How to fix flaws in the present microfinance model

How to fix flaws in the present microfinance model

As Basix plunged into the painful, slow, yet robust livelihood matrix, its contemporaries like Spandana Sphoorthy Financial, Share Microfin and SKS Microfinance flogged the typical touch-and-go method of loan disbursal and raced past Basix.

In 12 years, SKS, with its ‘acceleration model’ , offering highly standardised loan products of around Rs 12,000, to be repaid in 50 equal weekly instalments, acquired 7 million clients. Basix, by comparison, is at 1.5 million. Grameen Bank , set up by Muhammed Yunus, took three decades to reach out to 7 million Bangladeshis.

Vikram Akula, SKS founder, has always maintained: “There is no need to tutor the poor, they are smart enough to organise their lives.” It is now beginning to become clear that the SKS model of microfinance, with its heightened emphasis on rapid scale and high profitability, is flailing. Worse, Indian microfinance has been shying away from outcome studies. Impact measurement tools like the Progress out of Poverty Index (PPI) are largely ignored.

“As MFIs scale up, grow and make profits, shareholders shouldn’t be the only ones to benefit,” says Samit Ghosh of the Bangalore-based Ujjivan Financial Services. Ujjivan, in 2009-10 , its very first year of making profits, dropped interest rates on loans from 24.5% to 22%, one of the first MFIs to do so along with the Kolkata-based Bandhan.

The profit-maximisation breed – and a large section of MFIs, overtly or covertly, yearn to be one – have hit a roadblock, as can be seen by the turmoil within the sector. These MFIs are under a cloud. And for good reason.

Take, for instance return on assets (RoA), which indicates how much profit a company generates from each rupee in assets. The RoA of Spandana was a stupendous 8.99% in 2009; it’s 4.96% for SKS and a modest 3.12% for Basix. For a sector that sets great store on serving the poor, the pursuit of extraordinary returns is inexplicable.

“When dealing with the poor, boards of MFIs should decide what constitutes a reasonable profit. Good governance demands a laxman rekha,” says N Srinivasan, chairman of the US-based coalition Microfinance Transparency (MFT). Mahajan agrees. “Such RoAs in microfinance are embarrassing, it’s unjustifiable. It’s four times the returns even a Citibank would have made in its peak profit-making days,” he exclaims.

It’s not only profits that cause concern. Take, for instance, transparency in interest rates charged. In the absence of a Truth-in-Lending Act, as prevalent in the EU and US, the Indian microfinance client is not really aware of the ‘effective interest rate’ he or she is paying. The difference in what is stated and what is extracted can be huge indeed.

A few years ago, Chuck Waterfield of MFT studied the interest rates charged by Mexico’s Banco Compartamos, the first MFI in the world to go public. Compartamos advertises its loans as a 4% interest per month product. Chuck examined the quaint manner in which Compartamos computes its interest rate. He also incorporated all fees, commissions and taxes it charged, and arrived at a figure of 129%! This is the interest rate a Compartamos client was actually paying.

What is the Indian scenario? There is no systematic data collation by the industry. Effective interest rates (EIRs) or annual percentage rates (APRs) are unknown, although it is agreed they may not be as usurious as Compartamos. “Product pricing and overall transparency among MFIs is an issue that needs to be addressed,” concedes Sanjay Sinha, managing director, Micro-Credit Ratings International (M-CRIL).

Srinivasan goes even further. “Even the 99% repayment rate claimed by most MFIs is a myth, an illusion,” he insists. “It’s too good to be true.” Portfolio audits of MFIs, conducted by a few mainstream banks lending to them, indicate the data offered and the ground reality differ. How deep the rot is, only those engaged in the exercise would know.

These and numerous other distortions linked to untrammelled MFI growth – relaxing of controls to gain numbers, frauds at centre-head levels, loss of focus, design flaws, lack of transparency and consequent ad-hoc governmental intervention – are beginning to rear their heads.

Unnervingly, these were the typical signs betrayed by Latin American countries. The sheer pace of growth has overwhelmed scores of Latin American MFIs and may have gone belly up. “Here too, systems are apparently not holding up to match growth,” says Sinha. Over a 100 MFIs have failed in Latin America. “We have to learn from the Latin American experience,” says Ujjivan’s Ghosh.