The recent merger of Bharat Financial Inclusion (BFIL) — the largest microfinance institution (MFI) — with IndusInd Bank has only accelerated the pace of change in the microfinance space. The landmark transition of one of the largest MFIs — Bandhan into a universal bank, and eight MFIs into small finance banks — has led to a tectonic shift in the micro-credit marketplace. The Centre’s increasing focus on financial inclusion has also ushered in an increasing number of regulated entities — banks and NBFCs lending directly or indirectly through the business correspondent model into the microfinance space. As of June 2017, banks became the largest providers of micro-credit with a share of 36 per cent, while MFIs slipped to the second slot. Banks, small finance banks and BFIL together now constitute nearly 80 per cent of the MFI industry.
However, while banks have stepped up financial inclusion efforts, the drive has mostly stopped short of opening accounts in rural markets. The missing piece — providing credit to the poorer sections of the society — has been filled in by MFIs which have been able to do so in a cost effective way, while generating strong returns for stakeholders. The success of the MFI business model has drawn some banks into acquiring MFIs — a more profitable way of doing business in rural markets. It also offers banks a viable way to meet their priority sector lending targets, which hitherto has been a loss making proposition.
While the huge potential for micro-credit in India and the success of the MFI model is well proven, the underlying risks to the business that came to the fore, post-demonetisation, have raised new questions. The joint lending group model through which MFIs have been lending, proved to be a double-edged sword — containing risks in good times but triggering large-scale defaults, post demonetisation. What began as a cash-crunch problem, snow-balled into political instigation misleading borrowers — distorting group repayment behaviour and hitting collections. Farm loan waivers announced in various states only made matters worse. Since systemic and political risks continue to plague the sector, the fundamental challenge for MFIs, going forward, will be to raise capital, while for small finance banks and traditional banks acquiring MFI businesses, the challenge will lie in leveraging their asset and liability base. How this plays out on the way money flows into the industry will be key to future growth.