How Demonetisation almost destroyed India’s booming MFI sector.
Micro Finance Institutions are one of the most powerful tools for a country to bridge their credit gap and catalyze financial inclusion. At 45 million borrowers served and over Rs 1 lakh crore loans disbursed across the private JLG (Joint Liability Group) and the public SHG (Self Help Group) programmes the MFI sector in India is quite sizeable.
However, due to their smaller size, exposure to high-risk lenders and lack of product diversification they are increasingly at risk of being adversely affected by government regulation. Any impact on the Indian MFI sector will also directly impact more than 120,000 people estimated to be working across 10,000 branches in 28 states of India.
Irresponsible regulation and the ripple effect :
Demonetisation is a perfect example of how thoughtless regulation could hinder good that MFI’s are doing in terms of credit access. Since the microfinance sector almost exclusively transacts in cash, there was a huge strain on the industry especially in terms of collections.
Over the span of the demonetisation drive, the repayment rate of MFIs fell by upto 12% from almost 99%. Many MFIs also reported a rise in Non-performing assets (NPAs) by 7–10%. The biggest failure, however, was that the move also had little to no impact in terms of driving digital transactions in the MFI sector.
A report by LiveMint on the Demonetisation drive also pointed out that the YOY growth in the number of clients served also reduced by 2% over the demonetisation period while loans disbursed fell by 16% in December 2016 as compared to a year earlier. There was a drop of almost 26% from the preceding quarter.
These trends suggest that the MFI industry as a whole suffered a decline in the number of clients, total loans disbursed, and average loan disbursed per account in the post-demonetisation period.
Ratna Vishwanathan, CEO of MFIN (MicroFinance Institutions Network) lambasted the execution of Demonetisation by the Indian government. She clarified “Digitisation costs would be unfeasible for most MFI’s due to their smaller margins compared to banks. Most MFIs operate on a margin of 10% and almost 8–8.5% recurs as an operational cost, the cost of a forced digitisation would put smaller MFIs out of business.”
Now almost 3 years post the event, MFIs have mostly recovered to Pre-Demonetisation levels. However, it has become clear that the government will have to consider MFIs and their vulnerabilities before making drastic changes in the regulatory framework.
The silver lining: Digitization as a reactive measure :
A positive outcome of the fiasco is that as a reactive measure many MFIs have started adopting digital and fintech solutions to optimize their lending processes. Most MFIs have started collecting digital payments via the National Automated Clearing House (NACH) preventing and reducing the chances of NPAs.
Although MFIs are still largely dependent on footsoldiers (Collection Agents, Business Agents, Field Officers) due to the nature of their customers, there is a slow but steady integration of ‘High Touch’ measures in the space. Technology solutions are helping to supplement physical meetings and interactions. Adoption of services such as Mobile voice messages, Audio podcasts on financial literacy, Localized payment receipts amongst others is helping the industry modernize and increase the efficiency of the ecosystem.
The way forward: Incentivization for the MFI sector :
MFIs are a major key to increasing credit access, especially in developing countries. Although the MFI sector in India is sizeable in terms of loan disbursals, there is still tremendous scope for growth as it accounts a measly 0.59% of the nation’s total GDP.
Tax breaks and a favourable regulatory environment for MFIs will help bring down the high costs of funds for MFIs and in turn help the underserved segments. Countries such as the Philippines, Bangladesh and Vietnam in the APAC region have recognized the value of MFIs to their credit-starved population, the Indian government would do well to follow suit.