Many of India’s microfinance institutions are facing financial challenges in on-lending to their clients following the Andhra Pradesh Government crack-down on microfinance institutions in the state last year. While larger institutions have started lending again, lack of funding to smaller institutions, which generally have higher operating costs, has proven difficult to carrying out operations. By Anurag Kotoky

NEW DELHI, March 15 | Tue Mar 15, 2011 9:49am EDT

(Reuters) – Six months after the state of Andhra Pradesh slapped restrictive laws on India’s microlenders, availability of funding continues to plague the once-thriving lenders to the poor despite official encouragement.

Confidence building is needed to revive financing for microfinance operations, said Mathew Titus, executive director of Sa-Dhan, an industry body.

“You need somebody to step up and say the industry is fine,” Titus said on the sidelines of a conference organised by Sa-Dhan, which represents about 250 non-profit Indian microlenders.

The industry suffered a setback last year when Andhra Pradesh, which had the largest microfinance market in India, enacted legislation to regulate the industry following complaints about high interest rates, aggressive recovery practices and overextended borrowers.

Since then, India’s central bank and finance ministry have sought to allay concerns and encourage funding.

While some lenders including state banks and investors have resumed lending, a lack of funds has hurt smaller institutions, which typically have higher operating costs.

“Funding is the biggest problem. The cost of delivery is too high due to communication problems, and weekly repayment schedules,” said Biplab Saharia, who manages loans for Satra, a non-profit that serves far-flung customers in the northeastern state of Assam.

However, investors remain wary and borrowers are confused about the future of microfinance, which has attracted for-profit players into an industry that some critics argue has strayed from its social mission to help alleviate poverty.

Loans in India’s $4 billion microfinance sector average about $150, and are mostly to women.

Jayant Sinha, chief general manager of State Bank of India (SBI.BO), India’s largest lender, said banks need to exercise caution in lending to microfinance firms.

“We have to be careful … ultimately we are responsible for our lending,” he said.

The reluctance of domestic lenders is a deterrent for international investors, said Richard Weingarten, managing director of the Norwegian Microfinance Initiative, an investor in Indian MFIs.

“One of the biggest concerns is lack of liquidity from banks,” he said.

An uncertain regulatory outlook has also hurt the industry.

A panel appointed by the Reserve Bank of India recommended that a separate category of non-banking financial companies (NBFCs) be created in the sector and regulated by the RBI. Non-profit MFIs would be regulated by a separate institution.In the latest budget, the finance minister proposed to set up a 1 billion rupee ($22 million) equity fund for the sector and a 5 billion rupee fund ($111 million) to promote women’s self-help groups, solutions critics say are well-intentioned but inadequate.

Some in the industry have also called for financing options in case traditional lenders shun the industry.

“We should look beyond PSLs (priority sector lenders), and look at securitisation,” said Samit Ghosh, CEO of Ujjivan, a large for-profit operator based in Bangalore.

Shares of SKS Microfinance (SKSM.BO), India’s largest and only publicly listed MFI, have fallen by more than half from their peak after a hugely successful public offer last August.

The RBI’s decision on the panel’s recommendations, which industry participants expect will determine the sector’s future, is expected by the end of March.

(Writing by Arjun Kashyap; editing by Tony Munroe)