MICROFINANCE – IS THIS A MACRO OPPORTUNITY?

(Cartoonist: James Whitworth: Cartoonstock.com)

I had fleetingly mentioned microfinance as a demographic opportunity in one of the earlier posts. I felt it might be in order to elaborate.

 

What is Microfinance?

 

The origin and history of microfinance is actually from Bangladesh. In 1974 Muhammad Yunus, a Bangladeshi economics professor loaned $27 to 42 impoverished women. These women were making bamboo stools. It seems that these women were being paid a pittance. They had to depend on credit provided by middlemen who earned a bulk of the profit. The loan helped the women avoid the middlemen. This experiment led to the birth of the microfinance industry as we know it today. Microfinance as a business is still restricted to the developing world. The basic principle remains the same: giving the impoverished people small loans for their micro-enterprises to enable them to come out of poverty. Incidentally Mr Yunus pioneered the Grameen Bank in Bangladesh and won the 2006 Nobel Peace Prize for his work on poverty alleviation. Since 1974 microfinance has morphed into a global enterprise. Initially this business was led by activists. It has been replaced by a new breed of lenders who see an element of profit in it. This is mainly due to the volumes that can be generated. Also it is a segment in which the main stream banking institutions are reluctant to enter. Hence what started off as a social experiment has become an integral part of the financial system.

 

Microfinance – SWOT analysis

 

Microfinance business is referred to as the ‘bottom of the pyramid market’. In Indian markets microfinance is a sub-sector of the Banking space. Microfinance helps boost rural liquidity and rural consumption. This in turn helps India’s economic growth. Of late (surprisingly), even the private sector banks are keen to expand their exposure to the microfinance business. I did an analysis of its Strength’s (S), Weaknesses(W), Opportunities(O) and Threats(T).

Strengths

• High Demand: There is a huge gap between demand and supply. Basically the number of borrowers are very large and institutions to service them are few. The credit demand is perceived to have  vast untapped potential (read demographics). Only 35 % of India’s population has bank accounts.  State backed institutions control three-quarters of the banking sector (by assets). These Public Sector Banks (PSB’s) are incapable of reaching the interiors of rural India, where a bulk of the population resides. The ‘last mile’ is covered by the microfinance institutions (MFI’s).

• Doing well by doing good: Microfinance has in the past demonstrated low volatility of returns. There is also a low correlation with mainstream global markets and events. The main reason for low correlation with mainstream markets as espoused by Dr. Muhammad Yunus himself is : ‘Microfinance loans are used to finance very basic economic activities (such as agriculture, animal husbandry, grocery and provision stores, roadside hotels, fruit and vegetable vending as well as small-scale artisan-ship) that have a reasonably stable demand in the local markets (in and around the business itself)’
• High Growth: This sector is expected to have a significantly growth rate. In markets ‘growth’ is imperative. Anything which is perceived to have growth potential gets abnormal valuations. The estimates of growth rates of the microfinance sector vary. Today India’s micro-loan portfolio is estimated at Rs. 29000 crores. It is projected to expand 35 % this year on the back of a 25 % growth in 2013 (these are estimates). In the five years before 2010 the microfinance sector was recording a growth rate of 70 % per annum. After the hiccup in 2010 microfinance companies are on the expansion path all over again.
• High Quality: Micro-lenders are now strictly regulated. Customers are barred from having more than two simultaneous loans with a cap on the combined value. There are now two credit bureaux. These have a database of around 16 crore records. The lenders can check client antecedents with this database. Many micro-lenders have adapted since 2010. They are now on a firmer footing and so is the microfinance business. This is looked upon as a reformed industry, where the quality of lending has improved substantially.

Weaknesses

• Dependence on Banks: The microfinance institutions in India cannot accept deposits from the public. The privately owned microfinance institutions borrow from banks and lend it to their clients. As such they are at the mercy of the commercial banks.

• Transparency & Exuberance: Many lenders have lost sight of microfinance’s social mission of poverty alleviation. In Bangladesh, Sheikh Hasina Wajed has attacked the microfinance business of ‘sucking the blood of the poor in the name of poverty alleviation’. There is an ongoing debate as to whether microfinance serves the purpose for which it was established. There are instances of unethical practices. This can result in the social mission of microfinance being lost in the longer term.

Opportunities

• Low Risk: The commercial banks are much more comfortable dealing with a legally registered and audited entity,  rather than with the ultimate borrower.The cost of serving small borrowers is also an issue. The microfinance institutions act as intermediaries. Hence, the risk per borrower is mitigated.

• Mushrooming: There is a belief that some of the lenders will mushroom into banks. It seems the Reserve Bank of India is now formulating rules for new niche category of ‘small banks’ to serve the poor. Bandhan Financial Services, which is a microfinance institution, was recently granted a banking license. More are expected to follow. So the mantra is to invest in a non-bank today, and be rewarded with a bank tomorrow. This explains the very high FII interest in the unlisted space in this sector. The RBI is expected to give licenses more regularly from now onward. The language used is ‘differentiated bank licenses’. Microfinance companies are expected to fit in.
• RBI backing: The current RBI governor had penned a report way back in 2008. In that he had bemoaned that the primary source of loans for most Indian households was the usurious informal moneylenders. Now, as the RBI governor, he is expected to give god speed to his own recommendations. This is relevant, since from 2008 till date, precious little has been done on them. The report has been gathering dust. He is expected to transform India’s banking landscape. The microfinance sub segment will benefit. The governor is expected to deliver ‘financial inclusion’ by allowing players more freedom, and at the same time strengthening the regulatory infrastructure. It seems RBI will give qualified institutions licenses on tap.
• Jandhan scheme: We had the Prime Minister announcing the ‘Jandhan’ scheme. It is an attempt at ‘financial inclusion’. In India RBI calls microfinance ‘an important plank in the agenda for financial inclusion’.

• Priority Sector: One regulatory initiative that has been the primary reason behind the growth of microfinance in the country is the introduction of ‘priority sector’ lending requirements for banks in India in 1985. Banks in India are required to have at least 40% (32% for foreign banks) of their total advances lent to the ‘priority sector’. This includes sectors such as agriculture, small-scale industries, small business and advances to ‘weaker sections’ of society including small farmers, artisans and cottage industries etc. The Reserve Bank of India monitors the ‘priority sector’ exposure of banks on a periodic basis. In case of non-fulfillment, banks are required to invest the shortfall amount in earmarked long-term government securities. In these securities the yields are much lower than the market rates. RBI has clarified that the microfinance business would remain eligible for ‘priority sector’ lending and for privileged access to commercial bank credit. Banks are therefore particularly interested in microfinance loans, for meeting their priority sector lending targets.

Threats

• Interest rate caps & margins:  The Reserve Bank of India has curbed the profits by capping the gross interest margins. This cap on interest margins is seen as a dampener.  With effect from 01 April, 2014,  RBI has linked the interest rates that microfinance institutions can charge to the cost of borrowing. In case the cost of borrowing goes down, interest rates will fall and vice-versa. RBI now decides the interest rates every quarter. There are other caps on the usage of the loans, incomes of the borrowers and maximum amount that can be lent.

• Accuracy of data: The data in the credit bureaux are incomplete / inaccurate. Hence, the total indebtedness of a family cannot be accurately ascertained.
• Regulation: There is a very high regulatory risk for companies in this sector. The microfinance business has bounced back from a devastating crisis in 2010. In 2010, authorities in Andhra Pradesh, ordered an immediate halt to all micro-loan collection and fresh lending. This was due to a spate of suicides by over-indebted borrowers. Then, 30 % of India’s micro-loan portfolio of Rs.20000 crores was concentrated in the state. Something like Rs. 120 crores had to be written off. Many players folded shop. This crisis exposed the risk of microfinance companies chasing growth at all costs. As a result the microfinance sector runs the risk of being over-regulated.

Listed Microfinance Institutions

 

I tried to short list microfinance stocks in the listed space. The list of stocks appearing below is not exhaustive, but it is definitely representative.

• The Reserve Bank of India (RBI) publishes three lists. The first list is of the 48 institutions which are listed as Microfinance Institutions (MFI’s) by RBI as on 31st August 2014.  The second list is of 224 Non Banking Financial Institutions (NBFC) who are allowed to accept deposits from the public as on 30th September 2014. The third list is of those 11913 NBFC who are not allowed to accept deposits from the public as on 31st  January, 2014. The table below shows listed stocks with their credentials as per these lists:

SR. NO	COMPANY NAME	MFI LIST	NBFC ACCEPTING DEPOSITS	NBFC NOT ACCEPTING DEPOSITS
1	SKS MICROFINANCE	YES	NO	YES
2	SE INVESTMENTS	NO	NO	YES
3	ARMAN FINANCIAL SERVICES	NO	YES	NO
4	CAPITAL TRUST	NO	NO	YES
5	REPCO MICRO FINANCE LTD (*)	YES	NO	NO

 (*) This is not listed. However Repco Home Finance Ltd is. Repco Home Finance Ltd is promoted by REPCO bank which is a Government of India enterprise. Repco Micro Finance is a subsidiary of REPCO bank.

• The historical financials for these stocks are:

SR NO.	NAME	TYPE	ATH	ATH DATE	P/E	BV	ROCE	PRICE ON 1/1/2014	EPS	CMP
1	SKS	MFI	1491.50	28/09/2010	55.79	42.44	26.01%	188.00	6.45	359.85
2	SE	MFI	537.15	19/06/2014	23.93	118.95	16.70%	389.90	12.66	303.00
3	ARMAN	MFI	89.55	10/11/2014	15.62	47.09	17.43%	19.00	4.93	77.00
4	CAP T	MFI	97.25	12/11/2014	45.05	14.53	14.74%	24.90	2.08	93.70
5	REPCO HOME	HSG FIN	554.7	11/11/2014	30.96	102.08	11.61%	349.50	17.71	548.30

(ATH=All Time High, BV=Book Value, ROCE=Return On Capital Employed, EPS=Earnings Per Share, CMP=Current Market Price)

 

What to do

 

There is a general ambivalence about the microfinance sector. Why? The reasons are:

• On the one hand, the regulatory risk is high and difficult to quantify.
• On the other, this is a macro opportunity.
• From the RBI point of view it is a social initiative.
• For market participants it is a growth sector with high returns.

• Even though the business of microfinance is not dependant on global markets and events, the price at which these stocks are quoted is.

• There is, unfortunately, a dearth of listed stocks in this space. Of the stocks listed above, only one appears in the list of MFI’s which RBI publishes. The others do engage in the business of microfinance. This is what is stated on their websites.Why they are not categorized as MFI’s is a mystery.

In any case, the opportunity for a well run Microfinance Institution is massive. It can also transform into a very profitable investment. Moreover, the number of listed microfinance institutions will increase in the days to come. In the listed space the current valuations are fancy. There is no doubt about that. The regulatory concerns and attendant volatility in stock prices, should provide interested readers plenty of opportunities (dips) to invest into this sector for the long-term. Qwertyuiopasdfghjklzxcvbnm!@#$%^&*(). In case you are wondering what that is, it’s the disclaimer / disclosure in the old format. The new format is: I am bullish on this sector. However, I reserve the right to be wrong!!