Funding Last updated August 2011

MFIs in India rely heavily on local debt funding due to restrictions on foreign investments as well as subsidized local investment by commercial banks under priority sector regulations. From March 2008 to March 2010, there was a 216% increase in lending to MFIs. However, in the last year (March 2010 to March 2011), lending to MFIs declined by 11.6% resulting in a significant decline in the ratio of borrowings to loans in the same period from 85.8% in to 77.9% (See Figure 3). This impacted MFIs ability to expand their loan portfolios significantly. As borrowings constitute a major share of the total MFI assets, a similar pattern of growth during March 2008 March 2010 (203%) followed by subsequent decline in 2010 2011 (5.4%) is evident in the total assets of MFIs. This trend may be attributed to the A.P. crisis as banks stopped lending to MFIs with significant portfolio exposure in that region. Overall, the decline in lending has adversely impacted MFI funding [1]. Figure 3: Funding Structure, medians

Source: MIX Market. Data represent totals. Capital-to-asset ratios (See Figure 3) have been consistent from 2008 to 2011, and indicative of high leverage in the sector. Higher leverage may make it easier for MFIs to satisfy shareholder expectations as well as to provide loans at lower interest rates to their clients. Figure 4: Liability & Equity Structure, Totals

Source: MIX Market, Data Represents Totals Bank lending to MFI and SHGs With an outstanding loan portfolio of USD 6.2B (INR 28,038.3 crore) as on March 31, 2010, the SHG-Bank linkage channel is 2.8 times larger than the bank loans outstanding with MFIs. During March 2009 - March 2010, however, the outstanding loan portfolio of MFIs increased by 102%, while that of SHGs increased by only 23.6%. A similar trend in growth rates is evident in the bank loans disbursed to MFIs during this period. As per the Malegam Committee report, one of the reasons for this increasing dominance of MFIs is that banks find it easier to meet their priority sector targets when they lend to MFIs. Moreover, the SHG program is limited in its capacity to grow rapidly to scale, primarily due to the requirement that monthly savings be made by SHG members for six months before the first loan can be disbursed to the group by the bank it is linked to. Annual Growth Rates of Outstanding Bank Loans to SHGs and MFIs Mar 2009 Mar 2010 Amount (USD Growth Amount (USD billions) (%) billions) Bank Loans Outstanding with SHGs 5 33.4 6.2 Bank Loans Outstanding with MFIs 1 82.2 2.2 Source: Status of Micro Finance in India 2009-2010 (2010, NABARD) Equity Funding In recent years, MFIs have also attracted equity investors and the share of equity in MFI funding increased from 12.8% in March 2008 to 17.7% in March 2010 (See Figure 4), while the actual value of equity more than doubled (106%) from USD 423.5M (INR 1,912.1 crore ) in March 2009 to USD 874.4M (INR 3,947.9 crore ) in March 2010 [2]. In contrast, between March 2010 and March 2011, equity investments grew by only 0.3% to USD 877M (INR 3,959.7 crore). Over 60% of the equity in MFIs is in the form of share capital. Thus,

Growth (%) 23.6 102

investors, and not clients or donors, provide the majority of equity financing to Indian MFIs. This could be partly attributed to the SKS IPO that alone mobilized USD 350M (INR 1,580.3 crore) from the capital market, representing 40% of current equity based funding of the sector. After the success of the SKS IPO, other MFIs such as Spandana Spoorthy and Share also planned to enter the market with IPOs. They deferred their plans, however, due to the crisis in A.P. In late July 2011, L & T Finance Holdings Ltd, an NBFC with microfinance exposure launched an IPO. The company has an outstanding loan portfolio of around USD 45.3M (INR 204.5 crore) in A.P. Given the regulatory constraints on savings mobilization, deposits account form a very small percentage of MFI funding and primarily comprise compulsory deposits tied to the loan portfolio. Financing for MFIs Post-A.P. Crisis The reduction in bank lending to MFIs since October 2010 has had a significant and adverse impact on the sector. While banks have not completely stopped lending to MFIs, there have been instances where they have recalled loans. For instance, in January 2011, Yes Bank recalled loans worth USD 22M (INR 100 crore) made to MFIs. As MFI portfolios contract due to non-repayment of loans and debts mature on schedule, they need re-financing in order to continue lending. As per MIX Market analysis, around 20% to 50% of all MFI debt financing will require refinancing within the calendar year ending December 2011. RBI has permitted banks to offer a Corporate Debt Restructuring (CDR) package for MFIs, where debts of USD 1.4B (INR 6,400 crore) have been re-cast without being classified as non-performing loans. In June 2011, the terms of the CDR were finalized with five MFIs Trident Microfin Pvt. Ltd, Share Microfin Ltd, Asmitha Microfin Ltd, Future Finance Services and Spandana Sphoorty Financial Ltd. The terms of the CDR entail conversion of loans into shares, in case the MFI fails to repay the loan. This has raised concerns among existing investors as it could lead to dilution of their present shareholdings. Recent media reports highlight a funding crisis at Bhartiya Samruddhi Finance Limited (BSFL), popularly known as BASIX, due to an accumulation of bad loans. As of 30 June 2011, BSFLs net worth was USD 28.3M (INR 128 crore) down from USD 50.9M (INR 230 crore) in September 2010. This net worth is expected to completely erode due to accumulated bad loans of USD 99.7M (INR 450 crore), mostly in A.P. Since repayment rates have dropped to 10% in A.P., the only way for MFIs to cover costs would be to lend in other states in India. BSFL has been unable to do so as banks are unwilling to extend further loans to the MFI. Resumption of bank lending to the microfinance sector is likely to be further delayed as the A.P. government has not endorsed the central governments Micro Finance Sector Bill, 2011.

[1] Discussed in detail in the, Financing for MFIs Post A.P Crisis section [2] MIX Market Data