfinance industry, it has seen a paradigm shift in people’s perception of the industry as an innovative methodology for poverty alleviation to a booming money minting industry. With a crackdown by Andhra Pradesh (AP) on the way the industry operates, the MF industry in the country is faced with stiff challenges ahead. In this interview with M. S. Sriram, an expert in this field, we explore what lies ahead for the micro-finance industry in India.
Growth Issues in the Indian Context
The industry has been growing at a rapid pace since it started in the 80's. Has it reached a saturation level? If not, what is the way forward in the present context?
India is a vast country with tremendous growth potential. MF has not touched a large part of population and geographies it should have touched. Its growth is skewed in favour of the southern part of India and largely in the urban peripheries. However there are large gaps to be filled. Unfortunately the growth not only concentrates on certain geographies, but it also seems to grow through a process of "herding". One micro-finance institution (MFI) enters an area and several follow to capture the same market. This happens because of parameters of efficiency, cost cutting and quick turnaround. Therefore, the overall investment in making the client robust and bankable keeping a longer horizon has possibly not happened. There is scope for growth if the delivery model can be adaptable and client centric.
As the profitability of the industry was established over the years, more and more NGOs have either started a MF arm or have wanted to transform to MFIs. Is the legal framework in India for the transformation from not-for-profit to for-profit sufficiently robust in India?
The legal framework in India is not conducive to "transformation". It need not be. There was a phase when the concept of MF was untested, no capital was flowing and therefore there was a need for people with donor grants to experiment with the idea. For these institutions, transformation became essential because they grew in size and had to become commercial. However, now the proof of concept having been established, there is no reason why the legal framework should allow for transformation. Commercial capital is naturally flowing in and it has to go in the organisational form that is appropriate.. the for profit enterprise.
Micro-finance as a Tool for Social Change
The industry started from the concept of self help groups. No doubt that it has reached millions of poor people in India, but has it brought about poverty alleviation at a larger level?
Poverty alleviation is a claim made by the micro-finance institutions. This is like a banker promising to make a middle class person wealthy by providing enterprise loans. We need to look at micro-finance for what it delivers. It delivers financial services to a certain segment of the population in an innovative way. What the customers do with this service and how they use it is left to their enterprise. Therefore it would be appropriate to say that microfinance performs the limited function of providing a type of financial services in a niche market which was eluding the mainstream financial service providers. It has to be appreciated for this innovation than anything else.
SKS has openly publicized its vision of reaching every poor person in this country. What are the most important barriers in the scalability of operations of MFIs?
The barriers for scalability is basically the diversity. We are dealing with people and people are diverse. Therefore the needs of each household is bound to be unique. The sector can offer certain standardised products and the households will have to adopt those products to their needs. The providers have to appreciate this and offer an array of services that would help the customer. This needs constant feedback, and innovation. Innovation cannot co-exist with scale and standardisation. Therefore it has to be a fine balance between constant innovation and regional scaling.
Currently commercialization of MFI operations is under scrutiny. Does India need to prepare itself better for a new wave of innovation that may happen in the way MFIs operate? Particularly, should there be stricter or lesser regulation on forming a commercial MFI? Are there examples from other countries that may help in defining the course of action for the government and RBI?
The regulatory framework to undertake microfinance as is carried out now is adequate. I do not believe that we need a new framework. However, the players who are in the regulatory space will have to perform their tasks in using the regulatory provisions rather than create a new provision. Most of the MFIs are operating under a regulatory framework of a Non-banking Financial Corporation (NBFC). There are well laid guidelines on how NBFCs should be run including codes for client protection. This needs to be followed. It might be useful to have some code for protection of the borrower, since this is one segment where the borrower could be particularly vulnerable. Apart from this, nothing else needs to be changed in "regulation." However there could be changes in the positive direction that loosens up and encourages players to offer diverse services. There are examples of other countries - Mexico, Bolivia, South Africa, Bangladesh.. however we need to be aware of our context.
What should the reaction of the MF industry be to tackle the crackdown enforced by the government, particularly in AP?
The AP crisis is different. Part of it is to do with the practices of MFIs, part of it is to do with the political situation and equations. MFIs should be deeply aware that when they deal with the poor, they would be watched closely and there is a huge political risk. Therefore it is necessary that they embed themselves as much with the state as possible and participate in the developmental agenda of the State. It is important that they are seen as furthering the cause of the state rather than furthering the cause of investors. This perception is important for carrying out business with the poor. Unfortunately the MFIs have constantly treated the state as a competitor and adversary. The state is a both a player and an arbiter. This role will not change soon. The earlier the MFIs recognise this, the better it would be for their business.
How is the MF industry going to sustain itself with the current situation of sluggish lending by the banks to the MF industry?
If the banks close the tap and the MFIs are unable to sustain themselves, it just proves that they did not have diversified sources of funding. It also shows that the exuberance shown by the investors in the fundamental model was short lived. If the investors in MFIs are so fickle, it possibly is appropriate that it does not survive. However, given that we are several months into the crisis and MFIs are continuing, it possibly shows their maturity in accessing non-conventional markets for sourcing funds.
The micro-finance industry has seen tremendous growth in the last half decade and it should be appreciated for its innovative ways to cater to the marginalized poor people. However, its current region-centric growth leaves a huge scope for MFI to grow in other parts of India. Moreover, it can achieve tremendous growth if it follows a customer-centric flexible model instead of the current standardized product and service model, which acts as a barrier to expand in unknown territories. However, in order to achieve this growth, the expert believes that MFIs should be run only by profit organizations as there has been enough proof of this concept in the past. Also, MFIs should work with the government to gain the support of people and should not treat state actors as competitors.
It is also believed that the industry is adequately regulated and there is no need to bring any new regulation. Instead the regulators should monitor the industry in an effective manner. The expert also believes that the MFIs will come out as mature players after the current crisis.
M.S.Sriram is an expert commentator on the micro-finance industry. A fellow from the Indian Institute of Management, Bangalore, he also holds a PGDRM from Institute of Rural Management, Anand and a B.Com. from Bangalore University.
Apart from being an active consultant to several reputed institutions in the world, he has also authored several research papers, teaching cases, news articles and book chapters.