I had the opportunity to attend the London Microfinance Club meeting last week where the Microfinance_Banana_Skins_2014_-_WEB was launched and discussed. In the past, I have always used the Banana Skins report as a barometer to check if my assessment of risk in the sector is accurate and in line with larger sectoral perceptions. Also, when I was making investments in the microfinance sector, it helped to both reinforce our own monitoring as well as check for new developments.
The last Banana Skins report was published in 2012 and several interesting changes have taken place since then, particularly in the Indian context. For one, microfinance institutions had to deal with a cap on their operational expenses, making it necessary for management to re-look at their operations and see how to do this. Secondly, the Reserve Bank of India has been bringing about several changes in regulations rapidly. This includes allowing NBFC MFIs to act as Business Correspondents for banks, the proposed licensing of payment banks and two new players in the Indian context were given bank licenses: IDFC and Bandhan. This, combined with the fact that a client could not have more than 2 lenders lending to her, should have MFI CEOs worrying about the strategy of their companies, which I find missing. Third, the cap effectively reduced the ROE of institutions resulting in lower equity investments. This raised the question of long term funding and viability of the sector to continue expanding at the same rate.
In the Indian context, the greatest risk, as expected is political interference. The Andhra Pradesh crisis is testimony to what can go wrong if politics and finance are mixed. I continue to wonder what is happening to low income households in the state of AP. How can a system that drives people into the arms of money lenders be possibly more effective in the long run? The one good fall out of the AP crisis, however, is that the Reserve Bank of India has stepped in to regulate microfinance institutions and hopefully prevent the kind of risks that we saw three years ago. What is unusual as a risk is over-indebtedness that continues to rank fairly high in the list. This comes as a surprise because most microfinance institutions in India now have a credit bureau check and do not lend to customers who are already borrowing from two other lenders. There are two things that might be happening here: one, this could be debt from a bank or an informal source like a money lender and therefore, is not quite a risk to the microfinance sector as one might imagine. Two, the borrowing from banks as a third loan might be possible because banks are not using the same credit bureaus as microfinance institutions. Which leads me to wonder if there is a need for a banana skins report for the financial inclusion sector as a whole. Why are we not thinking about the risks to large balance sheets as a result of priority sector lending targets?
A new risk that has been stated in the Indian context is ‘strategy’, which is something that I concur with. However, the absence of long term strategy may not be a soft skill input, as is often thought, but the absence of inadequate long term funding to the sector. If CEOs do not have long term funds, how would they plan for and make investments for the next 5 years or a decade?
One cannot deny the importance of local finance/microfinance institutions as an important mechanism for cash flow smoothing for low income households. Given this importance, it is critical that investors and MFIs begin to think of the gaps in the sector and the long term vision to address some of these challenges.
1) Governance: is it possible to create database of independent directors along with their specific areas of expertise which can be used as a common knowledge base by the sector as a whole?
2) Long term capital: Can banks and financial institutions pool in their CSR funds to create a long term fund for microfinance institutions, which specifically targets aspects like investment in MIS, making systems and processes efficient, investing in data analytics and decision making tools?
3) Common infrastructure: Credit bureaus that are used across financial institutions should be uniform. It would not make sense for banks to follow one set of Credit Bureau data while MFIs use another. There is also a need to have data analytics firms that would help understand product development in a more scientific fashion. This should solve the challenge of over-indebtedness.