MICROCAPITAL.ORG STORY: Venture Capital and Private Equity Firms Invest Millions in India, but is there Risk in Microfinance Funding?

According to Arun Natarajan, CEO of Venture Intelligence (a provider of analysis and information on private equity (PE), Venture Capital (VC) and Mergers and Acquisition deals (M&A) in India), Venture Capital firms invested USD 117 million in over 27 deals in India during the six months ending June 2009 [1]. Microfinance Institutions (MFIs) raised roughly USD 68 million in India from venture capital (VC) and private equity (PE) firms in May through July 2009 [2]. While this increase in capital bodes well for MFIs, it brings forth a necessity for greater level of due diligence. According to Deepti Chauhary of Livemint, (an Indian provider of global, financial and economic headline news), such high cash inflows may bring new risk to MFIs such as over-indebtedness and malpractices in pre-loan disbursal [2]. Does this pose a barrier for MFIs to obtain future funding from outside investors?

According to Sa-Dhan, a New Delhi-based industry associate, outstanding debt for microfinance loans doubled from 2008-2009, totaling USD 2.4 billon [2] [5] [6]. In India, the microfinance sector’s rapid growth (with the aims to create a positive social impact for the region) has attracted many private investors, according to Ms. Chaudhary. Spandana Spoorthy Financial Ltd (Spandana) fundraising capabilities is one such example in India of the microfinance sector’s appeal to private investors. Microfinance institution Spandana is close to raising USD 50-60 million through private equity [3]. While Spandana has been aggressive with its fundraising, they are not the only example as rapid growth, attractive returns and double bottom line has grabbed the focus of many VC and PE investors. According to the Mix Market, Spandana’s gross loan portfolio is USD 245.2 million with total assets at USD 359.5 million as of March 31, 2008 [3]. Total Outstanding Borrowers for the MFI is roughly at 1.2 million with ROA of 6.89 percent, ROE at 51.16 percent and PAR > 30, > 90 days at 0.11 percent and 0.02 percent respectively [3].

While VC and PE firms look at the microfinance sector’s as an attractive investment opportunity, some firms express concern that there are significant risks to investing (during this rapid capital inflow) in the microfinance industry at this time. These risks are as follows: 1) loosening of underwriting standards and due diligence resulting in inclusion of sub par borrowers, 2) over-indebtedness as banks and MFIs extend credit to the same target markets and 3) scalability of business resources (in essence, to maintain high credit standards and risk management) may prove to be difficult.

Risk of loosening underwriting standards and due diligence resulting in inclusion of sub par borrowers

Mohit Bhatnagar, Managing Director at Sequoia Capital India, is concerned that with too much cash at hand, MFIs may loosen their due diligence on underwriting standards resulting in over lending to microfinance clients in order to boost their consumer base [2]. In addition, Suresh Gurumani, CEO of SKS microfinance, believes that too much inflow of investment capital may lead to (greater participation and inclusion of sub par borrowers) unplanned micro loans and increased defaults [2].

Over-indebtedness as banks and MFIs extend credit to the same target markets: “multiple lending because of greater capital infusion”

Aavishkaar India Micro Venture Capital Fund has also expressed concern about over-indebtedness as banks extend credit. As banks and MFIs increasing the availability of credit/loans, it may result in a saturated market for certain areas serving the same population. It is difficult to measure the number of MFIs and local lenders that people are borrowing from and some clients may eventually exceed their capacity to pay and walk away from their debts. In the end, over-indebtedness may lead MFIs to reduce their investment operations in certain (at risk) communities. Eventually, over-indebtedness may lead to financial exclusion of an area altogether [2] [7].

Scalability of business resources (in essence to maintain high credit standards and risk management) may prove to be difficult

Bejul Somaia, Managing Director of Lightspeed Advisory Services India Pvt. Ltd. and Venky Nataran, Managing Director of Lok Advisory Services Pvt. Ltd, both believe that such rapid growth of capital inflow poses some concerns for MFIs. The scalability of business resources (maintaining portfolio quality, management structure and credit analysis standards) for MFIs may prove to be difficult without unique product offerings to differentiate themselves from their competitors [2] [8] [9]. No additional information is provided regarding prospective product offerings.

VC and PE firms expect to become even more rigorous in their due diligence of microfinance institutions (and any over-lending that may occur by MFIs to potentially sub-par borrowers in an effort to utilize this inflow of capital and gain greater market share/customer base).

By Zoran Stanisljevic

Additional Resources

[1]Venture Capital firms invest $117-M in India during H1 2009 by Tamil Nadu Chennai, July 21, 2009:
http://www.indiaprwire.com/pdf/pressrelease/2009071529428.pdf

[2] Money Matters “VCs wake up to risks in microfinance funding” by Deepti Chaudhary September 1, 2009: http://www.livemint.com/2009/09/01004231/VCs-wake-up-to-risks-in-microf….

[3] Reuters India “Spandana Spoorthy to close $60 mn Private Equity deal next week” by Akshay Kumar, August 28, 2009: http://in.reuters.com/article/indiaDeals/idINIndia-42053020090828?pageNu…

[4] MIXMarket, Spandana: http://www.mixmarket.org/mfi/spandana

[5] Sa-Dhan The Association of Community Development Finance Institutions: http://www.sa-dhan.net/

[6] http://finance.yahoo.com/currency-converter

[7] Aavishkaar India Micro Venture Capital Fund: http://www.aavishkaar.org/index.htm

[8] Lightspeed Advisory Services India Pvt. Ltd.:
http://lightspeedvp.com/International/India_en-US.aspx

[9] Lok Advisory Services Pvt. Ltd: http://www.lokcapital.com/index.html