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Hedge Funds and Equity Firms Using Micro Finance to Profit from India's Poor

Politics / India May 03, 2010 - 07:36 AM GMT

By: Global_Research

Politics

Best Financial Markets Analysis ArticleKavaljit Singh writes: The massive investments by private equity firms coupled with an initial public offer (IPO) by SKS Microfinance has ignited a debate about the ethics and objectives of microfinance institutions (MFIs) in India.


The SKS Microfinance, the largest MFI in India with substantial investments by private equity firms and hedge funds, is planning to raise Rs.11000 million ($250 million) through an IPO.

According to media reports, the original promoters of SKS Microfinance have sold part of their stake to a hedge fund thereby making a 12-fold profit even before an IPO. This shrewd act by promoters and top management not merely raises doubts about their long-term commitments but, more importantly, questions the real motives of promoters who have become instant millionaires while their borrowers remain desperately poor.

Though initially started by women’s groups and NGOs to empower poor people at local level, microfinance is no longer a micro or local phenomenon. Globally, the microfinance industry controls over $50 billion in assets.

In India, MFIs are increasingly dominated by corporate structures with the large-scale funding by commercial banks and private equity firms. The commercial bank lending to Indian MFIs alone was $2.5 billion in 2009.

To private equity funds, microfinance business in India offers new avenues of profit-making since interest rates range from 30 to 60 per cent and repayment rates are over 95 per cent, far above commercial lending.

Unlike commercial banks, MFIs are presently not regulated and supervised by RBI or any other agency. The deregulated environment provides an incentive to unscrupulous MFIs and their financiers to charge very high interest rates from poor borrowers and thereby make super profits. The Microfinance Bill which mandates NABARD to regulate MFIs was recently introduced in Parliament.

One of the main reasons cited by some MFIs for charging high interest rates is that their administrative costs are higher than commercial banks. Indeed, delivery of small loans to people living in remote areas entails higher administrative costs. But such costs could be substantially offset by economies of scale which unfortunately has not happened in most cases. Several large MFIs still charge abusively high interest rates despite their operations have increased manifolds.

The other argument that greater competition among MFIs will lead to lower interest rates is yet to be demonstrated in India. It is well known that given the widespread existence of information asymmetry, microfinance cannot be a market with perfect competition.

It would be erroneous to draw an analogy with any other industry or services because the raison d’etre of MFIs is to serve poor people and promote financial inclusion.

The higher interest rates charged by MFIs place an unreasonable burden on poor borrowers. Why should poor borrowers pay the price for inefficiencies of MFIs? Why should poor borrowers be exploited in the name of promoting financial inclusion? Isn’t profiteering from poor people in the name of financial inclusion? What about social and developmental objectives of MFIs?

No one is arguing that MFIs should seek subsidies from donors to serve their clients. Rather they should pursue financial sustainability by removing operational inefficiencies and charging interest rates high enough to cover the lending costs.

There are plenty of MFIs in India who follow a balanced approach between financial sustainability and social objectives in terms of collective action and borrower empowerment. The microfinance interventions by such institutions have produced better results because of their integrated approach towards building sustainable livelihoods. It is critical that such MFIs should voice their concerns against greedy promoters and financiers who are no better than traditional moneylenders and loan sharks.

Throughout the world, MFIs are drawing greater public attention. In 2007, Banco Compartamos, a Mexican MFI, issued an IPO and consequently its original investors became instant millionaires. They received $450 million for selling 30 percent ownership of the institution. The reason for such a high valuation of Banco Compartamos was that it had been generating super profits (returns on equity at 55 percent), arising out very high interest charges at 85 per cent a year to poor borrowers.

In September 2009, CARE (a US-based humanitarian aid agency) pocketed $74 million when it sold 77 per cent stake in a Peruvian MFI, Financiera Edyficar, to a local bank.

This author has come across several malpractices by some MFIs in Andhra Pradesh and Karnataka in order to meet lending targets. The practice of multiple lending and loan recycling (which ultimately increases the debt liability of poor borrower) is very widespread.

There are many instances of aggressive lending by MFIs with negative outcomes. In 2005, many poor borrowers (mostly women) landed themselves in a spiral of indebtedness in Andhra Pradesh. For these borrowers, MFIs were no better than traditional moneylenders as they charged exorbitant rates of interest (80 per cent and above). Some MFIs also used coercive methods of loan recovery that were humiliating to women borrowers, including making them stand in the hot sun and locking up their homes. Some borrowers reportedly committed suicide in Andhra Pradesh as they were unable to bear the harassment by MFIs.

All these recent instances suggest that lending by MFIs could also be counter-productive if not properly regulated. In some countries, legislated interest rate caps for MFIs are under discussion. The RBI should examine the relevance of interest rate caps and other measures, particularly for large MFIs in India.

Due to growing public concern, efforts are being made to launch a self-regulation code to discipline MFIs. But self-regulation code is voluntary and non-binding and therefore can not stop greedy promoters from reckless profiteering. At best, self-regulation code can complement the regulatory measures.

As the numbers of MFIs in India multiply, a proper regulatory framework must be developed to ensure that these institutions follow minimum norms and standards. Otherwise, MFIs may simply end up as an exploitative form of organized money lending with no public responsibility and accountability.

Rather than becoming institutional moneylenders, MFIs should give a strong competition to traditional moneylenders in India.

Kavaljit Singh works with Public Interest Research Centre, New Delhi. He can be reached at kavaljit.singh@gmail.com.


Kavaljit Singh is a frequent contributor to Global Research.  Global Research Articles by Kavaljit Singh

© Copyright Kavaljit Singh , Global Research, 2010

Disclaimer: The views expressed in this article are the sole responsibility of the author and do not necessarily reflect those of the Centre for Research on Globalization. The contents of this article are of sole responsibility of the author(s). The Centre for Research on Globalization will not be responsible or liable for any inaccurate or incorrect statements contained in this article.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Ajay
03 May 10, 13:29
MFI- India

Excellent job Kavaljit. There seems to be hardly any difference between these MFIs and our old 'Sahukaars'. Some things never change..


k a prasanna
13 Jul 10, 09:52
micro finance

The Andhra Pradesh government has constituted district level ‘Task Force Committees’ (TFCs) to investigate the unethical practices of micro finance institutions in the state. The committees were constituted after the government received many complaints against the loan shark practices adopted by some leading MFI’s of the state.


k a prasanna
20 Jul 10, 03:46
micro finance

SKS MICRO FINANCE RESULTS - CAUSE, EFFECT AND SIDE EFFECTS, WHOSE CASH IT IS ANY WAY?

SKS Micro Finance earned profit before tax of Rs 267.70 crore on the total income of Rs 958.92cr for the FY 2010. The basic is EPS of Rs 33, much more than some of the large software companies. The country’s largest micro financier is exploiting the poorest of the poor in rural India in the name of providing credit access to them. The company charges interest between 27% -36% p.a. on money lent to the poor. On the one hand, the company says, that there is no scope for reducing the interest; on the other hand, the company is posting robust profits year after year. The so-called valuations they are trying to create for the company is to serve for their own selfish motives. That will benefit the handful of shareholders / promoters.


A.K.Mohamed Anwar
24 Jul 10, 04:40
micro finance needed

we need microfinance for 10,000 poor rural women.


k a prasanna
08 Aug 10, 22:17
sks micro ipo

The regulator has stepped in. RBI, in its recent review meeting with the Chiefs of Banks has raised concern over lending to for-profit MFIs. The analysis of SKS Micro IPO by FIRSTCHOICE has again proved correct. In the first week of July 2010 itself FIRSTCHOICE had indicated that the regulators would step in and take actions against profiteering MFIs.


k a prasanna
13 Aug 10, 23:25
MICRO FINANCE INSTITUTIONS

In the last few days, some interesting development has taken place in the Financial sector, particularly concerning the micro finance segment. Firstly, RBI,in its review meeting with the chiefs of PSU banks has raised concern over bank lending to MFIs which are into profiteering. The MFIs borrow from banks around 15%p.a., which is categorized as priority sector lending and lends at usurious rate in the rural areas.

Secondly, on the instructions from the finance ministry, the PSU banks have submitted a comprehensive plan for financial inclusion, including aggressive branch expansion in un banked rural areas.

On 11-08-10, the RBI released the discussion papers on new bank licensing norms. Among others, it stipulates that the new bank have to open 50% of their branches in rural un banked areas.

These measures are going to have far reaching consequences on the set-up and functioning of micro finance institutions and their long term sustainability.


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