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Archive for January, 2011

India Regulator Proposes Radical Microfinance Reforms

January 22nd, 2011

This week, the Reserve Bank of India (India’s central banking regulator) proposed significant new microfinance regulations which would impact the majority of microfinance lending in India.

There are many new regulation recommendations which they hope to have adopted as early as April 1, 2011. Here are a few highlights:

Create a new non-banking financial company category called NBFC-MFI with new regulations
Max microloan size of RS 25,000 (~US$500)
Minimum 12 months duration for loans under RS 15,000 (~US$300) and 24 months for loans above that
Each borrower chooses whether they make weekly, bi-weekly or monthly repayments
Only one joint liability group (or self-help group) per borrower and max of 2 loans per borrower
Interest rate cap of 10-12% margin over cost of capital
Minimum 90% of assets must be for microloans and at least 75% of these loans must be for business purposes
Limitation on loan-related revenue to interest, loan insurance (must be optional) and max 1% loan origination fee
NBFC-MFI must have minimum capitalization of RS 15 crore (~US$3m) up from RS 2 crore (US$500k)
Minimum capital adequacy of 15% up from 12% and with stricter definitions of capital basis
Consideration of appointing local bank officials or political appointees as arbitrators in loan repayment issues

The RBI is attempting to create a national regulatory framework which supersedes specific India state-based legislation like we have seen in Andra Pradesh. Overall, I think national banking regulation with an independent regulator is positive for the poor in India.

It is going to be interesting to see what the reaction to this proposal is from the microfinance industry. Typically, this type of legislation is generally embraced by the large, established players because it creates more certainty and they have the resources and sophistication to leverage this to grow their market share at the expense of the smaller players. Since in microfinance scale often benefits operational efficiencies, it is easier for the larger players to manage their profit optimization under regulations with price caps.

So, I would expect that if this is implemented it would have the following results:

Slower growth in access to microfinance. The report notes that microfinance and self-help group market penetration is < 1% in all regions of India except the south where is is 3.4%. Most MFIs will have to slow down growth as interest rate margin cap discourages forward investing. Fewer new MFIs will start because of the higher initial costs and higher operating subsidy required before getting to large scale. The interest margin cap will also dramatically slow growth in areas which are currently the most underserved — i.e. higher poverty and lower density areas of India where cost of operations are higher and revenue per client is lower (due to lower loan sizes).
Significant industry consolidation. The big, at-scale players will gobble up many of the smaller players or the smaller players may just fold. This is not necessarily good for borrowers as it reduces competition and some of the higher value add approaches of these smaller players.
Less financial product innovation. The strict requirements are going to stall the development of better quality (from borrower perspective) financial products outside of the one-size-fits-all business microloan product. This includes more business-cycle friendly working capital loans, housing loans, various insurance products, savings-type products, etc. And % of revenue restrictions will prevent MFIs from distributing 3rd party products as well.
More populist politicalization of financial products for poor. This concept of appointing a local ombudsman (for loan repayment arbitration) from the local business or political elite has predictable results — corruption, political posturing and ultimately higher costs for MFIs (which can’t be passed along to borrowers).

Do you agree with my observations and/or conclusions? Please add additional insights and thoughts in comments.

UPDATE: Here are additional responses to RBI recommendations:

Disinformation on Microfinance Hurts the Poor

January 17th, 2011

Muhammad Yunus’ OpEd piece in Friday’s New York Times entitled Sacrificing Microcredit for Megaprofits is plainly and simply factually challenged. Yunus advocates for changes which will result in fewer of the working poor receiving quality financial services and those who do will pay more for those services.

[NOTE: Those of you who read my blog know that I have been a big fan of Yunus and his innovative contributions to the microfinance sector. But, more recently he has instigated a fierce vendetta against some of the strongest innovators in the microfinance space which undermines his credibility as an advocate for the poor. I honestly don't know why he is doing this. See references at end of this post.]

Bad Facts Lead to Bad Conclusions

Yunus has misrepresented facts which leads him to wrong and harmful conclusions. Here are some examples:

“[commercial microfinance] banks needed to raise interest rates.” False. Microcredit interest rates for well-run, commercial microfinance operations are often lower than for non-profit microfinance operators. What’s even more interesting is the fact that SKS Microfinance’s microloan interest rate is 24.55% APR vs. Grameen Bank’s interest rate of 24.36%-26.87% APR despite SKS having a much higher cost of capital since it can’t accept savings.
“borrowers [in India] came to believe lenders were taking advantage of them, and stopped repaying their loans.” False. Populist politicians created falsehoods about microcredit loans leading to borrower suicides and enacted laws which prevented borrowers from repaying. Fact: microcredit borrowers were 5-10x less likely to commit suicide then the general population.
“[commercial microfinance operators] treat microcredit as an ordinary profit-maximizing business.” False. Neither SKS nor Compartamos have operated in this way. In fact, they have always been managed as client-focused, sustainable businesses. See letter to editor below.
“Furthermore, it means commercial microcredit institutions are subject to demands for ever-increasing profits, which can only come in the form of higher interest rates charged to the poor, defeating the very purpose of the loans.” Sounds credible, but too simplistic. Just about every growth business achieves higher profits through scale and additional services, not higher prices. Think Walmart, Google, Bharti or … SKS.

Here is a letter that Michael Chu, a respected microfinance expert submitted to the NY Times in response to Yunus’ OpEd:

Sunday, January 16, 2011 5:10 PM
To: letters@nytimes.com
Subject: Muhammad Yunus Op-Ed

To the Editor of the New York Times:

Having served in the front lines of microfinance for two decades, I found Muhammad Yunus attack on commercial microfinance (Op-Ed, January 14, “Sacrificing Microcredit for Megaprofits”) dangerously misleading at a time when the industry most needs clarity. His accusation that commercial microfinance inevitably leads to higher prices is plain wrong. Since its IPO in 2007, Mexico’s Compartamos Banco, which I am proud to have helped establish, has actually been reducing its interest rate (and, by the way, tripling its active clients.) Yet, Compartamos has continued reporting outstanding financial returns. How is that possible? Simple: cost structures can be lowered, assets more efficiently managed and capital structures optimized. As any able manager knows, price is only one, and often the crudest, lever of profit.

But even more damaging, Yunus calls for government-mandated interest rate caps. This ignores the Latin American experience, where such short-sighted measures have always made reaching the poorest, and their smaller-sized loans, not more but less viable. Intense, open competition has been the most reliable way to ensure that the lowest priced loans reach the largest number of the poor in the shortest amount of time. That is why Bolivia has the lowest microfinance rates in the continent. And for that you need a healthy, commercial industry serving the poor.

Michael Chu
Senior Lecturer
Harvard Business School

Additional related resources: