The Asian Development Bank is establishing a $250 million guarantee fund for loans to microfinance institutions from regional banks. The program would allow the Asian Development Bank to share the default risk of loans to MFIs. The move comes after the microfinance industry, particularly in India, has received negative attention. India’s microfinance institutions (MFIs), under pressure because of stricter rules in their largest market Andhra Pradesh and the consequent slump in repayments there, may get a boost from the Asian Development Bank (ADB).

ADB is constituting a $250 million (around Rs.1,135 crore) facility to offer guarantees against loans to MFIs extended by banks in the Asia-Pacific region where it operates, including India. The move is aimed at encouraging banks to lend more to MFIs.

Lakshmi Venkatachalam, vice-president of private sector and co-financing operations at ADB, said the proposed facility would recompense the exposure that banks have to microcredit lenders—to the extent to which they are guaranteed, if they were to go bad—in return for a fee. The extent of exposure that ADB could guarantee and the fee it will charge will depend on the due diligence of the banks’ credit processes and a thorough assessment of their quality, she added.

The facility will be operative over the next three years. “…A good part of this facility will accrue to India, given the vibrant, upcoming microfinance sector in the country,” she said.

Venkatachalam, who was in Mumbai on Tuesday, plans to meet the managements of several banks to discuss the proposal.

Mint had reported on 29 November that private equity funds with MFIs in their portfolios had been lobbying with international development finance institutions to furnish such guarantees as a measure of comfort to banks, which had stopped lending to them following the crisis in the sector in Andhra Pradesh.

After a spate of suicides among microfinance borrowers in Andhra Pradesh, allegedly due to strong-arm tactics used by some MFIs to recover loans, the state government imposing strict regulations on their functioning in October. As a result, repayment rate fell sharply and fresh business came to a halt.

A panel constituted by the Reserve Bank of India, under the chairmanship of noted chartered accountant Y.H. Malegam, called for a cap of 24% on the interest rate charged by MFIs and a 10% limit on the margins they retain.

“We have been studying the feasibility of such a risk-participation facility even before the crisis broke out and believe that such a facility would help banks increase the headroom for lending more to the microfinance space,” Venkatachalam said. “The current situation, however, will make us very cautious about due diligence.”

ADB’s proposal is a part of its long-term vision of scaling up private sector development and operations, reaching 50% of annual operations by 2020.

India enjoyed the largest share of ADB’s private sector operations as of 30 September, accounting for at least 23% of the total portfolio, or $1.2 billion. The potential financial assistance lined up for private sector development in India over the next two years was pegged at $1 billion by Venkatachalam. A sizeable portion of this amount, about $700 million, would be deployed towards the development of renewable energy, apart from healthcare, education and housing finance.

While stakeholders in India’s microfinance space hailed ADB’s initiative, much will depend on the cost of the guarantee, they said. “The step is most welcome and in line with our requests to other multilateral agencies,” said Vijay Mahajan, president of Microfinance Institutions Network, a lobby of MFIs in India, and chairman of Basix, an MFI. “Lots of lenders that have no exposure to Andhra have suffered collateral damage because of the liquidity crunch and guaranteeing their portfolio would be helpful.”

MFIs such as Bangalore-based Ujjivan Financial Services Pvt. Ltd and Kolkata-based Arohan Financial Services Pvt. Ltd have been facing difficulties in securing bank finance in the aftermath of events that unfolded in Andhra Pradesh, he said.

Vineet Rai, chief executive officer of Aavishkaar India Micro Venture Capital Fund, a microfinance-focused fund, points out that if banks build the cost of such a guarantee into the interest rate charged by them, the activity may become unviable.

“Banks are already lending at around 13-14% to MFIs and if the guarantee cost is passed on, it would make bank funding more expensive. Given a 24% interest rate cap recommended by the Malegam committee, microlenders may find the situation difficult,” he said.

While bankers are not yet aware of the proposed facility, they’re keen to review it. “If such a guarantee scheme comes and we are able to pass on the fee to the MFIs, we will be very much interested in such an initiative,” said a senior official at a large public sector bank. He did not want to be named.

Mahajan said even if the microlenders have to bear a marginal loss in the short term due to the higher cost of borrowing, it would be useful to restart the flow of funds into the sector and “get the business going again”.

Anup Roy contributed to this story.
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