Access to Finance for Financiers

dKXGkaWhile enough literature is available pointing out to the lucrative business (and impact) that local financial institutions could target by reaching out to the micro and small businesses in any economy, there is very little written about how these “local financial institutions” can access funding to re-lend to this segment underserved segment. By nature, small businesses are risky and lack of formally verifiable income makes it difficult for banks to lend to small business. To some extent, it is right that banks avoid getting into financing risky business at a large scale given that they risk putting retail deposits at risk in case they build a very risky loan book. This means that there is clearly a need to address the credit needs of smaller enterprises through a network of more nimble financial institutions. In fact, in India some specialised lenders have come up over the years catering to different types of small businesses. Such financial institutions are recognised by the Reserve Bank of India as well.

They reach out to the “lucrative” MSME segment through customised appraisal mechanisms and lending processes and often due to their close ground presence manage to have a fairly good quality of loan book. Higher risk is adequately compensated by higher yield AND additional measures like closer monitoring prevents high default rates. This makes it look like an attractive proposition for people who want to invest (as debt or equity) in such businesses. In fact, a lot of these business have got significant equity interest. And that is where it starts to get interesting.

They have an interesting problem of being able to raise equity while not being able to raise enough domestic debt. A clearer inspection would reveal that the equity raises have largely been from foreign sources and often result in companies facing hurdles around the guidelines that guide loss of shareholding vs FDI amounts invested.

While the debt could have also come in from offshore sources, bringing debt into India from foreign jurisdictions faces lot of obstacles in terms of process (which has become significantly smoother over the years but it still continues to be a pain). These small financial institutions depend largely upon banks for debt funding and banks in India don’t fund anything unless the borrower is large enough or unless they the borrower is classified as priority sector. If a corporate entity doesn’t fall into any of those categories, their growth expectations are doomed because banks just wouldn’t fund.

Of course, banks have their own reasons. Most of these small financial institutions would be less than investment  grade (as per rating agencies) or just about investment grade. “Risking” money in something that the rating agencies don’t call investment grade is criminal in a bank setup.What banks miss though is that there is a way to assess such companies by moving out of the branches and observing the operations of those companies, their people and their practices. A small group of debt funding companies (companies that I have worked for most of my career) understand that and provide funding to such small financial institutions based on strong/relevant evaluation practices. In my experience of working with such companies and debt funding of more than INR 9000 Crores, there has not been a single case of non performing assets, be it in the form of on balance sheet loans or in the form of off balance sheet transactions.

Beyond banks, we also have other sophisticated financial institutional investors who can measure and establish appropriate risk mitigation strategies but even they don’t because the size of funding that each individual small financial institution seeks is not economically interesting. Honest and successful efforts have been made by the organisations that I have worked with to bring larger investors to fund these smaller financial institutions but it still takes a lot of push to make such transactions happen. It is not the norm.

As a result, the growth of new small financial institutions which have the ability to cater to smaller enterprises and customers, enabling financial access for all have been very slow, painfully slow. Entrepreneur interest in setting up new financial institutions to reach out to smaller enterprises and households have waned in spite of all data/reports and literature suggesting that there is a large market to be addressed. The number of new NBFCs coming up in the Indian market have slowed down in the last 2-3 years. The only ones who continue to move ahead are the ones with significantly large equity backing. Crossing the Chasm before success is dependent entirely on equity.

A portfolio size of INR 100 Crores in portfolio outstanding seemed to be like something that could garner interest of banks. Such a portfolio size could also give rating agencies enough track record to consider a rating upgrade. It seems that the number is of INR 100 Crore in portfolio size is becoming less important now. It is more important to know how much of that INR 100 Crore is funding with equity because more often than not, debt wouldn’t be easy to get for such companies anyways.

In other words, bootstrapping as a strategy to enable access to finance for SMEs in India is a very challenging job! So, banks won’t fund small enterprises because they are small and risky and no body would fund those who can fund small enterprises because they are not large and not priority sector. How do we then make it easier for small enterprise to access debt in India?

Photo Courtesy: rgbfreestock

Also published on LinkedIn.

MUDRA Bank – How will it help?

First things first, a regulator cum re-financier (market player)  is bad design. Period. It leads to moral hazard where the regulator will shape policy to grow only its business. Yes, refinance is business.

But I hear that MUDRA Bank is expected to be a regulator and financier of microfinance institutions and micro-enterprises. Why?

The only other entity with such an entitlement, the National Housing Bank (which is a regulator and refinancier for Housing finance companies and bank housing loans) is expected to lose that status once the long pending NHB Bill is passed in its current form. The bill aims to move the regulatory powers of the NHB to the RBI and let NHB continue to operate as a sector focussed bank like NABARD and SIDBI. Obviously, the law makers realised that regulation and business do not go hand in hand.

That brings me to the second question, NABARD refinances MFIs, so does SIDBI. SIDBI refinances/ guarantees small/micro enterprise finance. So, basically, between the two they pretty much already do what the MUDRA Bank is supposed to do on the refinance side. So, why do we need a MUDRA Bank?  Yes, they don’t regulate. So, to regulate?

When the microfinance crisis broke out, there were discussions of NABARD being made a regulator for the MFI industry but that did not happen, primarily due to the fact that NABARD was actually a refinancier (a service provider) for MFIs and the significant majority wanted NABARD to continue as a service provider and not become a regulator in parts due to the lack of infrastructure and in parts to avoid the moral hazard issue. The only reason why NABARD was brought into the picture was microfinance institutions not only included the RBI regulated NBFC-MFIs but also societies and trusts not regulated by he RBI.  However, NABARD felt that they did not have some of the “missing links to operate in the sector” as a regulator.

What then, will the MUDRA Bank do differently? If the several decade old and experienced NABARD thinks they can’t handle the job, how will the MUDRA Bank manage?

Another interesting proposed change is that the FMC and SEBI are going to be merged, the logic seems to be that financial and commodity markets are, at the end of the day,markets and hence they should have a common regulator because this will streamline decision making and potentially trigger new products. Great!

And there comes my third question, why then are we trying to create multiple entities for microfinance and enterprise finance? Where is the coherence in “strategy”?

Instead of seeding new ideas, would it not be better to energise the NABARD and SIDBI to take the word “Development” in their names seriously for their respective sectors? To adopt innovation and  shake away  some of the bureaucracy that binds them down? To adopt proactive measures to tackle the problem of access to finance for small businesses?

And please, for the sake of humanity, why should a bank promoting entrepreneurship favour only the scheduled castes and tribes? Favour all enterpreneurs, if you can. Nobody does that in our country.

(Edited on 9th March, 2015 to add an article on the same topic by noted journalist/author Mr. Tamal Bandyopadhyay. He seems to point out similar concerns.)

Money comes full circle (?)

(Ramblings below. Just thinking out aloud. Any guidance helpful.)

Currency evolved as a means of exchange of value, an improvement over the barter system. The barter system was in itself an exchange of value but it was not standardised and secondly, because the items exchanged varied from people to people, the barter system did not have the ability to duplicate/compare the value in two separate transactions. It could not “store” value  beyond one transaction. If you duplicated the same transaction in another situation with another set of people it may/may not have the same worth or value. It was each specific transactions that decided the worth of the exchange. The value of a transaction changed with the type of item exchanged and with the demand and supply situation of that item exchanged.

Commodity based currencies were the first to evolve, I guess, gold drops, silver coins, bronze coins. All created by nature and shaped into some form by men and introduced into transactions by a royal order. Standardisation arrived. Now, instead of the individuals deciding the worth of the exchange, the royal authority did.

Then came Central Banks and paper currency backed by gold, silver, etc. Now, instead of a small local kingdom, the value of a transaction was set decided by a Government. It created currency and assigned values based on gold stock available.Then the currency was de-linked from gold.

The Government or Central Bank now controlled the circulation and creation of more currency and hence had complete control over the value assigned to the currency.

With BitCoins, the creation of currency is decentralised to individuals instead of Central Banks or Governments. BitCoins interestingly do not represent a currency but a transaction . The worth of  a specific transaction is decided by individuals in that specific transaction. Its value goes up and down with the demand/supply. Is BitCoin a standardised Barter System with a central register where all transactions are authorised?

Payments, Banking and Cost implications of cash – India

Electronic Payments have always intrigued me. I have written about this in the past. I was reading through a few more documents on electronic payments and read through the Reserve Bank of India Vision Document on Payments. Quite an insightful document in terms of statistics. However, my feeling was it doesn’t quite clearly layout the strategic framework to be adopted for payments in India. SOme statistics from the vision document and some other sources.

 Penetration of banking services
  • Of the six lakh villages in India, the total number of villages with banking services stands at less than one lakh villages as at end March 2011 and nearly 145 million households are excluded from banking.
Penetration of Electronic payment
  • Only 0.6 million of the 10 million plus retailers in India have card payment acceptance infrastructure.
  • Mid-2011, the number of non-cash transactions per person stands at just 6 per year.
  • 32% of e-commerce takes place through the system of “cash on delivery” (COD) NOT online payment.
 Other numbers:
  • The Indian bill payment market is a US$ 160 billion market. Indian households pay on an average 50 -55 bills a year. Among the electronic payments infrastructure, ECS occupies a 50% share followed by cards and bank account funding.
  • It is estimated that Government subsidies alone constitute more than Rs. 2.93 trillion and if these payments are effected electronically, it may translate to 4.13 billion electronic transactions in a year.
  •  The penetration of ATMs is 63 per million population and that of PoS terminals is 497 per million population
 Banking Infrastructure
  • Today, the banking infrastructure in the country consists of 80,000 bank branches, 1,50,000 post offices, 88,000 ATMs, and 500,000 POS machines. Of these, the rural banking infrastructure only consists of about 30,000 bank branches and 1,20,000 post offices. In comparison, there are more than 10 lakh telecom retailers that operate throughout the country.
  • 18 million outstanding credit cards and 228 million debit cards.
 How much cost does the economy bear to support a cash economy?
Cost of cash to the economy is 5-7% of GDP.
-costs for rbi  include printing currency, currency chest management, and wear and tear
-cost for bank include cash logistics, cash management, security, storage, and the opportunity cost of idle cash in branches and ATMs

Pricing: Loan against property v/s home loan

Simplified Definitions

Mortgage Loan/Loan Against Property (LAP):A mortgage loan is given for an open end use and is given against the lien of a property.

Home Loan: is given for a restricted purpose of buying/ constructing a house to stay.

Typically a mortgage loan is often the most common way of raising funds for growing the business. Banks typically get comfort from the availability of fixed collateral to be able to recover from in case of loan default.

The rate of interest charged on a Loan Against Property is higher (much higher) than a Home Loan.

Historically, default rates of LAP (for business purposes) have been high justifying a high rate of interest.


Question 1: Is the assessment of loan eligibility for LAP done assuming that cash flows from the business will grow due to utilisation of the funded amount for capex/WC use? If that is not the case, why would the default happen?

Question 1 a.) why can’t we give the loan based on existing cash flows?

People say that the loan size would be too small and not meet the requirement for the capex. My comment on that response would be “Oh common! let’s grow step by step. Give me some other reason”.

Question 2: Why doesn’t the “emotional attachment” story that works in case of home loan doesn’t work for LAP?

Question 2. a.) Does the person seeking a LAP have multiple properties and so property offered on mortgage has lesser “Emotional attachment”?

Guess so.

(Also, the question is how enforceable is the mortgage? In a lot of cases, especially developing countries, legal recourse may just be too cumbersome/ inefficient. So, isn’t the collateral acting more as a deterrent. I guess it is.)

Question 3: Would a LAP given based on existing cash flows AND after taking the owners current residential home as collateral completely change the loan performance?

That is what a number of financial institutions are now trying out with the lower income/informal sector entrepreneurs. Assess loan eligibility based on current cash flows and take the residential property of the entrepreneur as collateral. However, the interest rates continue to be higher going with the notion that LAP has generally resulted in high defaults. Interestingly, last 3 year’s history in these kind of loans show very low (between 0.5- 1 % delinquency in the 90 days past due bucket). Off course, three years is not enough time but these 3 years have been the roughest phase for business in India in general as well. The other key reason for good portfolio performance could be that this type of lending is new and the good quality selection could be due to the initial “start-up precautions” taken by the financial institutions starting this product.

Assuming loan performance does show improvement in this kind of loans, is there a reason to suggest lower interest rates and hence greater affordability?

At last but very important, one oft stated reason for low home loan interest rates is that the purchase of home does not generate additional revenue but LAP for small business does and hence the borrower can pay a premium. For all practical purposes, this reasoning silences all the discussion and the confusion around the pricing by simply stating that the lender wants his pound of flesh! That’s all!

What do you think?

Housing and Housing Finance (Part-3)

In addition to the points discussed in the earlier post, there are a few other key elements that go a long way in ensuring access to finance. Two major aspects are discussed in this last post of this series.

Credit Infrastructure: In addition to the above, comprehensive credit information systems, reliable information on house transactions and prices and mortgage registries improve transparency in the process of credit evaluation for housing loans and thereby improve the ability of housing finance companies to build a less risky portfolio.  Interestingly, a lot of work has been done in these spaces over the last couple of years. Significant growth in borrower information in credit bureau databases and mortgage registries like CERSAI as well as measures like the RESIDEX are great beginnings.

Customer Protection: While all of the above are important in increasing the flow of credit to the lower income or informal sector households, an associated issue is that of customer protection. A robust financial architecture is built on strong customer protection norms and this can be achieved only if the originator is directly liable for the appropriateness of the financial product being sold by them to their customer. This becomes all the more important in the case of the informal sector and lower income borrower because the cash flows and risks faced by such a borrower are very different from a standard salaried home loan customer.

At this point of time, all of us in the financial sector need to take a hard look at the issue of customer protection and frame appropriate guidelines for the same. Regulators are best placed to initiate such measures which look at a shift from the conventional financial literacy and disclosure based approaches of customer protection to a more involved engagement of the originators, where they take responsibility for ensuring the right housing finance product is offered to each class of customer.

(While thoughts are mine, I can’t deny that a lot of these thoughts have been shaped by the organisation I work for. I owe a lot of the thinking to IFMR Trust. IFMR Trust does extensive work in the access to finance space and has built several high quality institutions that enable access to finance.)