I attended a talk by Vijay Mahajan of BASIX organized by Manthan in Hyderabad last evening. Apart from being one of the pioneers of microfinance in India, and I hasten to clarify that BASIX provides microfinance as opposed to just micro-credit, he is also the president of the Microfinance Institutions Network (MFIN). He thus represents not just his own organization, but is in the acutely uncomfortable position of having to answer for the Microfinance Industry as a whole. I am going to take the liberty of highlighting what I felt were the most interesting aspects of his talk and the discussion which followed. I will try to be as faithful to my memory of the talk as possible, and I hope you will forgive any lapses.

Mr. Mahajan began with an overview of what microfinance is, how it functions, and a basic look at the different kinds of microfinance models in operation before addressing the causes and nature of the current crisis in Andhra Pradesh. Private microfinance institutions (MFIs) in the state uses a joint liability model similar to the one pioneered by the Grameen Bank in Bangladesh, borrowing from banks and then sub-lending this money to their clients, while the government supported Self-Help-Group (SHG)model facilitates a linkage between womens’ groups and the banks directly. Aside from the structural differences inherent, the SHG-Bank Linkage  model according to Mahajan has relied on government and foreign aid in order to achieve operational break-even. NABARD’s initially contributed $22,000 in 1987 to the Mysore Resettlement and Development Agency (MYRADA) and a further $20 million from NABARD, the Reserve Bank and 11 commercial banks went into setting up a fund called the Microfinance Development Fund targetted at scaling up the SHG model across the country. Mr Mahajan suggested that a some of this money along with loans obtained from the World Bank has been diverted to subsidizing interest rates and propping up portfolios where repaymement rates have dropped to 70%. If we are to take him at his word, then the SHG model does not at present offer a viable alternative to private microfinance, whose worst critics cannot accuse it of non-viability. However the most serious charge Mr Mahajan levelled against the state government was to suggest that it has undermined the integrity and viability of SHG initiative, subverting the system to strengthen vote banks through indiscriminate loan waivers which could disrupt the financial discipline of borrowers, making lending to the poor an even more difficult proposition.  

One of the most popular debates in microfinance is the justifiability of the prevailing interest rates that range typically between 24%  and 30% . The argument is that MFIs source loans from banks at about 12% interest, and the mark-up is attributed to the operating cost of reaching finance to the clients doorstep. As an MFI increases the size of its portfolio, cost per client declines, but 24% on a declining balance has become the industry stanadard. To put this in perspective Mr Mahajan cited a CGAP study which estimated that the transaction cost involved for an individual from a village who wants to access a bank loan directly is about 16.8%. A bank loan therefore ends up costing 12% + 16.8% = 28.8%.

More than interest rate, it was the entry of private equity capital into what had thus far been considered a non-profit sector, that led to raised eyebrows. Mr Mahajan explained that banks lend to MFIs on the basis of something called Capital Adequacy Ratio (CAR), where the MFI must have assets worth a certain percentage of their loan portfolio in order access loans. In India this is about 15%. As an MFI expands, it is becomes necessary to expand their stock of capital in order to continue to operate, and if your loan portfolio is close to $1 billion as in the case of SKS, the $150 million required to fulfil the ratio is most easily sourced from the private equity market. Mr Mahajan argued that the link between private equity and microfinance is essential if the industry is to provide services to every potential client in the country.   

The injection of private equity capital into microfinance does more than just allow MFIs to access a larger client base. It also brings with it a need to be more profitable, and signals a definite shift in the identity of microfinance. Mr Mahajan suggested that this shift in image like beauty, lies in the eyes of the beholder, and that microfinance is an example of a social enterprise, where methods from the world of for-profit business can be used to serve a social need.

 Thus far I have tried to represent the views put forward by Mr Mahajan in yesterday’s speech which I found both compelling and insightful. He talked for some time about how greed and indiscriminate lending in order to swell portfolio size has contributed to the current crisis, but said that shutting down microfinance would constitute throwing the baby out with the bathwater. I would appreciate any reactions to his appeal, and will discuss my own  reactions in my next post.