Microfinance, macro problems?

Is it possible to make money while helping people out of poverty? In the last five years or so, one business — microfinance — seemed to suggest that the answer was yes. Look at the numbers: from merely $12 million in 2003, the market for lending tiny amounts of money mainly to groups of women has grown to more than $7 billion now. And analysts expect this to grow to a staggering $50 billion soon.

It’s easy to understand why. Many people in rural India don’t have access to loans from formal banks. In any case, procedures are cumbersome, paperwork intimidating. That explains why people go to moneylenders, who charge them upwards of 50% for loans. Microfinance, based on a model borrowed from Bangladesh, was supposed to change all that.

Micro-credit institutions would make small loans to groups of women at rates lower than what moneylenders charge. These would go into productive investments and defaults would be kept low because the entire community — or a group of women borrowers — would keep an eye on each other to make sure that the funds were used properly and repayments were on time.

Today, it’s reckoned that women’s selfhelp groups (SHGs) reach about 50 million people. Another 20 million are covered by microfinance institutions (MFIs). That leaves about 100 million people who still rely on moneylenders or relatives for loans. That’s a huge untapped market, which explains why analysts are falling over each other to talk up microfinance.

A few months ago, India’s largest micro-credit company, SKS Microfinance, had a hugely successful listing. But now, the whole micro-credit story seems to be fraying at the edges. And that’s even if you discount the churn at the top in SKS. What’s worrying many people is whether it’s possible to keep poor borrowers happy while growing profits fast enough to keep shareholders smiling as well.

In June, the governments of Andhra Pradesh and Kerala asked MFIs to comply with local rules that regulate the money lending activity. A handful of MFIs are contesting this in court. And last week, Andhra Pradesh passed an ordinance to regulate MFIs, one which stops short of capping interest rates.

These southern states are worried about two things: the interest rates charged by the institutions and the possibility that borrowers could be coerced by goons hired by MFIs to make repayments. Andhra Pradesh has good reasons to worry about micro lending. Numbers from the Reserve Bank of India (RBI) show that over 53% of loans there are sourced from moneylenders. Tamil Nadu follows, with moneylenders accounting for 40% of all borrowings. Moneylenders account for more than 30% of all lending in four more states: Bihar, Manipur, Punjab and Rajasthan.

MFIs borrow from banks at around 12% and lend at anything between 25% and 30%. This can be hugely profitable. The return on assets — a ratio used to measure profitability of financial institutions — is 6.8 for SKS Microfinance; it’s 1.7 for HDFC Bank and 1.1 for SBI. Over the years, profits have grown at a fast clip: in the last two years, earnings per share at SKS shot up by 346% and 59% respectively; they expected to rise to 79% by March 2011.