Microfinance in India Growing Fast Again: Should We Be Concerned?

In India there is much talk about the growth of microfinance possibly causing a repeat of the 2010 crisis, when the sector grew fast and there were allegations that multiple lending led to the overleveraging of clients. Having largely recovered from the 2010 crisis, the growth of microfinance today creates a new set of challenges. The findings of the recently released Inclusive Finance India Report 2016 suggest that these challenges should be addressed soon.

Growth of debt is concentrated in a few client segments

There is a consensus based on interviews conducted for the report that the growth of microfinance is aggressive, putting strain on the credit officers. The data on regulated microfinance institutions (MFIs) that submitted their numbers to the Microfinance Institutions Network indicates that over the past year, loan portfolios grew by 84 percent and loan disbursements grew 45 percent. In comparison, consider these numbers:

• 22 percent growth in branches
• 38 percent growth in staff strength
• 44 percent growth in number of clients
• 45 percent growth in number of loans

Together, these numbers indicate that the loan portfolio grew at a substantially higher rate than branches, employees or clients. This means more debt within the same client segments, leading to overleveraging, which could end up in a large-scale default.

Growth of loans is heavily concentrated in a few MFIs, and staff load is increasing

In addition, 22 of 71 registered MFIs have a portfolio of more than $73 million, and these represent 90 percent of the sector on all parameters. The typical employee at one of these providers is possibly managing more clients with larger loans, which leads to a larger concern about the quality of the growing portfolio.

How could these challenges play out?

Compared to 2010, there are better customer protection measures in place: caps on loan size, repayment frequency, tenor, margins and lending rates. Also, the MFIs report loans to credit bureaus and use credit reports in disbursement decisions. Due to MFIs’ aggressive growth targets, however, growth is being pushed in areas with limited debt absorption capacity. These include areas with limited credit off-take, little urbanisation, thin diversification in non-farm activities, and no robust banking system.

As the figures above show, India is seeing a concentration of loan portfolios across a modestly expanding branch network and rising loan amounts. All of this suggests some serious pockets of concentration risks for MFIs. The data point to three possible scenarios:

• Stress in a given MFI because of excessive growth. If large defaults are in a single MFI, the contagion could be managed. If the MFI is systemically important and its products are difficult to differentiate, then the problem might spread to other MFIs.
• Stress in isolated geographies. In 2006, there were isolated incidents of default and stress in Kolar, Krishna and Nizamabad districts. They were brought under control, but they were precursors of the 2010 crisis. Any instance of regionally focused stress events should ring alarm bells.
• Stress in a geographical area spreads with a domino effect. Uttar Pradesh province, which is seeing aggressive growth and anecdotal reports of stress, will have elections soon. Any stress-induced crisis there would likely have wider consequences.

Worry, but don’t panic

While there are worries, there might not be cause for panic. For instance, Bengaluru district has the highest portfolio, but as it subsumes the large city of Bengaluru, there are opportunities to lend for diversified livelihoods. Stress represents the ability to cope and changes contextually. The loan size of $400 in Bengaluru is easier to absorb than in remote areas.

A paper issued by Microfinance Institutions Network flagged issues that are causing stress:

• Ambitious targets for field staff in areas of over penetration and concentration
• Undue influence exerted by members and leaders due to excessive reliance on them
• Inadequate time spent by MFI staff on compulsory group training
• Proxy and ghost clients

India’s newspapers report debt stress from eastern Uttar Pradesh, Madhya Pradesh, Chattisgarh and Jharkhand provinces. Interestingly, these reports do not match the list of districts that have the largest MFI exposure, suggesting that concentration may be in areas with greater capacity to absorb debt. For example, the district of Azamgarh in Uttar Pradesh was featured as a debt stress area in news articles but does not feature in the top 100 districts in terms of concentration. However, the district has reported incidents that are flagged by the Microfinance Institutions Network. These anecdotal incidents, plus instances such as suicides or attempted suicides due to indebtedness and coercive recovery practices, obstruction by ring leaders, mass default, or the closure of branches by government officials, could snowball into a crisis.

A crisis could be averted if the MFI sector investigates such instances and takes measures to prevent them from spreading. MFIs, in particular, should be concerned about reputational risk. For instance, the data in the Inclusive Finance India Report 2016 is only from regulated MFIs; however, self-help group programs exist alongside providers regulated by the state law (co-ops, nidhis, chitfunds). Some providers pretend to be mainstream but are unincorporated. Any negative news about them is also going to affect the regulated MFIs, so it is important for regulated MFIs to demonstrate superior practices that differentiate themselves from the others.

Do MFIs have manageable default levels in spite of the overall stress in the banking sector, continuous droughts across the country, and now demonetisation? The microfinance sector is having a dream run: great valuations, two successful IPOs and eight new small finance banks. Is this euphoria going to last?

The microfinance sector should now be careful and pause to ensure that it does. Slowing down, pausing, and taking stock of the negatives is important. Otherwise, they could have a far-reaching effect.