Ed: Is Yes Bank doing right in recalling loans to microfinance institutions?


Microfinance Focus, December 27, 2010: Receiving yet another blow, the aggrieved microfinance institutions are now being asked by private sector lender, Yes Bank to pay back their loans by the year end. According to a Livemint report, the Bank has sent notification to MFIs seeking a recall of around Rs 100 crores of loans which it has advanced to them.  YES Bank however declined to comment on its move citing client confidentiality.

Oddly enough, Yes Bank’s decision to recall loan has comes after a recent Reserve Bank of India meet with the bankers where RBI urged banks not to choke lending to microfinance institutions. The RBI said that microfinance is an important sector for the growth of the country and banks should continue lending to it.

Exhibiting low confidence on sector’s performance even outside of Andhra Pradesh, Yes bank has sent notification to microfinance institutions which are operating outside AP and have not been radically affected by the microfinance ordinance which was issued by the state government two months ago.

Bangalore based Ujjivan Financial Services and Chennai based Equitas Microfinance for instance have been asked to pay back their loans by December 31 along with few other MFIs according to media report.

Yes Bank started lending to microfinance sector in the financial year 2007 and as on March 2010 it was lending to 17 MFIs and was planning to lend to 20-25 MFIs by the end of this year. However, the bank seems to have taken a U-turn post promulgation of microfinance ordinance in Andhra Pradesh.

Microfinance institutions till now were benefitting from the priority sector status and availed banks loans at concessional rates. According to a Morgan Stanley report, banks contributed almost 80% of the money lent by microfinance institutions to poor customers and Yes Bank in particular had a total exposure worth Rs. 450 crores to the microfinance sector as on November 2010.

Earlier this year, RBI even recommended withdrawing priority sector status of microfinance. Most private and foreign banks use this facility to fulfil their priority sector lending targets. However, sensing an opportunity to boost profits in this form of lending, many banks have been very aggressive in their lending to MFIs. The competition that followed among bankers to lend to select few profitable and professional MFIs has helped some of these institutions to raise funds at competitive rates besides bargaining power, the RBI report stated.

A top-rated MFI can raise funds from banks at close to 12-13% or a little higher. However under the present circumstances, when the future of the industry looks bleak, banks can deploy funds on promising and even higher yielding assets where the rate of interest is even higher.

The RBI-Bankers meeting that was held last Wednesday in Mumbai generated a lot of hope among microfinance practitioners who are reeling under liquidity crunch due to reduced banks lending to the sector in the wake of the Andhra Pradesh microfinance crisis.

During the meeting, the banks were of the view that while the structural issues regarding the MFI sector may be addressed by the RBI’s Malegam Committee, some interim measures may be required to address the gap between the recoveries by MFIs and their payment commitments to banks. The banks stressed on the need to work out an interim arrangement involving, inter alia,  rescheduling of exposures to MFIs subject to certain covenants such as MFIs agreeing to reduce their leverage and growth projections.

As far as at the banks’ exposures to MFIs were concerned, the MFIs had so far been able to meet their repayment obligations to the banks till November 2010. However, going forward this may be a matter of concern and has become a cause of unrest amongst the bankers.

Banks who till recently were lining up to invest in microfinance seem to have lost confidence in the sector and are in a hurry of find exits. Yes Bank’s move to recall loans can further trigger instability in the sector whose funds are already drying up. A wait till Malegam Committee comes out with a report on the sector could be a wiser option.


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In response to Pratap Singh's

In response to Pratap Singh's view on employees of MFIs to consider this crisis as part of their learning....Part of learning what??? This is the fulcrum of the industry. In the personal loan industry the Banks could come back strongly on their defaulting borrowers by atleast taking them to court. In the MFI industry the Center Manager is the only connect with the Group and once this connect is broken, the MFI will not be able to collect the money lent. The decision to retrench is a forced one. During the recession, there were many banks who had to retrench their employees, but very few of them really lost the battle with the defaulter. The employees too had a reasonable bank balance to take care of themselves for the next 6 months and now they are back with a vengeance. However, the MFI employee is a profile which lives hand to mouth just in the same manner as in case of their customers. These guys are out and buried if they lose a job. Learning not at such a cost.

only way for banks to control losses is through joint action

In response to Pratap Singh - the suggestion that there is minimal difference between stopping new lending and pulling out existing loans is strange. Yes, stopping lending is putting strain on MFIs. For those who have near-term cash-flow issues, it can seriously squeeze liquidity, and may certainly undermine portfolio quality. I am not out to support the banks' current stance either, though in the absence of clear policy guidance, it's surely understandable.

But there is a world of difference between a group of lenders acting in concert by cutting off lending and a single lender acting on its own and calling its loans. What Yes bank has done is throw down the gauntlet to other banks, all but challenging them to doing the same. And if they follow, the result will be immediate bankruptcy of the MFIs, which will in turn show up as huge losses to the banks.

Whether you support the MFIs or not, the only way for banks to control their losses is through joint action. The result of everyone for himself would actually be the opposite -- it will maximize losses for all. This is basic economic game theory that any banker worth his salt should know. Yes Bank obviously doesn't.

what is the line of thought at YES Bank

The entire MFI industry would have appreciated and backed if YES Bank had taken the lead in engaging in dialogues with the Government and RBI instead of announcing one of the worst strategic decisions of Indian Banking history.

These are trying times for the MFI's and I just don't understand k. With MFI's facing a huge liquidity crisis, I don't see any MFI acting upon this callback of loans. It looks to be anti "sustainable banking" which YES Bank has been priding itself under.

Gold Loans is the next

while Yes bank's loan recall is known in public domain - I am sure similar action wd have been taken by all lenders - anyway further stoppage of lending was almost instaneous post Andhra Govt ordinance news was out - so there is absolutely no difference between the actions of various lenders except that some having lower appetite have gone a step further to recall part loan while others have stopped & waiting for things to unfold. Either ways the situation is grim, further lending is stopped - customers are suffering for credit & due to some misguided customers not willing to repay - MFIs are suffering on account of low collection efficiency & hence likely default on the repayment. Employees being part of the MFIs network will have to take this as a part of their learning - many will choose to move out & those stays post tough times will come out much stronger on both learning & ability to deal with similar situations in future.

Like any other industry MFI have few very serious players working for a cause & there are others with short term gain.

Like the Personal Loan industry that faced a similar situation due to unwarranted settlements drives MFI's current phase is no different & there is absolutely no point rationalizing the irrational thoughts & actions.

Next 2 years will be tough till such time grain is segregated from chaff & both lenders as well as customers need to have patience.

MFIs working for a cause & those having patience will be able to survive & come back even stronger while the weakers ones & with short term vision will get eliminated in due course.

So irrespective of a particular Lenders action of recall or no recall - cycle has to get completed & it will take a while before normalization.

Next similar cycle will come to the Gold loans- wherein sameheard mentality is working wiht lot of players wanting to start Gold Loans - so do not get surprized to see similar cycle for Goldloan industry.There are players who are serious & there are few with objective to make money - but customers, employees as well as institutional lenders are same - so watch out for the next similar action shortly.

I beg to differ

I beg to differ on the observations made by Mr. Jaggarao Malipeddi. Yes Bank knew all these operational aspects before lending. Does it mean that they did not do due diligence before taking this call? The Banks took the easy route to lend and 85% is Bank money, is very much true but this is more or less the same in any industry. Equity always comes at a higher cost and ROE of 35% is very much acceptable considering the risks which the investor takes. Is it any different from the PEs who invest in Banking sector? Banks are allowed to leverage even higher and again who is questioning their intent as to which sector they lend? Whether that sector is ethical or not? Does anyone really bother? That is also public money, is it not? It would be inappropriate on my part to compare the greed in the organized sectors vs the greed in Micro credit, there should always be a social cause attached to it. But when it comes to Banks recalling loans when there is a struggle happening in the segment, it seldom hurts the MFI promoters or the PE, it hurts the end customer rather badly as suddenly there is complete withdrawal of Credit for them. One should also understand the deep trouble which the families of many MFI employees are facing now, it is rumoured that one of the largest MFIs in the country has retrenched about 3000 employees. By doing this YES Bank has actually created a sub-prime situation and it will have a catastrophic effect on the Banking system sooner than later.

There is lot of change in the

There is lot of change in the ground realities in the functioning of MFIs especially in Andhra Pradesh. The recent analysis brings out the following mal-practices contributing for the present state of affairs.

The for-profit MFIs invite private capital to build an equity base. They then leverage this equity to borrow from banks up to 6 times the capital for purpose of on lending activity. The private equity is only 15% of money lent to the sector. The other 85% comes from Banks which are depositories of public money. With Banks having to lend 40% of their portfolio to the priority sector and preferring the indirect mode , this is easily done. End up with a return on equity of 35% and invite more private capital in the name of scaling up. As a result of this, private capital recovers its investment in 3 years and all that is left in the cycle is 100% public money from Banks. Private capital is the mainstay of drive for profits which has led to the current crisis. The earnings of MFIs can be classified a) Interest, b) Loan Processing fee, c) Cash margin d) Commission from value added services like insurance, capacity building, technical guidance.
The interest rate charged by some MFIs are on flat basis. They also calculate or compound on daily, weekly or monthly basis. Thus a nominal rate of interest without the qualifications of how it is calculated, does not reveal the real interest rate. In effect it becomes exorbitant. They include the operational cost interest rate. In such case why they should charge separate processing fee? When they extend repeated short terms this fee becomes attractive revenue for them. These repeated loans are extended for non-productive purposes which include for repayment of overdue loans. Another peculiar practice is cash margin. Some MFIs insist deposit of 10% of loan to treat it as equity contribiution but they use it as a security deposit at a low interest rate. The accumulation these cash margins again being pumped into market as fresh loans. This will cost more to the borrower and squeeze his working capital (if at all if the loan is for productive purpose). The commission component is considered as another source of income to MFIs instead of extending the value added services for the benefit of the borrower. MFIs are considering Joint Liability as main security. But this is not a sufficient reason for repayment potential. Peer pressure works out in some of cases of willful defaults only. It is only a collateral and secondary to income generated out of the funds deployed. But without a purpose, an activity, a cash flow, loans are given. Thus Joint Liability Guarantee has become primary consideration for extending the loans.

This is the blatant misuse of the system by greedy MFIs. When these factors came out explicitly, the major stake holders the Financial Institutions should made their review and recall their advances to bring back the health to the system. YES BANK is right in its action.

After Yes Bank's move

Sorry to be blunt, but this decision is downright stupid. Indian MFIs are funded mainly by banks. After Yes Bank's move, what should the other banks do, now that their borrowing MFI is facing an even greater liquidity crunch? Should they also ask for their funds back, by Jan 5th maybe? Sure, why not. By January 6 we will have 10 failed MFIs, and the banks will be explaining to their investors why they are having to write off 1% of their own balance sheets...

What Yes bank has done is fired the starting gun for a run on the bank, though in this case it's a bank running on a non-bank. Go figure. The ignorance behind such a move is beyond me. Anyone in microfinance should know -- if a borrower knows she won't get another loan, she'll stop paying her current one. So an erosion in an MFI's liquidity is a recipe for a collapse of its portfolio, which is what hypotheticates the bank loans in the first place. Saving their beards by cutting off their heads. Genius.

Never mind what the MFIs think. Such a move undermines all Indian banks with exposure to microfinance (basically everybody), and I can't imagine that it will endear Yes bank to its competitors or to RBI.

Yes Bank is right

Yes Bank is right in its action. Since lending to MFIs is priority sector lending, banks were crazy and competitive in extending credit to MFIs. When this is not really doing good to the beneficiaries under priority sector there is no rationale in supporting this segment. A strict regulatory system by Central Bank is required to control the situation. The credit institutions can not wait for such actions, as the moment is sluggish in this directions for the reasons best known to the Government. Till then the responsible credit institutions need to exercise caution and review their risk for taking appropriate decisions either to continue the support or recall the advances.

To recall such loans now seems a bit knee jerk

What Yes Bank is doing may quite well be sensible from a pure credit risk management perspective. However, as an institution they are probably being a bit opportunistic because they are merely making a decision to suit their convenience. In the past most commercial banks would headline their lending to MFIs as part of their CSR initiatives, but the decision was probably mainly driven by commercial interests and nothing more. To recall such loans now seems a bit knee jerk.

It all depends on the business objectives of the lende

It all depends on the business objectives of the lender/s. If the objectives do not include a social angle but holds lending to MFIs merely as a financial product, it is only natural that the organisation tries to cover its risk in a turbulent scenario.

If a government appears to be unsymapthetic to the cause, why are we expecting commercial establishments to be otherwise.

And yes, we do not know the compulsions of the lending institution. After all they too are responsible to their investors and depositors.

Moreover, still there could be opportunities for buying time, re-scheduling, re-negotiating terms and so on before really the panic button be pressed.

This is best taken as a method of correction that is taking place. MFIs would do well to provide for such contingencies which in future could be recurring too.

Hemantha Pamarthy
In Individual Capacity

Action is certainly not unusual

What Yes Bank has done is nothing unusal - Any responsible lender would like to protect its interest. Money lend by YesBank also belongs to its stakeholders & they are also accountable for corrective actions basis Early warning & portfolio health perspective. Moreover if local governing councils, regulators as well as customers are not showing any empathy to MFIs & banks - why one specific lender should continue to act like a charitable trust.

I am sure this might not have been a knee jerk overnight action - this must have been the outcome of a continuous discussion between lender & borrower & in line with an absolutely well thought thru strategic direction till such time Govt/regulator as well as end users demonstrate their solidarity to resolve the current crisis.

While only Yes Bank wd be aware of the inside story - however action is certainly not unusual given the mute spectator approach of regulator/govt & delinquent behavior of end customers who have chosen not to repay the EMIs basis misguiding efforts of some vested interest parties.

Another example of knee jerk reactio

Another example of knee jerk reaction, which has the potential to compound the crisis. The present crisis can only be met through a three pronged strategy- a) supportive regulation b) commitment of MFIs to reducing cost by passing on efficiency gains, going back to client relationship in place of pursuing unsustainable growth and adhering to global best practices in client protection and c) continued provision of liquidity by banks. Any chink in either of the three is going to derail the gains made during last 25 years.

One reason to ensure funding to MFIs

One more reason to ensure the funding for the MFI's are diversified. They will face significant risks ahead and managing this is critical for their long term success.

Loan to micofinance companies

I am with Yes Bank and other banks to recall the loan given to Micro finance companies.These loans given by banks and government organizations is diversified , misused and does not reach to actual beneficiary to whom it should go.It is all because this is not backed by any law or regulations which can protect the interest of financing institutions. Thanks G.B.Singh Mumbai EX Banker

Winning the client through business competition

I appreciate your concern. But, i feel to raise some question as you are an ex-banker that what is the alternatives from govt/bank side to cater the loan requirement of these sections... We all know that for more than 40 years, banks and govt are in the business with low interest, huge infrastructure and large human machinery. Despite of that these MFI are prevalent with high interest rate. It clearly indicates about rampant corruption/inefficiency of these institutions. If you calculate the effective rate of interest charged to SHG members through banks it will come more than 60%. Don't surprise. Plz take these factors such as bribes to officials, time lag in disbursement, and n times visit to branch for getting sanction while calculating the effective rate. My only point is that don't try to kill any sector only through legislation/ordinance. You people should also think about winning the client through business competition when you have already so many business advantages with you and also through efficient operational system.

Please clarify the debate

The author of this article has left out crucial data.

It explains that the banks that lent to MFIs "have taken a U-turn".

Can he please add the exact repayment rates of borrowers to MFIs, which in other articles is said to go below fifty to even under twenty %? With such alarmingly low repayment rates and further politicisation of the MF sector, what should a bank do that depends on people's deposits for lending? Should your bank, in which you deposit your money, lend to companies who run a real risk to not pay back their loans or who would need to renegotiate subsidies with government or foreign donors?

Please be clear what a bank should do with Microcredit in India.
Should it continue to be considered a central bank obligation out of socio-political objectives or start a public debate on what Microfinance really is?

Maybe a clear separation should be made between Socio-political Microcredit and Microfinance as a self-sustainable business tool to build inclusive financial sectors comprising financially sound financial institutions?

Until such clarification and choices have been made, these articles add to chaos and hurt the poor the author seem to be so committed about.

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