A microcredit business model change that might be crisis ending

The microfinance crisis in the Indian state of Andhra Pradesh has really hurt the reputation and earnings of the lending institutions. In addition, it has cut off the only way that the poor could obtain access to credit.

A new law that is about to be passed in India may help put microcredit back into operation. Before the law takes effect, one of the microcredit lenders has found a little change in the business model that might also help.

From Wall Street Journal, writer Paul Beckett describes the change that the company BASIX is beginning to use.

For the better part of nine months, the microfinance industry has been in paralysis because of restrictions put in place by the government of Andhra Pradesh, the state that was the center of micro-lending in India. Almost immediately, banks turned off the credit tap that allows microfinance lenders to operate, and borrowers abandoned the high repayment rates of the past and stopped paying.
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And Vijay Mahajan, the chairman of BASIX, a company that specializes in micro-lending and other services targeted at the poor, warned that his microfinance operation is on the brink of folding.
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Mr. Mahajan, however, is testing a new business model that may, if it catches on, provide something of a lifeline for the industry though it won’t solve all its problems.

The key move he has made is to establish a business within the BASIX Group that acts as a partner to banks rather than a borrower from banks. This is a tweak that doesn’t necessarily change much on the ground but changes tons in perception and viability. Under this model, the company stops being the originator of small loans to the poor, the definition of microfinance, and instead turns BASIX into a bank agent. Borrowers (BASIX lends to individuals and doesn’t use the group model favored by other lenders) won’t see much difference. They still will interact with BASIX representatives, who will be responsible for originating loans and collecting repayments.

But, critically, the BASIX representatives will be dispensing bank loans, rather than BASIX taking credit from banks onto its books and then assuming responsibility for the loans it issues. The bank will be able to set the interest rate and will pay BASIX a fee for handling the loan.

If the politicians of a particular state don’t like what they see, they will have to deal with a politically-connected, well-established bank — most likely government-owned — as well as possibly the Reserve Bank of India, rather than targeting small, politically lightweight microlenders. For microfinance companies, this model has the added advantage that the bank assumes the risk of default on the loan.

Mr. Mahajan told India Real Time that this bank partnership model represents a “desirable future” for the company. He declined to name the area where the company currently is using this structure (though we might hazard a wild guess) or to name bank partners.

But he said BASIX already has secured approval to lend out $56 million in bank capital. That contrasts with what he says is a total of just $5.6 million in bank loans to BASIX itself under the old model in the months since the crackdown in Andhra Pradesh in October made banks skittish about lending money to MFIs.