By Parnika Jhunjhunwala
The main aim of financial inclusion is to ensure access to formal credit at an affordable cost for people who depend on informal sources for fulfilling their financial needs. The Micro Finance Institutions (MFI) sector started in India in the 1970s with the emergence of SHGs (Self Help Groups), owned and run by women to provide access to credit to women. The National Bank for Agricultural and Rural Development (NABARD) recognised the importance of MFIs in poverty alleviation and later in 2004, the Reserve Bank of India (RBI) included MFI in its priority lending sector. In 2015, the government launched the Micro Units Development and Refinance Agency Bank (MUDRA) bank to finance MFIs.
Recently however, due to demonetization, the rate of Equated Monthly Installment (EMI) submission fell and the collection rate fell to 66%. Even though the cash crunch hit the market, the sector has shown recovery. Indian Non-Banking Finance Companies-Microfinance Institutions (NBFC-MFIs), have grown 26 per cent during the first quarter of the current fiscal as compared to the last year. The continuing growth of this sector can be attributed to myriad reasons.
Key reasons for growth
The sectors ability to adapt to change and the ability to maintain high repayment rates of up to 99.5% along with rigorous credit bureau discipline has enhanced growth. The MFIs are familiar with the nuances of banking with poor borrowers and thrives on a very high level of customer connectbefore, during and after the credit approval. Banks hesitate to expand in remote areas, where a huge chunk of the population cannot gain access to formal financial channels. Thus, the inability of the banking system to reach out to the last man standing is the root cause of growing MFIs which are tapping the marginal markets successfully. A major reason why banks hesitate to expand is higher operational costs plus lack of raised collateral. The low-income segment cannot provide secure collateral which discourages big banks to lend. MFIs, on the other hand, are collateral-free, gaining popularity among the poor.
Proper utilisation of better funds
The MFIs are also utilising the services provided by the Credit Bureaus (CBs), such as CRIF High Mark Credit Information Services, which aim to gather data on MFI borrowers and bridge the lack of information a lender faces while evaluating a prospective borrower. This, in turn, checks the delinquent borrowers, reduces Non-Performing Assets (NPA) and helps MFIs to comply better with the regulations set by the RBI.
Funding to MFI has also diversified. Once primarily donor-led, it is now also funded by banks and NBFCs which are acquiring more equity stakes in MFIs. MFIs are also tapping non-banking financing resources such as mutual funds. Thus, a steady flow of capital and debt enhances the operational efficiency, leading to growth. Giving out small, collateral-free loans to test clients and hassle-free loan lending norms have lured the customers who were once financially excluded.
Is m-Finance the solution?
The practice of group lending is also slowly shifting to a more personalised mode. The shift away from groups stems from the stress attached to group guarantees, coupled with the fact that group meetings consume time and are costly. This shift can pave the way for mobile-financing. With Indias mobile phone subscriber base crossing 1 billion in January 2016, MFIs can leverage Indias mobile phone revolution to provide m-Finance. Facilities including the ability to repay installments whenever convenient to the borrower, telephone reminders to make repayments, emergency loans and flexible savings accounts lead to low operational costs, which will help them expand their operations in remote areas at a reduced cost and also get a strong foothold in the market.
Better technology will further help MFI to penetrate the market, even in the absence of pre-existing branch network; especially with the advent of M-Finance. With payments over the mobile, distance from a physical outlet will no longer be a reason for exclusion. The government initiative of Digital India also gives MFIs a reason to switch to m-Financing. Further growth can be ensured by tapping into the debt and equity market more extensively, elevating the growth rates of MFIs.
Bumps on the way
Though the MFI sector is gaining ground, it still faces a few challenges mostly operational in nature. The most important one is the excessive dependence on cash transactions. MFIs have to incur significant cash-carrying costs, mainly the forgone interest. Small and medium-sized MFIs cannot enjoy lower operational costs due to lack of funds to access advanced technology. The use of low-cost technology affects their credit ratings which in turn makes it difficult for the MFIs to raise funds. Lack of an effective risk-management framework and greater manual intervention increases the probability of internal fraudulent activities by employees, which threatens the functioning of MFIs.
Discipline to succeed
MFIs has proved its viability as a business model, acting as a complementary to banks. The key focus areas for this sector should be strengthening the credit discipline and culture of repayment, operating cost optimisation through tech enablement and to plan for current and future risks that can impact payments given the inherent vulnerability of the customer base. Moreover, the government initiative of Make in India requires that MFIs and NBFCs be pushed in India since they penetrate the rural market as well.
Featured Image Source: Flickr