Besides the usual activities of lending, borrowing, customers profiling etc., Microfinance firms play a much bigger and righteous role. The role of empowering & educating the powerless & uneducated. The role of providing a righteous life for those with lesser choices in life and for those who are often omitted by the bigger corporates. The 7-8% GDP growth India boasts about never touches these masses and we cannot be a developed country until this section of people are developed.
What it is to run a MF business? What are the challenges of microfinance firms? How does their business work? How do they justify charging humongous rates (20-25%) from the poor? What to the borrowers do to manage the repay such heavy interest?
Find out this and more from Mr Samit Shetty, Co-Founder and Director Chaitanya Microfinance. Chaitanya is 6 year old firm with exposure across Karnataka and loans books of value greater than INR 100 Crore. Before Chaitanya, Samit had worked in Olam international for 9 years with exposure across Africa and South America. Samit is an alumnus from IIM Ahmedabad.
About Chaitanya Micro Finance:
We are setup as a company focused on delivering credit products to rural segments. Setup and operating entirely in Karnataka, we have an exposure of about INR 100 crore. The idea is also to evolve into building liabilities and other non-joint liability group financing.
We started off focusing in Karnataka because we knew the market well (comfort of home state etc.) At the moment, we have obtained a stability which allows us to look at other states too.
40% of Indian population is unbanked. A lot of things are happening today to improve the figure – but why are we in this position in the first place? What are the practicalities of Financial inclusion?
We need to create a viable platform for private enterprises to spread banking across India. And for various reasons, we have not let private establishments to survive in the rural segment.
To have a good heart is only a start; to scale up and make your company impactful – you need to have a business case and investment case. Government in general has not allowed private enterprises to thrive in rural areas.
There are unreal expectation from Government in terms of interest rates and cost of transaction. For example, person ‘A’ is borrowing INR 1 Crore and ‘B’ is borrowing INR 1 Lakh – cost of the transaction is same or similar but you should obviously charge greater interest rates from person B to make your business viable. Regulation of interest rates and other interventions ends up killing the business; you don’t allow the business model to function and evolve.
A poor family borrows INR 25000 (for example) to set up a tea stall or buy a cow. MFI business demands humongous rates in the range 20-25%. How is it viable for a poor family?
There are a few ways to look at it:
A company lends money at 25% while the cost of transaction and cost of borrowing for the MFI is an average of 22% which means the microfinance company makes only 3%. The 25% lending is not because of any monopoly – there is enough competition in the market to drive the rates to equilibrium.
Second angle is from the borrower’s point of view. Most businesses for which MFI lends would have high marginal return on capital. For example, you buy a sheep for INR 4000 – in 6 months the sheep would return INR 7000. This means you have a 75% return in less than 6 months. The 75% return is certainly good to bear the 25% cost on the loan. On the other hand, it is only MARGINAL and if you do invest on 20 sheep (expecting 75% return) you also need to spend on manpower and other infrastructural aspects which would reduce the return %.
Besides all these factors, we charge the 25% on declining balances which means effective interest would be just 12.5% (means a INR 10,000 loans has an interest of 1,250 when repaid using a EMI)
What when loans are doled out for non-business activities (such as for marriage). How are the returns ensured/ mitigated:
Most important aspect in this business is, you need to be cognizant of the cash flows and overall loan portfolio of the customer – if you loan him INR 10000 for marriage expense, you should also understand what the customer is up to and can s/he generate enough cash flows to satisfy your requirements?
It is the responsibility of the microfinance institution to understand the customer’s other income generating activities and identify if s/he can make the repayment. If there is doubt that repayment is going to be beyond the means of the individual the lending is predatory and it does not change if it goes into non-business activities. A lot of our lending is for cash flow management, which the borrower essentially needs and then it is about being as affordable as possible.
How do MFIs track the loans?
All MFIs do Loan Utilization Check. At the time of loan issuance we are more accommodative and encourage them to tell exact purpose of the loan. This way we would really know how customers are actually using the money. We have seen that it’s better to keep the purpose open and lend to all purposes, rather than being very hyper about focusing on a specific purpose.
Further based on track-record of the customer we educate defaulting customers.
Small Finance Bank (SFB) License: how will your business change if you get a license?
Am very excited about this as we get an opportunity to prove that a private sector “for profit” model can solve financial inclusion issue in India (assuming Government keeps its hand away in terms of intervention). As for operation is concerned, we will try to keep the geographical focus sharp and stick to 20 districts in Karnataka.
Challenge of raising deposits (if SFB happens):
Some cash burning is indeed required – no one questions when Flipkart burns cash! In this industry if you burn cash, we will have a concrete business footprint in rural area and capture a large chunk of deposits currently going to informal entities. In this business, market entry is comparatively very difficult. We should be more willing to burn cash!
We have a roadmap to financially break even in 5 years – by breakeven I mean make profits at return on capital of 14-15%.
Men vs Women – who are more trust worthy when it comes to repayment?
There is no doubt about this. The question is, do you want to support the family or support the individual? It’s women (mostly) who support the family and the reality is that men are more individual.
Road Less Travelled is a great book for kind of self-reflection and rationalization. I also like Gandhi and have read a lot about him and what he has written.
So there ended the interview – a good kind of sneak-peek into the Mircofinance business! Hope you liked it; please do leave your thoughts in the comments section. If you have further questions to be asked or discussed upon, again please leave it in the comments section.
Samit LinkedIn – goo.gl/T123kK