It has been a year since the microfinance crisis in Andhra Pradesh, and microfinance institutions are increasingly encouraged to focus on their social objective to serve the poor. Investors remain cautious about promoting rapid growth in MFIs and are increasingly scrutinizing the institutions and conducting social performance assessments as a standard part of their procedures. This can be seen through evaluation of corporate governance standards, internal audit practices, and transparency. Microfinance investor, Lok Capital, for instance has started including a clause for social performance assessment within term sheets itself. These assessments are also often undertaken by independent third parties.

Investors are employing agencies, apart from their own staff, to check whether the poor are the real beneficiaries.

Indian micro lenders, who were gripped by a crisis that began in October last year, are now under pressure from investors not to ramp up growth but to make sure they are sticking to their basic precept of serving the poor.

Microfinance-focused private investors are increasingly making social performance assessment a must for the lenders. Microfinance institutions, or MFIs, provide small loans to poor borrowers. They lend at 24-36% on account of high operational costs, sourcing money from banks to do business.

Investors want to know whether the micro lenders actually benefit the poor, their corporate governance standards, internal audit practices, treatment of employees and transparency of the management in running the firm.

“We are now going into an in-depth operational assessment of these companies. This helps us to see how these firms are actually serving their target customer and not diluting their mission,” said Vishal Mehta, managing director of Lok Capital, which has so far invested around $25 million in nine Indian MFIs. These include Bhartiya Samrudhhi Finance Ltd, Ujjivan Financial Services Pvt. Ltd and Spandana Sphoorty Financial Ltd.

Lok Capital, which typically picks up a stake of up to 35% in MFIs, has $10-12 million lined up to invest in such firms in the next one year, Mehta said. “In the term sheet itself, we have a clause which talks of social performance assessment,” Mehta said. These have to be agreed to before the deal is signed, he said.

Aavishkaar Venture Management Services Pvt. Ltd is also closely monitoring the operations of MFIs to ensure healthy practices.

Vineet Rai, founder of Aavishkaar and Intellecap, which have invested around Rs.200 crore in MFIs, said it monitors the lenders. “We spend a lot of time to understand what the MFI is doing, and do a lot of periodical monitoring,” Rai said.

The move has been triggered by the troubles that have beset the sector over the past year. Andhra Pradesh, which accounts for a quarter of the domestic micro-lending market, passed a law in October last regulating MFIs following reports of coercion in recovering loans that allegedly led to suicides. That sparked the crisis in the then Rs.30,000 crore micro lending sector. The industry is estimated currently at around Rs.20,000 crore.

Loan repayments have since dropped drastically to around 5-10% for most MFIs. Most MFIs stopped giving fresh loans as commercial banks turned off funding.

To keep tabs on MFIs, private investors are employing outside agencies, apart from their own staff, to check whether the poor are the real beneficiaries, investor community executives said.

“Clearly, if one specific MFI lacks on any specific parameter, we ask them to make up that part. If it fails to do that too, we may not go ahead with the plan,” said Mehta of Lok Capital. So far, the fund has conducted social assessment surveys at two MFIs—Ashirvad Microfinance and Satin Creditcare Network Ltd. It’s currently conducting the exercise in four other MFIs.

According to senior executives of Andhra Pradesh-based MFIs, global microfinance data platform Mixmarket has also begun checking social performance parameters of firms.

“They have started seeking information from MFIs on social parameters such as what is the (number of) poor borrowers and the children’s education level of MFI borrowers,” said Kishore Kumar Puli, managing director of Trident Microfin Pvt. Ltd and head of the Andhra Pradesh chapter of the Microfinance Institutions Network (M-fin) lobby group.

In July, Sa-Dhan, an association of about 250 MFIs, asked firms to deal “fairly” with debtors and avoid coercion in collecting dues. It has circulated a ‘code of conduct’ among its members on how to interact with clients.