The Reserve Bank of India is preparing a discussion paper on new banks. Meanwhile, SKS Microfinance, India’s largest microfinance institution (MFI), has just raised a whopping Rs 1,600 crore through a public offering. SKS and other MFIs could evolve into banks. Bangladesh’s microfinance pioneer, Grameen Bank, is a regular bank.
The RBI severely restricts bank licensing. It prohibits industrial houses from opening banks because of a potential conflict of interest: such banks could give unwarranted but preferential credit and write off loans to related companies and other favoured borrowers. This is a valid concern, given India’s weak corporate governance.
The RBI wants the next generation of banks to focus on rural lending, to promote financial inclusion. However, rural operations are perilous. All government regional rural banks have suffered heavy losses.
Rural operating costs are high because of poor logistics and scale diseconomies (rural deposit accounts and loans are very small by urban standards). Agricultural defaults in many states are high since political loan waivers have encouraged wilful default. Banks find it politically impossible to seize the land defaulters have pledged. So, despite RBI guidelines and directives to state-owned banks on financial inclusion, they have not penetrated the countryside. By contrast, MFIs have.
Historically, MFIs started as non-profit NGOs. They depended on donations for expansion, and so could not grow fast. To expand their reach, many NGOs converted into for-profit Non-Banking Finance Companies (NBFCs). These NBFCs raised equity from various sources. For every rupee of their own funds, they could borrow six rupees from banks. This enabled them to expand fast.
They raised ever-larger sums for every expansion. Today, major MFIs raise hundreds of crores at a time. Till now, private equity players have been willing to provide the money. But SKS has grown too big for this and needs the stock market for future subscriptions. SKS is now bigger than some banks, with almost seven million borrowers, Rs 5,000 crore of loans and 21,000 employees.
RBI guidelines say new banks must have equity capital of at least Rs 300 crore, and no promoter group should have a stake of over 10%. The SKS issue of Rs 1,600 crore shows major MFIs can raise more than enough equity, with a wide shareholder base.
Other MFIs (Spandana, SHARE) may launch public issues within a year. This causes much heartburn among NGOs, who fear the social ethos of MFIs is losing out to commercial orientation. Maybe, but the traditional NGO approach created only small boutiques of rural credit, whereas rural India needs giant networks. Giant networks require massive capital, which can be attracted only by for-profit corporations. Besides, scale economies will permit giant MFIs to lower their interest rates to poor clients.
The RBI has said that NBFCs — like Religare and Bajaj Finserv — can apply for bank licences. But these urban giants lack the rural skills and reach of MFIs.
However, MFIs may not want to become banks. MFIs are free of RBI regulation, and have flourished in the consequent freedom to innovate and expand. The RBI takes ages to approve bank branches, while MFIs open several every month. MFIs have cheap, flexible staff, but as banks they will face high, unionized wages and inflexibilities. As banks, they will have to put 25% of their money into government securities and 6% with the RBI, suffering losses on this count. Political loan waivers could devastate the loan discipline that keeps their repayments today at 98-99%. Some MFIs want to do non-financial things like selling consumer goods cheaply to borrowers, which will be difficult for a regular bank.
However, a bank status will let MFIs accept deposits, hugely reducing their cost of funds. Instead of borrowing from banks at 12-14%, they can gather deposits at 3-6%. This will also help their clients, who want savings avenues. A half-way solution — and an excellent first step — will be to allow major MFIs to accept deposits. This will help lower their lending rates while providing savings outlets to poor villagers.
In the 1990s, several NBFCs went bust and could not repay depositors, so the RBI now bans all NBFCs from accepting deposits. Non-profit MFIs can accept deposits, but not for-profit MFIs, which are formally NBFCs.
This rule must be changed. Major MFIs have an excellent track record in both social and financial terms, and should not be treated like run-of-the mill NBFCs. Rather, major MFIs with equity capital of over Rs 300 crore (the benchmark for new banks) should be allowed to accept deposits. This will immediately improve financial inclusion. And some deposit-taking MFIs may evolve into full banks. That’s the way to go.