Equity & Leverage in Indian MFIs

This technical note aims to provide a practical understanding of the need for equity to improve the resource position of MFIs. The note discusses:

• Equity and the importance of financial leverage and states that financial leverage can magnify return on investments;
• The financial leverage of Indian MFIs, arguing that:
  • Indian MFIs have used financial leverage to increase outreach and improve performance;
  • Equity is being eroded by operating losses.
• MFIs' sources of funds, opining that:
  • Indian MFIs are over-leveraged because of operational losses or having accumulated debt in excess of prudential norms;
  • Increasing proportions of MFI portfolios are becoming "off-balance sheet" items, increasing the actual debt-equity ratios to astronomical levels.

The note provides a "dynamic analysis" of the issue and presents the trend in the capital adequacy ratio for 15 of India's leading MFIs. It finds that:

• The following factors influence leverage:
  • Profile of the promoters;
  • Size, growth rate and legal form of an MFI.
• The lack of a market for MFI equity calls for the development of innovative instruments for investments in microfinance;
• There are many constraints to the flow of funds for microfinance, such as:
  • Strict capital requirements;
  • Regulatory restrictions, etc.

The technical note concludes by calling for the formation of an "Equity Fund" to promote the activities of MFIs in India.