Without question, the present scenario, in the wake of Friday’s circular, places a huge burden of responsibility on the Department of Non-Bank Supervision and the RBI and for the sake of real financial inclusion, we sincerely hope that the department lives up to its roles and responsibilities with diligence, aplomb and efficiency
On Friday (2 December 2011), the Reserve Bank of India (RBI) created a special category of non-banking finance companies (NBFCs)—NBFC–MFI. The RBI must be congratulated for creating this new category as it explicitly recognizes microfinance as an important facet of the larger financial sector.
While Moneylife will be providing a detailed analysis of this RBI circular and its implications through a series of articles next week, we continue the analysis of the growth of the commercial microfinance model with a focus on what led to the growth of the commercial NBFC MFI Model in India in the last few years along with the supervisory/regulatory lessons therein. This piece is especially for the Department of Non-Bank-Supervision (DNBS), RBI that will now have to play an even greater role—given that a new category of NBFCs called as NBFC–MFI have been created —in the overall regulatory architecture for micro-finance henceforth.
As outlined in recent Moneylife articles (Dissecting the mechanics of growth in Indian microfinance and Lessons from the commercial micro-finance model in India), the growth of NBFC MFIs was unbridled during the period (April 2008–March 2010). The key question that arises here is how was this growth possible in the first place, especially given that the Krishna microfinance crisis had occurred, just about a couple of years earlier (in 2005-06)?
In part, it must be noted that this growth was possible among other things, because of growing equity investments into Indian microfinance. Coming on the backdrop of the Krishna microfinance crisis of 2005-06, the so-called social equity investors (including some donors) provided the much needed relief to MFIs. They helped MFIs overcome the temporary liquidity problem by providing them with financial resources. Aided by such social equity (investment) pioneers, including donors, some MFIs started to grow again and grow fast. They were rewarded almost concurrently as they received significant equity from other so-called social as well as commercial investors, during the same period and thereafter.
However, I would like to first state a few caveats, which are in order. Actually, I had been trying very hard to unearth the level of equity investments in Indian microfinance but have been severely hampered by lack of reliable and valid data on the same. Several people, whom I approached, refused to share information citing confidentiality aspects. I was left wondering at this rather strange situation, where we have had almost Rs3,000 crore ($700 million) of equity coming into microfinance till up to July 2010 but there is still paucity of authentic, published data. Sometimes, I even get worried that we have no (real) idea of exactly the identity of those who are investing in a very sensitive sector like microfinance and much of my concern relates to the norms laid down by the financial services task force set up after 9/11. I do hope that regulators and other industry stakeholders share my legitimate concerns. They may be interested in looking at the June 2011 issue of India Today which states:
“There are also legitimate investments that come through proper channels. Sources at the Bombay Stock Exchange say funds from Dawood and his associates now come through the foreign institutional investor (FII) route. …The Securities and Exchange Board of India (SEBI) tried to track such investments. SEBI even tried checking dubious realtors. …In 2009, IB officials worked on a tip that terrorists had invested in Indian stock and commodities markets and that Dawood was instrumental in channelizing some investments because of his proximity with several business magnates in the oil-rich Gulf countries. Dawood’s clout with the sheikhs was evident after the fugitive was seen actively participating in buzzard-hunting expeditions near the Guddu and Sukku barrages across the Indus river in Pakistan.” (Source: Quoted from The House of Dawood, by India Today, 6 June 2011)
Anyway, after a lot of struggle, I was finally able to create a reasonably valid equity database, subject to caveats (of course). However, as I am still in the process of (re) validating the same, I would therefore like to caution you to view the following data and numbers accordingly. That said, it is also my belief that any further data updation will not significantly alter the trends—at best, some numbers for the respective years may increase or decrease but the trends should broadly remain the same. Having set out these cautionary aspects, let me now proceed to share what I have found.
Specifically, NBFC-MFIs (including the top 13 NBFC-MFIs from among the top 14 MFIs) received equity worth several million dollars (see Table 1 below) and this again should have been disclosed as per their statutory (quarterly) filings with the Department of Non-Bank Supervision, RBI.
The data suggest the following basic facts:
That said, given the above, the key question that arises here is: whether or not, this unprecedented and sudden inflow of equity, into select NBFC-MFIs, raised any alarm bells for the concerned departments (DNBS and other departments) at the RBI, especially in terms of the following:
OK, there is some very interesting data—on the last point with regard to these five Andhra Pradesh headquartered MFIs—in an excellent Intellecap report. As the Intellecap report (www.intellecap.com/assets/81/Inverting_the_Pyramid_3rd_Edition-Print.pdf) notes,
“Indian MFIs are receiving the highest valuations in the world. A recent report by the Consultative Group to Assist the Poor (CGAP) and JP Morgan (CGAP, JP Morgan, occasional Paper: Microfinance Global Valuation Survey 2010, March 2010) shows that the median price to book value (P/BV) multiple is 5.9 in India, thrice that of global multiples. Some have been quick to call this “irrational exuberance” on the part of investors.
Analysis shows that while the leading large MFIs have been able to command very high premiums, valuations vary across the sector based on investor type, MFI class and stage of investment. The vast market potential, demonstrated growth of the sector and positive macro-economic outlook contribute to relatively higher valuations in India.
In addition, the number of investors (see below) chasing deals with the few large, high growth MFIs has driven up their valuations considerably. These MFIs are able to command valuations upwards of 10 times their projected profit after tax (PAT). Early stage MFIs are, on the other hand, typically valued lower, at between one and three times the book value (Analysis by Intellecap in the report -www.intellecap.com/assets/81/Inverting_the_Pyramid_3rd_Edition-Print.pdf). Across the sector, the drivers of value are primarily growth and returns, both demonstrated and potential. Thus, to put Indian MFI valuations in perspective, it is instructive to compare the return on equity (RoE) and PAT growth of the leading MFIs with other financial service business, banks and NBFCs. As shown in Table 2, leading MFIs outperformed Banks and NBFCs on both counts. On average, MFI Roe is 32.1%, a full 12 percentage points higher than that of Banks and NBFCs. MFI profits grew over three times that of the sample banks’, and five times that of the sample NBFCs’ between 2006 and 2009. The closest comparable, in this sample, to MFIs in terms of business model is Mannapuram General Finance (a listed NBFC that provides gold and vehicle loans, amongst other services), as their clientele is similar to that of MFIs and loan sizes are relatively low (Rs20,000), although their loans are backed with collateral. Despite the company’s RoE and PAT growth being lower than those of MFIs, its P/BV is at 8.4, higher than average for leading MFIs. Thus, given the enormous market potential, the ambition of leading Indian MFIs, and their demonstrated high growth, prudent cost management and thus high returns, the current valuation levels are not surprising.” (www.intellecap.com/assets/81/Inverting_the_Pyramid_3rd_Edition-Print.pdf)
The above makes it reasonably clear that one of the major reasons for MFIs to grow, in the manner they did, was to attract capital at higher valuations, generate unusual profits and the like…
Again, the key question here is whether the department of non-bank supervision (DNBS) at RBI spotted this?
That said, going forward, especially after Friday’s RBI circular, there are several important questions that the department of non-bank supervision should keep in mind while monitoring equity investments into Indian micro-finance:
Without question, the present scenario, in the wake of Friday’s circular, places a huge burden of responsibility on the Department of Non-Bank Supervision, RBI and for the sake of real financial inclusion, I do sincerely hope that the department lives up to its roles and responsibilities with diligence, aplomb and efficiency. Well, time alone will provide the answers…
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