Money & Banking
Lessons from the commercial micro-finance model in India

Fresh perspectives and radical (systemic) changes are required for developing an enabling micro-finance regulatory and supervisory mechanism that can really work on the ground for the benefit of large numbers of low income people

Moneylife reported last week that charges of serious misreporting and mismanagement have again surfaced in the public domain with regard to Indian micro-finance. Specifically, the article reported that Sahayata Microfinance Pvt Ltd, which was the darling of so many investors, lenders and stakeholders had apparently gone astray - with its now suspended CEO and senior management supposedly involved in serious misreporting and mismanagement. (  

As several previous Moneylife articles have noted, the dominant model in Indian Micro-finance is the commercial model where the MFI is registered as an NBFC with RBI and taps commercial funding (debt and equity) through different means. This model is based on fast tracked growth and generally carries a standard loan product - delivered to clients through joint liability groups and/or agents-based on weekly repayments and having (mandatory) loan related insurance. The emphasis is on-efficiency, standardized processes, large outreach and enhanced profitability – all elements of hardcore commercialization, strongly supported by agencies such as CGAP.

While there could be some modifications to the above model to suit different contexts, the above description is true, by and large, of most NBFC MFIs. The dominant NBFC MFI model is also based on the notion that, to reach and include vast number of unreached and excluded people (including the poor), MFIs must tap commercial funding in a big way from lenders and investors – Mr. Vijay Mahajan’s (Chairman, BASIX, Chairman, MFIN and Chair, Executive Committee, CGAP) statement to this effect, when SKS was to tap the capital markets, strongly resounds in memory. To do this successfully, the model also believes that commensurate (market) returns must be provided to the commercial investors. It is important to note that much of the basic tenets of this (commercial) model have evolved from the global development of new wave micro-finance – which was spearheaded by several stakeholders including CGAP, especially since 1997 onwards. This is a description of the commercial model as I understand it. And as long as the game is played fair and square (no frauds, no multiple/ghost/over lending, no tweaking of performance results etc), I have no problems with the commercial model.  

That said, let us get back to the 2010 Indian micro-finance crisis. A critical point to be noted here is that the fastest growing MFIs, who perhaps contributed to this crisis in India, are primarily NBFCs MFIs that come under the purview of the Department of Non-Bank Supervision (DNBS), RBI. These NBFC MFIs grew at a phenomenal rate, adding several million clients and dollars to the gross loan portfolio over the period April 2008 to March 2010. The following basic facts are discernible from the data (

  • 13 of the top 14 MFIs (ranked on the basis of active clients and gross loan portfolio added from April 2008 to March 2010) are NBFCs. One  of them is an NGO MFI registered as a trust
  •  6 of them are Andhra Pradesh headquartered NBFC MFIs and they constitute the largest chunk within this group of 13 NBFC MFIs. 9.76 million clients were added by these 6 Andhra Pradesh headquartered NBFC MFIs from April 2008 to March 2010 whereas the other state 7 NBFC MFIs and one NGO MFI added just 4.52 million clients (this is less than 50% of the outreach of Andhra Pradesh headquartered NBFC MFIs).
  •  Likewise, these 6 Andhra Pradesh headquartered NBFC MFIs increased their gross loan portfolio by 2.076 billion US $ during this period whereas the 7 other state NBFC MFIs and one NGO MFI recorded a growth of just an additional 703 million US $ (which is less than 1/3rd of the gross loan portfolio of Andhra Pradesh headquartered NBFCs)
  • All of the 13 NBFC MFIs (including the 6 Andhra Pradesh headquartered NBFC MFIs) file quarterly papers with the department of non - bank supervision (RBI). This is a point to be noted with significant emphasis
  •  As the above data indicate, there was phenomenal growth in gross loan portfolio (GLP) and active clients for many of these NBFC MFIs.

Please note that the phenomenal growth spurt was led by 5 large Andhra Pradesh headquartered MFIs (SKS, Spandana, Share, Basix and Asmitha), who added 2049 million US $ and 9.59 million clients between April 2008 and March 2010 which is very significant indeed. This is equivalent to each of these 5 large Andhra Pradesh headquartered NBFC MFIs, adding a gross loan portfolio of Rs.78.55 crores per month, month after month, quarter after quarter, year on year for the 24 months in question (Rs.1 crore = Rs.10 million and exchange rate assumed is Rs. 46 per dollar).

And as noted in box 1 below, the department of non-bank supervision RBI is supposed to supervise every NBFC that has a loan portfolio of over 100 crores closely. As noted above, each of these 5 AP headquartered MFIs were adding (on an average) almost the equivalent of 78% of that threshold value of (Rs. 100 crores portfolio) every month during the period April 2008 to March 2010.

Further, in numerical terms of clients added, this is equivalent to each of these 5 large Andhra Pradesh headquartered NBFC MFIs adding almost 79916 clients every month, quarter on quarter, year on year for the 2 years in question – April 2008 to March 2010. This translates to on the average, adding (on the average) about 2664 (fresh) active clients every day, month after month for the 2 years in question.

These are huge tasks indeed. And in the past, it has taken many MFIs, several years to reach the figure of 75,000 clients and/or portfolio size of Rs.75 crores which is why the RBI specified that NBFCs with asset size greater than Rs.100 crores are systemically important (significant in the first place) and argued for them to be closely supervised. Clearly, these are trends that should have grabbed the attention of anyone, let alone the regulators/supervisors but, for some reason, they perhaps did not.

Several key questions arise here and require serious introspection by the Reserve Bank of India

The key issue here is, whether or not this huge and unnatural growth - quarter on quarter during the period April 2008 – March 2010 - raised any alarms within the department of non -bank supervision, RBI, especially with regard to the following:
  • What was/is the motivation of these NBFC MFIs to grow at this never before seen pace? This is a very critical question indeed!
  • How were they growing so fast? Did they still use green field client acquisition which is how micro-finance initially grew in India? Or were they relying on other strategies such as sharing of clients, takeover of SHGs, cannibalizing JLGs of other MFI’s etc? What role did agents play in all of this burgeoning growth? Were client level controls and KYC norms being violated? Was appropriate and required KYC documentation available, especially given the very rapid pace of growth?
  •  Did growth occur due to market skimming (first time loans to new clients), financial deepening/repeat loans to older clients and/or several other strategies? Was there any evidence that growth may be due to multiple, over and/or ghost lending, driven by perverse (unnatural profit maximization) incentives (a term often used by Dr Y V Reddy and Mr Vijay Mahajan)?
  •  What was the logic behind the business model of the NBFC MFIs? What were its ethical underpinnings? Was the overall model in accordance with the real spirit of inclusive finance, RBI NBFC regulations and the RBI code of conduct? Did the business model of the NBFC MFIs push (or incentivize) the MFIs to grow faster and faster? Was there any difference between the MFI model stated on paper versus that actually implemented on the ground? What caused this difference between theory and practice in strategy implementation?
  •  Where and how were the MFIs getting the resources (debt, equity etc) for this burgeoning growth? What was the motivation and track record of these investors? Where exactly were these resources coming in from (India, Abroad etc)?  Please read India Today (June 6th, 2011 issue) which states that there has always been a lurking doubt that terrorist, Dawood Ibrahim, may be involved in both secondary and primary equity markets, under the guise of foreign institutional investors. Under these circumstances, I am sure, it would be important for the regulator/supervisor to know about the antecedents of the various foreign institutional investors (FIIs) investing in micro-finance. Again, I am not sure whether the department of non-bank supervision, RBI was aware of the burgeoning equity investments by foreign institutional investors (FIIs) (including their antecedents) in Indian micro-finance, especially during the years, 2006 -2010
  •  What was the impact of this burgeoning growth of consumption oriented micro-credit on the low-income clients in terms of over-indebtedness, quality of life and other aspects?
  •  Were the RBI NBFC and other codes of conduct being followed in letter and spirit? Did the NBFCs have sufficient governance and systems to manage this turbo charged growth and, more importantly, not to violate any of the provisions in the law and the codes of conduct?
  • And several other questions

At this juncture, it seems pertinent to look at what Dr. Rangarajan and others have had to say about the business model of the NBFC MFIs and also apply the same to this analysis.

"The business model of microfinance institutions is faulty. They must revisit the model to support the income earning ability of the borrower," Prime Minister's Economic Advisory Council Chairman Dr C. Rangarajan said at an event organized here by Skoch Consultancy. Rangarajan said multiple lending done by MFIs is inconsistent with the very repayment capacity of borrower. He said MFIs have been indulging in multiple lending and large parts of the loans are given for consumption purposes and this model of business has landed them in trouble. "Income earning capacity must be criteria for granting loans... The provision of credit for consumption must be a small part of the total loan," Rangarajan said” (

Others have tended argue for the same and I reproduce a quote from Dr. Al Fernandez’s post on the CGAP blog. As Mr. Fernandez argues,

“The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%. In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 % (the highest being 41.29%). The report also says that economies of scale have not led to lower interest rates or lower yields. This implies that MFIs maximized their profits and competition did not decrease rates as it was expected to. The largest MFI recorded a 116% jump in net profit at Rupees 81 crores ($18 million) in the second quarter ending September 2010 as against the corresponding period last year.” (

The cornerstone of these arguments is essentially this:

Many MFIs engaged in excessive and multiple lending for consumption purposes and often granted loans without assessing the loan absorption capacity of the clients. Implied in this statement is the fact that many MFIs (in their desire to reach scale and show better results) pushed loans indiscriminately to low-income clients for consumption purposes without any sensitivity to their debt servicing ability and tried to grow (very fast) showing unnatural profits so as to attract capital at high valuations. This is evident from the Indian micro-finance experience and also as noted in a CGAP paper (CGAP, JP Morgan, occasional Paper: Microfinance Global Valuation Survey 2010, March 2010). Thereafter, they had to justify these high valuations by providing better returns to investors. And investors likewise, as they had paid huge premiums, wanted to recover their investment fast and hence, were perhaps pushing the MFIs to grow faster. Hence, as diagrammed in figure 1 below, there appears to have been a mutually reinforcing cycle of multiple/over/ghost lending, fast growth, high profits, very high share valuation, equity investments, faster growth, greater profits, more returns, turbo charged growth and so on.

Now, the key question here is whether the department of non-bank supervision at RBI spotted any of this? In turn, this question raises several unanswered questions with regard to RBI’s role in the 2010 Indian micro-finance crisis and its future regulatory/supervisory obligations:

1.    Did the department of non-bank supervision miss these (significant) trends? If so, why? What lessons can be learnt from this with regard to supervisory arrangements in the future (especially those given in the proposed micro-finance bill)?
2.    If not, having spotted these happenings in the first place, why did it not take necessary corrective action? Again, what lessons can be learnt from this with regard to supervisory arrangements for the future (especially those given in the proposed micro-finance bill)?
3.    Further, if the concerned RBI department could not properly supervise 13 NBFC MFIs that were supposed systemically important, then, how can they be expected to set up supervisory mechanisms for several hundred MFIs as per the proposed Micro-finance bill? Without sufficient supervision, none of this will work on the ground. I believe that the Malegam committee arrangement was very good because it ring fenced the large NBFC MFIs. This bill however clubs all of the MFIs together. This means that some several thousand organizations (including cooperatives) may have to be regulated and supervised. However, no single regulator/supervisor may be able to perform this task effectively, without constructive support of the concerned State Governments as supervising micro-finance certainly requires local clout and presence.
4.    Last but not the least, what changes in NBFC supervision will be required to ensure that the interests of the low income clients are protected in the future? In other words, given the above, how do the department of non-bank supervision and the RBI hope to prevent the misuse of the commercial NBFC MFI model in the future in India?

The answer to these questions can come only through a deep honest introspective analysis at the RBI and the RBI must undertake such an exercise so that future crisis situations are avoided. The Reserve Bank of India is one of India’s greatest institutions and it has done a fantastic job protecting the Indian financial sector through the recent global financial crisis. Let us be clear on that! However, micro-finance is not regular finance and it has many peculiarities which require appropriate strategies of regulation/supervision including local presence. The sooner the RBI recognizes these facts the better. Without question, fresh perspectives and radical (systemic) changes are required for developing an enabling micro-finance regulatory and supervisory mechanism that can REALLY work on the ground for the benefit of large numbers of low income people, who continue to lack access to quality and affordable financial services at the grass-roots.




5 years ago

The graphs and diagrams are not seen in the article. Can someone help us with them also please...

The article is an eye opener..

Utility companies should be asked to pay interest on security deposits

The utilities companies should be asked to pay interest to their consumers, who have given a security deposit, whether they are in the public or private sector. Though this does not amount to any substantial benefit individually, this is required to be implemented to ensure equity and justice to the consumer

The common man in our country is reeling under the burden of double-digit inflation for the last couple of years and the steps taken by the government do not appear to be yielding any result so far.  To add insult to his injury, every public utility in the country is frequently raising tariffs, putting additional burden on the consumer. This is happening especially in the power sector and telecom companies, too, are reportedly proposing to raise tariffs due to rising cost of their operations. This will be followed by increase in domestic gas prices, as the Govt. is reportedly in the process of finalising the withdrawal or restricting the subsidy element so far enjoyed by domestic gas users. The cumulative effect of all these developments is that the cost of living has been going up on all fronts, with little prospects of seeing any light at the end of the tunnel.

At present all public utility companies insist upon depositing with them a certain amount as deposit at the time of making available their services to the public. Electricity companies ask for a deposit of one month’s estimated use of power, while telecom companies insist upon depositing a fixed amount at the time of connecting basic landline and also for mobile connections obtained on post-paid basis. Water bodies, too, ask for a certain amount of deposit from the users depending upon the consumption of water. Gas supplying companies providing domestic gas take a deposit as a security towards gas cylinders, based on whether you opt for one or two cylinders. Even those companies providing piped gas do take security deposit just like electricity companies. Though these deposits are considered as refundable deposits, they remain permanent so long as you use their services, which are rarely surrendered, as they are a necessity for every household.      
These public utilities are perfectly justified in asking for a deposit to protect their own monthly receivables, but what is not justified is that these deposits do not bear any interest so far and the depositing public silently bears this loss of interest for no fault of theirs. As the saying goes, “there is no such thing as a free lunch in this world” and therefore, there is no justification for these utility companies to enjoy these deposits free of interest and there is no reason for depositors to forgo any interest, however small it may be.

The following utilities should, therefore, be immediately asked to pay interest to their consumers, who have given a security deposit, whether they are in the public or private sector.

1.    All electricity companies, who supply power to the consumers.
2.    All telecom companies who accept deposits from the users of their services as security deposit both for landline and for mobile connections.
3.    All corporate or government bodies who provide water to all the users and from whom they accept security deposits, either from individuals or from any other users.
4.    All companies who supply gas to the consumers through cylinders and who have taken security deposit towards the cylinders supplied to the consumers.
5.    All companies who supply piped gas in several cities and wherever security deposit has been accepted by them from the consumers.

Besides, the rate of interest payable on these deposits should be market-driven based on the long-term deposit rates offered by banks in our country. It is best to benchmark these rates to the long-term deposit rate offered by State Bank of India (SBI) as on 31st March every year and the companies accepting security deposits should automatically calculate interest in the month of April every year and pay it to the consumer as a deduction from the bill amount payable for that month. Though this does not amount to any substantial benefit individually, this is required to be implemented to ensure equity and justice to the consumer.
The regulatory bodies who regulate these utility companies are expected to take care of the interest of the consumers; hence they should direct all the companies coming under their jurisdiction to comply with this requirement of payment of interest, which will, though in a small way, compensate a large number of consumers, who belong to the lower strata of our society.  As this does not require any enactment or changes in the laws of the country, and it is within the powers of the regulators, it is all the more necessary to implement this suggestion without any further delay.

Yet another problem faced by the consumers of these utility companies is in respect of payment of their bills through the electronic clearing service (ECS) offered by banks in our country. Some times due to the mistake committed by the staff of the utility companies while claiming the monthly payment like punching wrong account number, etc, or due to any other reasons, the ECS claim gets rejected. But this non-payment is not promptly informed to the consumer either by the bank or by the utility company concerned. The consumer, who does not know about non-payment till he receives his next month’s bill, will have  to pay penalty for the delayed payment or face the risk of disconnection of the service, putting him into a lot of inconvenience. It should, therefore, be made mandatory for all utility companies to communicate non-payment of bills in such cases through a written communication to the consumer within reasonable time and provide sufficient time thereafter for payment.

The suggestions mentioned above may look trivial, but if and when implemented, will make life a little bit easier for the common man, who is already burdened with innumerable problems in his daily life. Will the concerned regulatory bodies act swiftly and take steps to improve the lot of our people in the larger interest of our nation?

(The author is a banking & financial consultant. He writes for MoneyLife under the pen-name ‘Gurpur’)



Nagesh Kini FCA

5 years ago

The matter of granting market related interest ought to be brought to the attention of the Regulators - the Central and Maharashtra Electricity Regulatory Commissions and the Telcom Regulatory Authority of India to direct the service providers.

What investors don't know could hurt them

Underground economy and corruption are a further blight on economic forecasting and investing. Both hide the price signals that make markets efficient and predictions accurate. This information is considered too dangerous to be revealed to consumers. The enormous value of the information is also illustrated by the killing of activist trying to enforce the RTI in India

JP Morgan described the panic of 1873 as a "cyclone which came upon us without an hour's warning". But actually there was warning. The boom prior to the panic was like all other booms. It was driven by too much unsecured debt that had driven the stock prices far beyond rational valuation. We want to think that 1873 was the dark ages of finance. But the problems and reason for the panic of 1873 are around today. No one knew then as no one knows now, just how much debt is out there and who owes what to whom. This is why the panic of 1873 occurred. This is why the world went into recession after the collapse of Lehman. This is the danger today.

The lack of information is simple enough. No one wants to give it for the simple reason that it has value. The irony is that much of economics including financial, quantitative and economic analysis assumes that there is sufficient accurate, timely and complete information available to make the theories work. When this rather obvious flaw can no longer be overlooked markets lose it.

The bleeding sore of the Euro crisis is a good example. Despite two sets of stress tests and relentless attention, there is a constant concern for the safety of European banks and the debt of several countries. Greek statistics come in for constant criticism often with good reason. Their unemployment rate is supposed to be 18% but is most likely higher. Still that is nothing compared to Spain's unemployment rate, which is reported to be 21%, but, like Greece, is probably much lower because of a large unreported underground economy.

Underground economy and corruption are a further blight on economic forecasting and investing. Both hide the price signals that make markets efficient and predictions accurate.

Governments certainly contribute and one of the largest contributors is China. Li Keqiang, the man who is likely to be China's next head of government, once described the country's GDP data as "man-made" and "for reference only".  Some assume that Beijing is the problem, but according to a recent book by Tom Orlick, it is a "recalcitrant sample set". In other words the locals are lying.

In some ways this is more unsettling than the central government spinning the numbers. If the Chinese government was responsible for the fraud, we could assume that at least someone was aware of the real numbers. If no one really knows, then policies based on bad numbers will be a failure. The prime suspects include the informal lending sector and the vast tumour of China's local government debt, which makes the US muni market look positively healthy. Added to these problems are Chinese corporate debts, which cannot be revealed. The reason given to the US Public Company Accounting Oversight Board, when it requested a review of Chinese auditing firms: state secrets. The issue is that these secrets are probably also withheld from the state.

It is unlikely that China will have a financial panic. A financial panic usually requires a question about the solvency of banks. China's state owned banks may be insolvent, but the state is not. China cannot have a run on itself. This does not mean though that there isn't plenty of room for panic. The China boom has caused bubbles all over the emerging markets. Even a slowdown in China could have some unfortunate effects.

The antidote for bad information is legal disincentives. However, legal disincentives have an issue. They have to be enforced. The Chinese banking regulator the China Banking Regulatory Commission (CBRC) has an enormous conflict of interest. It is a government agency trying to regulate government banks.

What does provide a disincentive are laws like India's Right to Information Act 2005 (RTI). Modelled on the United State's Freedom of Information Act, these laws allow any citizen the right to force a government to divulge information.

The resistance that governments put up to avoid revealing this information is stunning. It took five years for the British government to reveal information required under its act. The reason was simple. The information revealed massive waste by MPs. In India audits and inspections conducted by the central bank on the countries banks to insure solvency and safety is supposed to protect consumer. But the same information is considered too dangerous to be revealed to those consumers. The enormous value of the information is also illustrated by the killing of activist trying to enforce the RTI.

What investors don't know certainly could hurt them. What is worse is that governments who are theoretically responsible for maintaining economic growth and stable markets are systematically either preventing disclosure or allowing information to remain a secret. These are the real enemies of capitalism. If there are further panics, we know whom to blame.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected]).


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