Microfinance sector poised to grow robustly in five years

The microfinance sector, which is seen as a vehicle of financial inclusion, has seen a boom over the past year as government has laid more emphasis on financial inclusion. The sector is expected to grow robustly in the next few years as large players consolidate their position in their market. 

Schemes like Jan-Dhan Yojna and MUDRA Bank, which are specifically targeting those at the bottom of the pyramid, have come to define funding in the financial inclusion space. Alteration of rules by the RBI and introduction of new business models after the microfinance crisis in Andhra Pradesh have transformed MFIs into profit-making institutions while ensuring that the system works efficiently without any major glitches. The sector's outreach increased over 23 per cent and gross loan portfolio grew 42 per cent annually in FY14. 

"After the crisis, RBI has handled the sector very vigilantly, carefully and very thoughtfully. The kind of policy and intervention that it brought in to satisfy all the critics of microfinance is really commendable. It gave a framework, brought in a different setup for NBFC-MFIs and now it is regularly reviewing the quality as per the requirement and the fact that Bandhan got a banking licence and RBI came up with the small bank concept, encouraging MFIs to convert themselves, shows that RBI is serious about the sector,” said Dibyajyoti Pattnaik, director at Annapurna Microfinance Pvt. Ltd.

The profitability of the sector has declined from the phenomenal growth rates witnessed till the AP crisis. Microfinance sector is expected to grow at 24 per cent annually over FY15-19, said India Ratings and Research (Ind-Ra) in a report released on Wednesday.

Highlighting the success of MFIs post the AP crisis, the agency pointed out that the sector is growing and attracting banks and private equity (PE) investors again.

The report highlighted the steps taken by banks and the government after the AP debacle. "The growth of MFIs is sustainable in view of interest rate and margin caps, defined recovery procedures, caps on borrower indebtedness and credit check procedures," Ind-Ra said. 

While the report pointed to a strong medium-term growth with the MFI sector requiring an equity infusion of Rs 27 billion over FY15-FY19, it emphasised the fact that the current RBI guidelines may have a larger impact in limiting the growth of existing MFIs in their current form. 

"The growth expectations are constrained by the evolution of differentiated banking, banking penetration through the BC model and government initiatives such as Jan-Dhan and the impact of these models," Ind-Ra added.

Ind-Ra believes that competition from Jan-Dhan-driven bank credit, given that banks would provide overdraft facility to account holders, may hamper the growth of MFIs as loan demands take a hit.  Also government’s measures such as appointing BCs at high speed, trying to increase efficiency and transaction throughput of the BC model and permitting diversified banks may achieve sufficient traction only by FY19 for financial inclusion and pose competition to MFIs. The report also acknowledges that the sector still has a growth potential to transform itself if MFIs can convert themselves to small banks or by adopting the BC model whereby MFIs can move from group lending to individual lending to satisfy the need of borrowers who have graduated in the value chain.  

While Annapurna Microfinance’s Pattnaik believes that the MFI sector need to transform itself to accommodate BCs and apply for small banks, he holds a contrary view believing that initiatives launched by the government may eventually help the MFI sector. "I don't see competition; rather I see these as complementing one another as the space is so large. There is still space for innovation and because there is a large population of the country is out of the formal financial network, the only way forward would be through microfinance," he said. 

Another expectation in the industry is that the market would consolidate in the coming months. The MFI sector has seen impressive investment flow over the last quarter with the big MFIs securing funding. As big MFIs get more capital infusion, they are expected to expand their reach thereby eliminating small players from the market. As the MFI sector evolves over time expectations are that only a few big players would survive as the small MFIs get wiped out. 

The report by Ind-Ra points to this contingency indicating that RBI rules have transformed the policy to favour the incumbents. The report indicates that the gross loan portfolio of large MFIs has increased from 79.6 per cent in FY14 to 83.2 per cent in Q2 FY15 while that of small players decreased from 3.4 per cent to 2.6 per cent for the corresponding period. 

"We expect mid- and large-sized MFIs, especially with strong holds in certain areas, to continue to operate profitably for the medium term. Many small MFIs may have to merge with mid- or large-sized MFIs or adopt the BC model to remain profitable. Small MFIs may also face difficulty in obtaining bank funding, securitisation deals or attract PE and hence this raises questions on their long-term viability unless they have specific niches or operate in a particular state. This may expose them to state specific legislation risk,” Ind-Ra stated. 

The report also mentioned the high barriers to entry which has constrained the MFI sector. The report mentioned that incremental cost for a new entrant to find suitable members and foster credit behaviour is high and therefore a deterrent. There have been only two new entrants among NBFC-MFIs since 2011—Svatantra Microfin Pvt Ltd of Birla group which started operations in March 2013 and Altura Financial Services Ltd, registered in Delhi in FY14. 

The view is also shared by Pattnaik who believes that there would consolidation where large players would eventually evolve, but still there would be space for boutique MFIs who would specialise in specific products or areas. 

The prospects for the MFI sector seem brighter as it evolves and transforms itself over the next few years, while expectations are that the market would consolidate in the coming months and that efficiency of the sector is set to improve. MFI institutions coupled with schemes like Jan-Dhan and MUDRA would help the government further its growth agenda as penetration of credit improves. 

(Edited by Joby Puthuparampil Johnson)

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