The Law of Evolution- Survival of the Largest ?

As the central bank in its pursuit of achieving 100% financial inclusion keeps commissioning various committees, the landscape new age MFIs operate in is getting more and more dynamic. Well, what do we have today? –the recommendations made by V. K. Sharma Committee ( V K Sharma is the senior most executive director and the favorite to succeed Usha Thorat as the deputy governor at RBI).

In November 2009, a Working Group was constituted by The Reserve Bank of India under the Chairmanship of Mr. V. K. Sharma to examine the pros and cons of the Priority Sector Lending Certificates (recommendations about which were made by the Committee on Financial Sector Reforms, chaired by Dr. Raghuram G. Rajan), and to make recommendations on introduction and trading of the PSLCs in the open market. Later, RBI in its 2010-11 monetary policy report expanded the scope of the working group and mandated them to review the pros and cons of inclusion of bank lending to micro-finance institutions (MFIs) under priority sector lending. This is where the problem started 🙂 . The group was supposed to submit its report by June 2010, which has not yet happened. The group however has submitted a draft report on its findings and recommendations (ET report)

The recommendations as reported are-

 Bank’s exposure to Non-Banking Finance Company (NBFCs), having priority sector status should be withdrawn.

 The phase out period should be orderly and therefore should be allowed up to 31st March, 2012.

Now, we will try to see what could be the implications if the recommendations made are endorsed by the apex bank in its entirety.

The committee says since it could not be ascertained whether the loans extended to MFIs under PSL reach the poor, so banks should discontinue lending to MFIs under PSL. As of March’09 the loans extended by Pvt & public sector banks to all the MFIs aggregated to about 3/4th of the entire debt funding available to these institutions, so the impact of this recco is well understood. As of now banks lend to MFIs to meet their PSL targets (remember the 40% target?) as required, failing which RBI guides them to park an amount equal to the shortfall with institutions like NABARD, SIDBI etc, which yields a meager ~6% return. You might think this PSL thing might help MFIs to get a good bargain at the interest cost, well that logical too but it doesn’t happen at all! Going by the numbers the flag bearer SKS reports the cost is around 12% for them (that’s around 200-300bps costlier than what large corporate houses pay on a purely commercial borrowing), needless to say this number hits north as the size of the firm decreases. Now if this lending is excluded from PSL it will simply increase banks’ bargaining power, so the interest charged is bound to increase. This might be passed on to the customer by the MFIs which will push the dream of financial inclusion farther. Still worse, it might make it impossible for start-up and other growing MFIs to borrow at all, if that happens the microfinance market will never see competitive pricing as much it could have.

If this happens the large MFIs might still be able to protect their margins owing to their scaled-up operations, better bargaining power with banks etc, but smaller MFIs might just get wiped off making the market more inefficient.

The Rationale

To my limited understanding its very challenging to find a good reason how-

– On one side people (no names 🙂 ) complain about how the interest rates of MFIs have not come down as they should have, and on the other side we are talking of steps that will essentially translate to an increase in the borrowing cost further to ensure that the kind of competitive market place required for charges to come down is never achieved!

– WE say MFIs charge astronomical interest rates, and that they are wrong citing high operating costs as the reason as lower delinquency (98%+ recovery rates) should offset the higher operating cost. At the same time it’s OK for banks to charge MFIs higher interest rates on the grounds of riskier business model, why is it that the same argument of lower delinquency is no longer valid?