Global perspective Rising default rates have cast a shadow over the industry, as proponents blame declining standards.
Microfinance loans see diminishing returns
Savita Ramesh Rathore stands at the door of her dimly lit workshop in Mumbai's Dharavi slum, filled floor-to-ceiling with bundles of old clothes, and tallies up the cost of her son's wedding last year. "Jewels, clothes, food, the town hall," says Mrs Rathore, 50, who makes towels from discarded clothes. She borrowed 30,000 Indian rupees (Dh2,395) from money lenders charging 60 per cent interest and took additional loans from friends to pay for the wedding.
Three months ago, she got a 10,000 rupee loan from urban lender Hindusthan Microfinance to repay some of that debt. Mrs Rathore is one of 25 million Indians who have taken so-called microfinance loans, often without adequate documentation or collateral, according to Micro-Credit Ratings International. As the Hyderabad-based SKS Microfinance plans to become the first such lender to go public in the country, an industry credited with helping to alleviate poverty may come under pressure to tighten loan standards to avoid a pile-up of bad debts.
"Globally, microfinance is showing characteristics of the western financial markets before the collapse," says Sanjay Sinha, the managing director at Micro-Credit Ratings in New Delhi. "In the US, homeowners were given loans at 120 per cent of the value of their properties. In rural India, people are being lent to at 150 per cent of the value of their enterprises." Microfinance, which focuses on loans in poor areas largely shut out from traditional banking services, gained prominence globally when Muhammad Yunus won the Nobel Peace Prize in 2006 for his role in founding Bangladesh's Grameen Bank. Yet the past two years have been marked by surging defaults in some countries.
Microfinance markets in Nicaragua, Morocco and Pakistan have seen default levels climb to more than 10 per cent, the threshold that marks a "serious repayment crisis", according to a February report from the Washington DC-based policy and research firm Consultative Group to Assist the Poor (CGAP). While there has been no evidence of a "widespread repayment crisis" in India, "a number of industry analysts have highlighted industry vulnerabilities", the report adds.
Indian microfinance firms have reported bad-loan ratios of about 2.5 per cent on average, Mr Sinha estimates. Actual levels may be higher, in part because some lenders roll over loans to struggling borrowers to avoid defaults, he says. Most microloans in India range from 5,000 rupees to 20,000 rupees, according to a 2009 report by Crisil Ratings, the local unit of Standard and Poor's. The country, where more than 600 million people live on less than US$1.50 (Dh5.50) a day, is the world's largest microfinance market, according to a March report by CGAP and JPMorgan.
Interest rates range from 18 per cent to 33 per cent, according to Vijay Mahajan, the chairman of the Hyderabad-based Basix Group and president of the Microfinance Institutions Network, an industry lobbying organisation. Microfinance lending in India may surge by 40 per cent annually over the next few years, says Mr Sinha, whose company provides ratings services to potential investors. "The market is only 15 per cent to 20 per cent penetrated today," Sumir Chadha, managing director of Sequoia Capital India, said last month. "So even though microfinance has been growing at stupendously high growth rates for the last four to five years, we expect it to continue to grow at very high rates for the foreseeable future."
SKS, which mainly provides loans to poor women in rural areas, says its number of borrowers climbed almost twentyfold to 3.95 million in the three years ending March 2009. Outstanding loans increased more than 18 times in the same period, to 14.2 billion rupees, and profit jumped almost 49 times to about 802 million rupees, SKS says. Runaway growth at microfinance companies masks an erosion of standards and a lack of regulation that may help spark rising defaults, says Mr Sinha. India doesn't have a nationwide system for tracking borrowers' credit histories, making it hard for lenders to check whether clients have multiple loans.
"Rural lending is more difficult than urban lending," says Amit Kalokhe, a loan officer at the Mumbai-based Hindusthan Microfinance. "If there's a bad monsoon and the farmers lose their crops, our money can go along with it that year." Hindusthan Microfinance tries to reduce risk by making borrowers pay an 8 per cent deposit and lending to groups rather than individuals, founder Anil Jadhav says.
"That way, if one person defaults, others can pay the amount," he says. Another proposed safeguard is the Microfinance Institutions Network, which was set up by the largest microlenders in India and represents almost 80 per cent of the industry, according to the organisation. The entity, whose board includes Mr Mahajan and SKS Microfinance chief executive Suresh Gurumani, created a credit bureau to improve risk management and "ensure multiple borrowing and over indebtedness is checked", it says.