The rise and fall of India's little loans

India Dispatch: Authorities in India act after lenders are accused of exploiting the poor with high interest rates in microfinance.

Microlenders in India have been criticised for earning huge profits at the expense of the poor. Danish Siddiqui / Reuters

MUMBAI // Within 10 months, SKS Microfinance, India's largest and only listed microcredit company, went from rags to riches to rags.

The valuation of the company, which began operating in 2003 with capital of 100,000 rupees (Dh8,214), soared to 100 billion rupees last July after its initial public offering, which attracted heavyweights such as the US billionaire investor George Soros and Narayana Murthy, the founder of Infosys.

"For an investor, this is a hugely profitable business," the chairman of SKS Vikram Akula said at the time, lauding his company's business model of offering small loans to vegetable hawkers, weavers, potters and seamstresses without collateral in rural India.

"We want investors to continue putting more and more money into the hands of the poor," Mr Akula said.

But just months after his statement, the flow of money into the company slowed to a trickle.

On Friday, SKS reported a loss of 697.7 million rupees for the fourth quarter that ended on March 31, down from a net profit of 628.9m rupees in the same quarter last year. Total income fell 33 per cent to 1.9bn rupees from 3bn rupees last year. The share value has been falling since Friday and the company is now valued at less than 20bn rupees.

SKS's fortunes, and those of other microlenders, went into reverse last October when the southern state of Andhra Pradesh - home to the industry's largest market - introduced tough regulations for the sector after a spate of suicides by borrowers who had accused microfinance institutions (MFIs) of charging high rates of interest and using strong-arm tactics to recover money.

Microfinance companies in the region were accused of earning enormous profits at the expense of the poor.

Among the restrictions the government of Andhra Pradesh imposed was a ban on weekly debt payments, a move MFIs say has severely affected loan recoveries and dented their profitability. Some of them have had to postpone indefinitely their market listings.

Last week, the Reserve Bank of India also capped microloan interest rates at 26 per cent.

"The new guidelines give much-needed regulatory clarity to the microfinance sector and represent a big step forward in putting the microfinance industry on the path to recovery," says Alok Prasad, the chief executive of the private regulatory body Micro Finance Institutions Network.

"The government has taken a balanced and calibrated approach towards the evolving policy framework for the sector."

But in light of the new regulations, many in the industry are pondering whether the business model of this once-thriving sector is broken.

"Regulation is fine but profitability of this flourishing industry cannot be destroyed," says Raghuram Rajan, a professor at the University of Chicago and a former chief economist of the IMF.

SKS says the regulations introduced in Andhra Pradesh are encouraging borrowers to default wilfully.

In the March quarter, bad loans cost the company 1.06bn rupees compared with 148.2m rupees in the same quarter last year.

JPMorgan has forecast a net loss of 7bn rupees for the company in the current financial year. On Monday, Credit Suisse downgraded the company to "underperform" from "outperform".

Crisil, a ratings agency based in Mumbai, says an industry-wide slowdown is imminent because of the stringent regulations.

"Growth is likely to remain subdued over the medium term, especially in regions with high microfinance penetration," said Rupali Shanker, the head of the financial sector and ratings division at Crisil. "This would provide an impetus for consolidation in the sector."