Currently, there are about 800 MFIs and 22 lakh government-backed self-help groups (SHGs) that are the principal sources of microfinance. The latter is typically an informal association of 10-20 poor women who contribute small amounts into a savings pool. After saving regularly for six months, lending small amounts and maintaining accounts, an SHG becomes eligible to be 'linked' to a bank, which opens a savings bank account for the SHG and offers loans up to four times the group's savings. The SHG can then on-lend the money to its members, helping them to engage in some income generation activities. The MFIs, on the other hand, comprise a mélange of NGOs, NBFCs, Section 25 companies (which are treated as charities that cannot distribute profits to sponsors), and cooperatives (like SEWA in Gujarat). Unlike the SHGs, which tap funds from public sector banks, MFIs draw their capital mostly from private banks, SIDBI, and foreign investors. (Akula's SKS, for instance, has Silicon Valley venture capitalist, Vinod Khosla, as one of its investors.) Currently, the average loan size for an SHG is less than Rs 4,000 and for an MFI, about Rs 5,000.
... Clearly, there's a problem with the cost structure. And, unfortunately, a large part of the problem can be attributed to the absence of a proper regulatory framework. For instance, MFIs, unless they are mutual- or member-owned outfits, cannot collect savings as deposits, which are one of the cheapest sources of funds. Instead, they must depend on bank borrowings for lending onwards. Says SKS' Akula: "If we are allowed to take deposits, we would be able to slash the interest rates on our loans by about 5-6 per cent."
As a result, Indian MFIs have the highest financial expense ratio (8.5 per cent) in the world. So, how have the MFIs been able to grow at a furious pace? Thanks to private banks, which initially started lending to them to meet their priority sector obligations, but soon realised that microfinance could be a lucrative segment. Says J. S. Tomar, Managing Director of Varanasi-based Cashpor Micro Credit, which operates in eastern Uttar Pradesh and Bihar: "Banks see a huge market in micro-borrowers in rural areas because the urban markets are becoming increasingly competitive." (That also explains why VCs such as Hyderabad-based Bellwether, Mauritius-based Lok Capital and us-based Unitus Equity Fund are investing in MFIs.) ICICI Bank, for example, has funded more than 100 MFIs with an exposure of Rs 2,350 crore.