Fallout of a Crisis: The Future of Microfinance in India After Andhra Pradesh

From humble beginnings as rural giving built on a charity model, microfinance in India has grown into a multi-billion dollar industry over the last several decades. Andhra Pradesh (AP), an agrarian state located in southern India, found itself at the epicenter of Indian microfinance and MFIs in the region were among the first to attract interest from mainstream investors. Microfinance's designation as a priority lending sector made it advantageous for banks to lend to MFIs and by 2006, organizations in AP were experiencing a substantial influx of capital. Rapid sector growth and minimal regulatory oversight eventually led to predatory lending practices, wide-spread client over-indebtedness and allegations of abusive collections practices, culminating in 2010 with the sensational media stories of farmers in AP being driven to suicide as a result of their inability to repay their loans.

The Reserve Bank of India, India's regulated central bank, responded to the crisis by forming the Malegam Committee to investigate the situation in AP and to review the general MFI sector. Based on recommendations from the Malegam Committee, the RBI introduced strict federal regulation on microfinance operations in February of 2011. These regulations included capping profit margins, lowering lending interest rates and narrowing the definition of an eligible loan client. The regulatory changes added to the existing confusion in the sector after the AP crisis, causing many banks to move out of the industry and withdraw funding. With less financial reserves, reduced profit and international scrutiny, MFIs in India are now faced with the challenge of rethinking their traditional operational models and reevaluating their future strategy.

These institutions are now actively exploring ways to create additional revenue streams and reduce operational costs in order to survive in the new environment. Many institutions have begun diversifying their product offerings by expanding beyond lending and into insurance and pension products, among others. While regulation prohibits MFIs from accepting deposits from their clients, some institutions have partnered with banks that are able to offer this service. BASIX, an MFI operating out of Hyderabad and serving 17 states across India, promotes the savings offerings of KBS Bank, the only commercial bank in India to focus on microfinance. Bank accounts are often seen as an anchor product in the effort towards financial inclusion and partnerships like this one emphasize the utility of providing end clients with a comprehensive offering of financial services.

Streamlining operational practices is another way MFIs are reducing costs and while this is not a new concept, it is resurfacing with renewed urgency. Swadhaar Finserve, an MFI in Mumbai focused on urban lending, recently undertook an initiative to streamline their client lending evaluations by analyzing four years' worth of data in order to determine ways to tailor products, standardize evaluation processes, identify business growth indicators and develop a utilitarian credit scoring model. Janalakshmi, an MFI headquartered in Bangalore, is using a biometric scanner in the field where a thumb print verifies loan collections and disbursements in order to reduce an agent's time with each client, reducing both operational cost and the risk of fraud.

The use of innovative technology also extends to customer-facing applications. Moving microfinance into a cashless process has benefits for every player in the value chain as it reduces human resource labor, creates electronic records and transaction information in real-time and is ultimately more convenient for the client.

The use of mobile technology is widely seen as a particularly powerful tool in the effort towards financial inclusion but to date, there have been few, if any, successful mobile products in the Indian microfinance space. As a core mobile capability, MFIs would like clients to be able to pay their loan installments by loading money onto their cell phone by visiting a local merchant and then texting the balance to their loan provider. There have been a handful of product pilots that have offered some variation of this basic mobile offering but none have gained significant traction. However, in a country where 75% of the country will have a mobile phone by 2016, MFIs are continuing to explore ways to leverage this technology effectively.

There are, of course, substantial barriers to the widespread adoption of mobile payments in microfinance (lack of awareness, illiteracy, and trust being key among them). While it may take years to change ingrained payment behavior, the inclusion of technology, particularly mobile, in this sector is both significant and imminent. As Swadhaar CFO Abhishek Agrawal says, "We as an organization must be agile with the changing environment of mobile banking because it is a technology that is coming to microfinance, whether now or in five years."

While the Andhra Pradesh crisis caused significant changes and challenges within the Indian microfinance industry, the general consensus seems to be that the introduction of regulation into the sector is productive. As Agrawal says:

"These regulations are ultimately very positive. This was an unorganized sector with no definitive best practices. Each institution was using its own interpretation of things like lending rates and loan delinquency. Now the rules have been set and although there are still unclarities in the guidelines, the regulators are willing to make it a conversation. It is still a work in progress."

The crisis in Andhra Pradesh has normalized expectations of the industry and as Agrawal points out, the new regulation ensures that it is only the serious players who remain. Investors are no longer pouring capital into MFIs with the hope of large returns and the MFIs that are still operating have proven that they are willing to work within the confines of the evolving regulation.