SKS Microfinance India’s largest microfinance player arrived with a bang with its hugely successful IPO in August. However, the recent sacking of its MD and CEO has opened up a Pandora’s Box that is now threatening to expose the ugly underbelly of the sector which many allege is teeming with players who are no better than moneylenders but have so far been able to operate under the pious garb of poverty eradicators.
People associated with the sector found that most are of the opinion that far from pursuing their so called vision of eradicating poverty and being poor friendly private MFIs are actually in it just for profiteering as they are lending to the poor at interest rates as steep as those charged by money lenders or Pathaani Vyaaj a sobriquet derived from the ruthless moneylenders of Afghan origin who operated during the early 20th century.
Those familiar with the functioning of MFIs point out that the lending model for profit MFIs is not exactly pro-poor. While offering a loan, they quote a 10% flat rate of interest which on the face of it, appears like a good deal. However, there is a catch. This flat rate of interest means that it will not be calculated on reducing balance. It implies that even after the borrower has paid a few installments the interest would still be calculated on the initial sum borrowed and not on the balance loan amount. The result is a (hidden) final rate of interest of 24-30% or even higher of the poor who can barely afford a square meal a day. Microfinance as practiced by MFIs is unethical to the extent that it evades the truth in lending. The high rate of interest is also leading to defaults and fraud. Recently, there has been a spurt in suicides in Andhra Pradesh and Orissa, allegedly due to harassment by MFI agents who started resorting to strong arm tactics to recover loans as chances of default rise. The cases of alleged harassment by MFIs is a result of irresponsible lending. There is high pressure on the staff (or private MFIs) to lend. They have targets to meet and they dump money (on people)
Consider this: The loan outstanding according to the latest estimate by Microfinance Institutions Network (MFIN) the organization of 40 MFIs is about Rs 30,000 crore with about 3 crore poor banking on MFIs for their financial needs. While the four southern states of AP, Tamil Nadu, Karnataka and Kerala account for a chunk of this borrowing West Bengal and Orissa too have rural poor relying on MFIs. Besides the sector is also on an up stick in UP and Haryana.
We believe there is a right way to do microfinance and we have been practicing it over the past 13 years with not a single case of unethical practice against us. The company clearly communicates to the borrowers that though the loan was at a flat rate of 12.5% it effectively works out to over 26% because there is an extraordinarily high cost of doing microfinance. Since most of its lenders don’t understand rate of interest SKS agents communicate to its borrower how much they have to pay in terms of rupees per week.
Akula whose company is the largest MFI in the country with over 73 lakh customers also denies the possibility of its staff using strong arm tactics or misleading borrowers. Instead he blames the bad name that the sector is getting to new MFIs jumping into the fray sensing a lucrative business.
Of course eradicating poverty through the MFI route, for some is a lucrative business. The IPO document by SKS disclosed that Gurumani was drawing annual salary of Rs 1.5 crore an equal amount or more as performance bonus, and also a one time bonus of Rs 1 crore. Akula is entitled to up to 1% of SKS’s net profit, in addition to ESOPs.
Not surprisingly the success of some of the MFIs and the mega listing of SKS recently has stunned even seasoned bankers. When asked about the success of the MFI business in India, during a recent interview with TOI, SBI chairman even he was surprised by their numbers. He wanted to go deeper into their finances and business model to understand how MFIs which borrow form banks including SBI can make profits which these very banks can’t make. After all, like mobile tariff plans, no financial product by patents and IPRs and the uniqueness of any new and lucrative one cannot last for more than 24 hours.
The problems seem to be with the business models, and not the approach. In India, there are three kinds of MFIs: The government supported self help groups, non profit NGOs and the private for profit firms. While private MFIs say that the smaller entities have earned the sector a bad name, social workers and industry veterans at the grassroots say that bigger players with bigger targets have led to such incidents. In many instances, multiple MFIs lend to the same clients, resulting in repayment problems and eventually to defaults.