When the Wall Street Journal starts publishing poorly researched sensational articles about Indian microfinance institutions (MFIs), and senior analysts from major investment banks (MIBs) begin to call Indian microfinance assets “sub-prime”, it is time to try to put things in a proper and long-term perspective. In Hindi, there is a proverb, “doodh ka jala chhach bhi phook phook kar peeta hai”. (A person who has burnt his mouth drinking hot milk, tends to blow even at cool butter milk). The WSJ and MIBs have just emerged from an unprecedented financial meltdown. They are entitled to be cautious, even dark in their forecasts. Let us take their points one by one:

1. Growth rate of MFIs is abnormally high – False - There are several other sectors in the Indian economy which are growing at a searing pace. The number of mobile phones has grown from nil ten years ago to 400 million. The Indian mobile phone market continues to add over 10 million new connections a month. The insurance sector has grown at 37% per annum since doors were opened to private insurance companies. Thus the high growth of the MF sector represents release of demand pent up for decades.

2. Poor households are borrowing beyond their means, due to the easy availability, or even loan-pushing by multiple MFIs – Partly true – This has been a cause of concern, particularly as most Indian MFIs (with three exceptions) use the Grameen Bank weekly repayment model. However, MFIs are learning their lessons quickly and apart from changing internal policies and incentive structures for field staff, are also getting together to establish credit information sharing forums.

3. Portfolio quality of MFIs is deteriorating – False - Though there are some pockets which have seen mass default by a class of borrowers, such as the Kolar district in Karnataka, the overall portfolio quality is being maintained, with loans overdue beyond 90 days at about 1-2%. This number is now much more reliable, because almost all major MFIs have a computerized portfolio tracking system, which is audited by reputed audit firms and is watched like hawks by banks since some part of the portfolio is also assigned to these banks.

4. MFIs are growing way beyond their capability to manage – False - All big MFIs have mastered their methodology. Their systems for, staff hiring and training, customer acquisition, portfolio tracking and fund mobilization is now managed by professionals with financial sector experience. Product diversification has set in, though most are still offering variants of the basic Grameen Bank, weekly repayment loan. Most MFIs have stared offering life insurance linked to loans, and some also stand-alone life and health insurance.

5. MFIs are poorly regulated and weakly governed – False - Most big MFIs are now transformed into non-bank finance companies (NBFCs), registered with the RBI. They are subject to prudential norms that include capital adequacy (10% at present, slated to go up to 12% in April 2010 and 15% in Apr 2011). As MFIs have had to raise capital from diverse sources, they now have Boards which are quite involved with operational oversight.

Having said this, there are several actions that need to be taken. I have classified these into seven levels

• Household level - Need to build greater financial literacy among MFI customers so they know the consequences of over-borrowing and the benefits of savings and insurance in adversity.
• MFI level - Need to review their staff incentive systems and make attempts to correct the same to prevent irresponsible lending.
• Bankers - Need to exercise lenders’ discipline by insisting that MFIs do responsible lending and follow consumer protection norms. They also need to strengthen their monitoring mechanisms.
• Equity Investors - As investors are becoming much more familiar with the sector, they are becoming more realistic in their return expectations. Those investors who sit on MFI Boards must play an institution building role for their own long-term good.
• The Regulatory Level - The RBI has enhanced its supervision of larger MF NBFCs by seeking monthly returns from the systemically important ones, and doing on-site inspections. The RBI needs to simultaneously enhance protection of regulated MF NBFCs from arbitrary action by district and state government authorities.
• The Government of India level - The earlier Micro Finance Bill covers only NGOs and needs to be redrafted. Loan waivers and interest subsidies tend to cause credit indiscipline and distort the market. Instead GOI could offer support to MFIs working in 300 districts with low financial inclusion.
• International level - Finally to close where we began, CGAP, the global microfinance apex body, should educate the likes of WSJ and the MIBs to stop sensationalising small incidents and get on board the one part of the financial sector that is working – microfinance in India!